Cyprus readies for rigors of EU

Cyprus is eagerly waiting to join the European Union. This feeling is unmistakable in all contacts one may have on the island, and Finance Minister Takis Clerides could be an unlikely exception. Rather austere-looking – perhaps not surprising for a man who made a career as a chartered accountant and auditor – but a pleasure to talk to, Clerides makes no secret of the Cypriot economy’s «super-weapon»: The recent tax reform, unanimously approved by the House of Representatives, introduced one of the lowest tax rates on company profits, 10 percent, and also the lowest VAT rate in Europe, at 15 percent. Cyprus aspires to become the Ireland of the South in the EU. How ready is Cyprus for EU accession? What does the Pre-accession Economic Program (PEP) provide for? It is very important that the European Commission has applauded our program, which is considered fully feasible. As far back as 1999, we set the target of attaining the Maastricht Treaty criteria and have, indeed, done so earlier than planned. The main goal is to prevent a fiscal deficit and this we will achieve in 2005. Although this year we shall have a growth rate of 2.4 percent – one of the lowest on record – due to the global recession, the indicators of the economy confirm that Cyprus is fully ready to successfully meet the European challenge. Our macroeconomic performance leaves no room for doubt. Our economic growth rate is more than 4 percent on a medium-term basis, higher than any in the 15-member EU. This shows Cyprus is on a course of real convergence with the most developed economies. Our investment rate, at 19 percent of GDP, is also high, and the rate of registered unemployed is just 3 percent. The Cypriot macroeconomic stability is expressed in low core inflation, around 2 percent, the fiscal deficit is less than 3 percent of GDP, while public debt is smaller than 60 percent of GDP. The planned structural changes include the further liberalization of markets and bolstering of competition, the modernization of public utilities that are partly controlled by the State, important reforms concerning the financial sector, institutional adjustments in the labor market and reorganization of the public sector. Have the preparations for the adaptation of the economy to the shock of accession been completed? Cyprus has successfully adopted a policy of gradual adaptation to the conditions of globalization and accession. In the early 1990s, we pushed through the liberalization of commerce in the framework of the implementation of the customs union agreement and the commitments we have undertaken with the World Trade Organization. In the second half of the 1990s we promoted the gradual liberalization of the financial sector (interest rates, foreign investment in Cyprus and Cypriot investment abroad). Presently, the challenge is the liberalization of public utilities, in telecommunications, energy and air transport. The economy has shown adaptability to the changes; this is why I am convinced it is well placed to face the shock of accession. I believe our firms and society have accepted the coming changes, with all their advantages and disadvantages. I don’t believe there will be a shock. Nevertheless, industry and agriculture will face problems. Industry has indeed been affected because we have no raw materials, and it is not industry that can easily compete with the industry of European nations. For this reason, certain labor-intensive industries have lost their competitiveness, because wages are not comparable to those of other countries in Eastern Europe or outside the EU. Such companies, which had no technology but only good owners and salespeople, have no advantages and cannot survive. Tax reform What are the basic points of the recent tax reform? The reform has enabled us to achieve harmonization with the EU as regards indirect taxation and the code of ethics against harmful competition, simplification and modernization, a significant reduction in the tax burden for companies and individuals and, at the same time, social justice. Basic elements of the reform are an increase in the basic VAT rate and other indirect taxes to the minimum levels set by the acquis communautaire, and the use of the additional revenue thereby generated to grant tax breaks and upgrade social policy in favor of the low-paid and pensioners. In this way, we gained consensus at the political level; all parties supported the reform. The introduction of the uniform 10 percent tax rate on profits and the 15 percent rate on dividends will maintain the attractiveness of Cyprus as a business center. What will be the impact of the negative global climate on the Cypriot economy? Cyprus’s economy is small and open, with a strong export orientation, and therefore, susceptible to the influence of the recession. The growth rate will fall to 2.4 percent from a potential 4 percent, the fiscal deficit will rise to 2.8 percent from 2 percent initially. Nevertheless, the consequences are rather limited. The prospects are positive and macroeconomic indicators are projected to improve with recovery in the EU. The growth rate is estimated at 4.3 percent in 2003, inflation at 4.1 percent, core inflation at 2 percent and the fiscal deficit should fall to about 2 percent of GDP. The Cypriot economy has had high growth rates and conditions of full employment for many years. Where does the secret lie? The secret is the combination of many positive factors; the open character of the economy, which means Cyprus is affected by international competition, with firms having to continuously restructure in order to survive; the rational adoption of a mixed market system where the State does not intervene in production but supports the private sector. The maintenance of macroeconomic stability and the relatively high educational level of the people is a factor for success in the present knowledge-based economy. Offshore companies For many, Cyprus is a paradise for offshore firms, with all that this implies. What will change in coming years? It is unfair to present Cyprus as a tax paradise. In Cyprus, the owners of even the offshore companies have always been known to the central bank and paid taxes. There has always been control. Taxation was low, but this was a competitive advantage of the country. We are now implementing all the requirements of the OECD as regards transparency. For instance, the names of the shareholders of offshore companies will be made available to any country that may ask for them. With the reform, the taxation for these companies goes up from 4.25 percent to 10 percent, but the latest indications are that this has not made Cyprus any less attractive for firms with international activities. The dividends of such companies are not subject to tax and will be taxed according to the rates where the shareholders reside. The growth of this sector has helped in the differentiation of the productive base of Cyprus and in reducing the economy’s dependence on tourism. The country intends to remain a sound and reliable business center and has all the comparative advantages required for this.