Morningstar DBRS: Strong revenue growth drives Cyprus’ improved fiscal outcome

Strong revenue growth, mainly stemming from social security contributions and corporate income tax, have been the main driver of Cyprus’ strong fiscal outcomes which have “improved markedly in recent years,” international ratings agency, Morningstar DBRS has said.

The agency said in commentary that Cyprus’ strong fiscal outcomes were a key-driver for the trend change of Cyprus' long-term credit rating to positive on 20 September.

“Fiscal outcomes in Cyprus have improved markedly in recent years. After registering pandemic- related deficits in 2020 and 2021, the general government budget balance turned to surpluses of 2.7% of GDP in 2022 and of 3.1% in 2023,” the Canada-based agency said, adding that in addition to the unwinding of pandemic-related spending measures, this strong improvement was driven by an upswing in public revenues.

According to the agency, nominal tax revenues and social security contributions were bolstered by the economy's strong recovery from the pandemic shock and strong employment growth. In 2022 and 2023, total general government revenues rose by an average of 13.2%, exceeding the 6.8% increase in public spending.”

Moreover, Mornigstar pointed out that government revenues benefitted not only from cyclical tailwinds but also from structural improvements on the revenue side.

“In contrast to most other Euro area countries, public revenues grew at a faster pace than nominal GDP for much of the past few years,” it added, noting that the share of total government revenues in Cyprus rose noticeably from 39.4% of GDP in 2019 to 43.3% in 2023, whereas this ratio remained broadly unchanged for the Euro area.

Furthermore, the agency pointed out that the upswing in income tax revenues was driven by rising corporate income taxes, which accounts for 6.6% of GDP in 2022, up from a share of 5.6% in 2019.

“The increase in corporate income tax revenues resulted not only from favourable cyclical developments but also from a widening tax base as several foreign companies particularly in the ICT sector relocated operations to Cyprus. Over the past few years, the government has launched different programmes including the headquartering policy which incentivise the relocations of business operations to Cyprus through different measures, e.g tax incentives,” the agency said.

The agency also that Cyprus’ financial position of the social security system has been strengthened by favourable labour markets developments in recent years as high employment growth of Cypriot and non-EU foreigners bolstered social security revenues.

The number of contributors to the country's Social Insurance Scheme increased by 11.9% between 2019 and 2023, with “the higher number of contributors relative to the number of beneficiaries is projected to support the financial position of the social security system over the next years.”

Furthermore, social security revenues will continue to be bolstered by regular increases in contribution rates. Social security contributions in Cyprus are currently legislated to increase every five years until 2039 by 1.3% percentage points with the latest increase taking place in January 2024.

The agency notes that over the long-term, the financial position of the social security system will also benefit from the automatic adjustment of the statutory retirement age to changes in life expectancy.