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Briefing No 1
Cyprus and the Enlargement of the European Union

The views expressed in this document are not necessarily those held by the European Parliament as an institution.


II. POLITICAL SITUATION

a) Recent history

Cyprus (a British colony since 1925) became independent on 16 August 1960. The 1960 constitution instituted a presidential republic and a single state in which the Greek Cypriot community (about 82% of the population at the time) and the Turkish Cypriot community (about 18% of the population) shared power on a 70%/30% basis. There were growing differences between the two communities regarding the constitution and the disclosure of the Akritas Plan. Tension was increased by plans to unite the island to Greece (Enosis) or Turkey (Taksim).

There were violent clashes (between December 1963 and August 1964). Political and administrative representatives of the Turkish Cypriot community set up a provisional administration which had no constitutional basis.

In February 1964, the threat to international security prompted the United Nations Security Council to adopt a resolution establishing UNFICYP (still in place) to keep the peace and protect international security.

President Makarios attempted to pursue a policy of conciliation and independence. But the pro-Enosis campaign supported by the Greek military junta led to a coup d'état against President Makarios on 15 July 1974. Following the coup, Turkey carried out a military invasion of the north of Cyprus on 20 July 1974, which it justified under the guarantee treaty. After a second intervention in August, which could not be justified by the guarantee treaty, the Turkish army occupied 37% of the island's territory. A cease-fire was declared on 18 August 1974, confirming the partition of the island. The period that followed was characterised by territorial occupation, loss of life, flight by sections of the population and destruction of the cultural heritage. In November 1983, the illegally occupied zone proclaimed itself the 'Turkish Republic of Northern Cyprus' (TRNC), illegally in the eyes of the United Nations Security Council. Partition of the island thus became a reality.

Since 1964, the UN has been making proposals and engaging in other efforts directed at reaching a peaceful solution; it wants the negotiations to focus on a unified State, i.e. an independent, bizonal, non-aligned federal republic made up of two politically equal communities. So far it has been unsuccessful (see United Nations Security Council resolutions 1179/98 and 939/94).

b) Institutions

Under the 1960 constitution, the Republic of Cyprus is an independent sovereign republic with a presidential system. The President of the Republic, elected for 5 years by direct universal suffrage, exerts executive power through a Council of Ministers which he appoints.

The last presidential elections were held on 8 February (first round) and 16 February (second round) 1998 The outgoing President, Mr Glafcos Clerides, was re-elected with 50.8% of the vote. The turnout was 93.37%.

The next presidential elections will be held in February 2003.

Legislative power is exercised by the House of Representatives, which originally consisted of 56 Greek Cypriot members and 24 Turkish Cypriot members. Since the withdrawal of the Turkish Cypriots from the Republic's institutions, the House of Representatives has functioned with only the 56 Greek Cypriots. The last elections were held on 26 May 1996 (with a turnout of 91.75%).

The results in the last two parliamentary elections (1991 and 1996) were as follows:

 19911996
Political parties%Seats%Seats
DISY (Democratic Rally)35.82034.4720
AKEL (Communist Party)30.6183319
DIKO (Democratic Party)19.51116.4310
EDEK (Socialist Party)10.978.135
ADISOK (Democratic Socialist Reform Movement)2.401.440
New parties
Free Democrats (Ked)  3.692
New Horizon  1.710
Greens  1.000
Independents  0.130
TOTAL 56 56

The next legislative elections are to be held by May 2001.

The current Government comprises DISY (which now includes the former Liberal Party), the United Democrats (EDI), a union of the Free Democrats, Ked, and the ADISOK, formed in 1996, and former members of DIKO. Since the Socialists (EDEK) withdrew in December 1998, the government no longer has a majority in Parliament.

The Cypriot Government ( August 2000)
Minister of Foreign AffairsMr Ioannis Kasoulides (DISY)
Minister of FinanceMr. Takis Klerides (independent)
Minister of the InteriorMr. Christodoulos Christodoulou (DISY)
Minister of DefenceMr.- Socrates Hassikos (DISY)
Minister of Education and CultureMr. Ouranios Ioannides (DISY)
Minister of Communications and WorksMr. Averof Neophytou (DISY)
Minister of Commerce, Industry and TourismMr Nicos Rolandis (DISY)
Minister of Agriculture, Natural Resources and the EnvironmentMr Costas Themistocleous (EDI)
Minister of Labour and Social InsuranceMr Andreas Moushouttas (independent)
Minister of Justice and Public OrderMr Nicos Koshis (DISY)
Minister of HealthMr. Frixos Savvides (independent)

Cyprus is a member of the UN and its agencies, the Non-Aligned Movement, the Council of Europe and the Commonwealth.

c) Current issues

Since the illegal occupation of the north of Cyprus by the Turkish army, political debate has been dominated by this situation and the need for a peaceful solution. The Turkish invasion and the de facto partition of the island had serious consequences which have become permanent concerns:

d) Progress of peace talks

A framework agreement based on a 'set of ideas' was accepted by the United Nations Security Council. A series of 'confidence measures' was proposed by the United Nations Secretary-General in order to facilitate the conclusion of this general agreement, the content of which was accepted by the Greek and Turkish Cypriots in 1994.

Since then, no tangible result has been achieved and the most recent face-to-face talks between the President of the Republic and the Turkish Cypriot leader in July and August 1997 ended in failure.

Many diplomatic approaches have been launched by the UN, the United States and the European Union, including attempts to bring pressure to bear on Turkey, in an effort to change the status quo, which is deemed to be unacceptable. The European Union, for its part, appoints a special envoy under each Presidency.

In the framework of an initiative announced by the Secretary General of the UN on 30 September 1998, the Special Representative of the UN Secretary General established a process of separate meetings with the two Cypriot leaders aimed at finding a basis for a resumption of direct talks. In order to reinforce the UN efforts, the G-8 Summit of Heads of States decided on 21 June 1999 to "urge the UN Secretary General in accordance with relevant UN Security Council resolutions to invite leaders of the two parties to negotiations in the fall of 1999". In the conclusions, it was further stated that both parties should commit to set no pre-conditions, put all issues on the table, negotiate in good faith until a settlement is reached, and take full consideration of relevant UN resolutions and treaties. The Security Council endorsed this initiative by asking the UN Secretary General on 29 June 1999 (resolution 1250/1999) to invite the Greek and Turkish Cypriot leaders to hold negotiations in the autumn.

The proximity talks under the aegis of the UN Secretary General were opened in New York on 3 December 1999. The first round of talks, which lasted until 14 December 1999, was followed by a second round in Geneva from 31 January to 8 February 2000. The third round started in Geneva on 5 July 2000. The talks were suspended on 12 July and resumed on 24 July 2000. They continued until early August and will resume in New York on 12 September 2000. The UN is seeking to upgrade the talks to direct negotiations in the following round. Presently, President Clerides and the Turkish Cypriot leader Mr Denktash (re-elected in April 2000 as president of the self-proclaimed TRNC) meet separately with UN representatives.

The gap between the two sides is considerable: the bicommunal, bizonal federal solution advocated by the UN is supported in principle by the Government of Cyprus; the Turkish Cypriot leadership, backed by the Turkish government, insists that it be granted some form of recognition before direct talks can take place and that a confederation between two equal states should be the basis for negotiations.

The fact that Turkey is now officially regarded as a candidate for membership of the EU (cf. the Commission's second report on Turkey of 13 October 1999) could help to resolve the situation.

Turkey, which was granted candidate country status at the Helsinki Summit, will have to conform to the acquis communautaire, including the CFSP. At present, however, Turkey does not comply with the relevant United Nations resolutions nor with the European Union's position on Cyprus, which advocates a solution based on territorial sovereignty, independence, integrity and unity.

The recent improvement in relations between Greece and Turkey should also offer hope for a settlement of the Cyprus conflict.

Furthermore, the severe economic crisis in the self-declared TRNC could have a positive impact on the negotiations, as a settlement would imply an end to the effective economic embargo on the northern territory and result in substantial inflows of international aid, as well as increased tourism and trade.

On 15 June 2000, the UN Security Council extended the mandate of the UNFICYP (United Nations Peace Keeping Force in Cyprus) for a further period of six months, until 15 December 2000. In retaliation, the Turkish Cypriot leaders announced on 29 June 2000 a set of measures against the operations of the UN force in northern Cyprus, which have led to a renewed deterioration in relations.

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III. ECONOMIC SITUATION

In its report of 1998 on Cyprus' progress towards accession, the Commission confirms the ability of Cyprus' economy to adjust to the challenges involved in adopting the 'acquis communautaire'.

In the report of 13 October 1999, the Commission indicates that Cyprus is a market economy.

While Cyprus' economy is growing rapidly and inflation is under control, there are difficulties arising from macroeconomic and fiscal imbalances.

The Commission recommends that Cyprus speeds up privatisation and promotes the competitiveness of banking.

a) The state of the Cypriot economy up to 1998

Cyprus is classified by the World Bank as a high-income country. The per capita income has reached the level of $ 13 000.

The real growth rate of GDP during 1993/97 reached 3.4% on average per annum (with a drop in 1996-1997). The major contributor to growth was the service sector, the share of which in GDP exhibited an upward trend and reached 73% in 1997, compared to 67.5% in 1992. In contrast, the share of agriculture and manufacturing sectors in GDP exhibited a downward trend, from 6% and 14% respectively in 1992 to 4% and 12% in 1997. Growth in 1998 reached 5%.

In the labour market, unemployment has remained low even among groups which are considered vulnerable, such as the young, higher education graduates, women and older people (since 1996 the rate has ranged between 3.1% and 3.4%).

The full employment conditions led to tightness in the labour market, particularly during the early nineties, and exerted an upward pressure on wages. As a consequence, nominal unit labour costs rose by about 5% per annum during 1993/97, compared to about 1.5% on average in the EU, thus eroding cost competitiveness, which has mostly affected the primary and secondary sectors and tourism.

Inflation rose from 2.6% in 1995 to 3% in 1996 and 3.6% in 1997. This rise is partially attributed to the increase in world oil prices during this period and a severe drought in Cyprus, which exerted upward pressures on prices of agricultural products. Inflation fell to an average of 2.2% in 1998 , as oil prices fell.

Fiscal policies have been generally geared towards maintaining macroeconomic stability. Recently, however, the budget deficit exhibited an upward trend, reaching 3.4% in 1996 (from 1% in 1995), 5.1% in 1997 and 5.6% in 1998, diverging temporarily from the respective Maastricht convergence criterion. Public debt also increased from 51.9% of GDP in 1995 to 55.5% in 1997 and 59.7% in 1998. These developments are attributed, inter alia, to the slow-down of economic growth during 1996/97, that affected public revenues, the loss of revenues associated with the dismantling of import tariffs in the context of the implementation of the EU-Cyprus Customs Union Agreement, and the expansionary fiscal policy adopted by the Government. The latter was considered necessary to address the problems arising from the killing by the Turkish occupying forces of 3 Greek Cypriots in August and September 1996, which affected the investment climate and revenue from tourism, as well as the worst drought of the century, lasting for three years, which adversely affected agriculture.

b) Economic policies and recent developments

The basic objective of macroeconomic policies in Cyprus is to maintain conditions of internal and external macroeconomic stability, thus creating an environment conducive to achieving sustainable growth. The quantitative targets of the Government Strategy Development Plan for the period 1999-2003 take into account the constraints facing the Cypriot economy, as well as the Maastricht Convergence criteria.

The Government of Cyprus is promoting structural reforms in the fiscal, financial and trade sectors and in the labour market (incomes policy), with a view to reducing market rigidities and improving the allocation of resources in line with the comparative advantages of the economy.

- Fiscal policy

The Government of Cyprus recently prepared a fiscal package which, justified by the overall situation of the economy since the end of the first half of 1997, intended to reverse the fiscal imbalances of recent years. The objective of this programme in quantitative terms is to contain the fiscal deficit below 3% during the next five-year period. According to this scenario, public debt is projected to remain below 60% of GDP.

The fiscal programme contains measures both to restrain public consumer expenditure and to increase public revenue. On the expenditure side, the most important measures are a two-year freeze in the creation of new posts in the civil service, the abolition of one third of those posts in the civil service which become vacant during the next three years, the containment of increases in civil servants' wages and salaries and overtime work and a 10-15% reduction in other public expenditure.

On 25 May 2000, after a two-year delay, the House of Representatives finally approved an increase in the standard rate of Value-Added Tax (VAT) from 8% to 10%. However, the bulk of the extra revenue raised, estimated at CP 60 million (US $ 100 million) per year, will be offset by lower taxes and higher social welfare benefits for low-income groups, worth an estimated CP 47 million, which the government had to agree to obtain the backing of the House.

The Finance Minister, Takis Kleridis, is confident that revenue from other indirect tax increases approved at the end of 1999, tighter expenditure controls and improved tax collection will keep this year's budget deficit below 5% of GDP. However, the government, which does not have a majority in the House of Representatives, continues to face strong opposition to measures aimed at reducing the fiscal imbalance and will probably have difficulty tightening up policy before the 2001 legislative election.

The financing of fiscal deficits is also being gradually harmonised in accordance with the provisions of the Maastricht Treaty. In more concrete terms non-bank financing, through money creation, has been reduced significantly during 1995/97 and it will be abolished completely before accession.

- Monetary policy

In the financial sector, significant steps towards liberalisation and structural reform have been undertaken in recent years. Since January 1996, the Central Bank of Cyprus has introduced a new framework of monetary policy implementation, which is based on modern indirect methods of monetary control, instead of the direct control methods (minimum liquidity ratio, credit control etc.) hitherto used.

In parallel, the Government of Cyprus is proceeding with the liberalisation of capital inflows and outflows. Restrictions on current transactions and foreign direct investment in Cyprus are being gradually phased out, while investment by Cypriot entrepreneurs abroad is, under certain circumstances, encouraged. Further steps towards the liberalisation of capital inflows and outflows are conditional on the liberalisation of the rules governing interest rates and more specifically on the abolition of the legal limit on interest rates..

The Central Bank of Cyprus is prevented from increasing interest rates to control strong credit expansion by an interest-rate-9% ceiling, in place until 2001. As a result, it had to resort to direct instruments of monetary control with the governor of the Central Bank announcing new measures intended to curb the expansion of bank credit to the private sector. These measures, which came into effect on 1st June 2000, consist of monthly credit ceilings for individual banks. The Central Bank has set an overall target of 12% for annual credit expansion.

The authorities of Cyprus are aware that financial reforms can, under certain conditions, lead to sudden large increases in total liquidity, with potentially destabilising effects on the economy. Therefore, the liberalisation of the financial sector is being accompanied by a strengthening of banking supervision. The recently approved Banking Bill is an important step in this direction, fully in line with EU directives.

- Foreign exchange policy

The Cyprus pound has been unilaterally pegged to the ECU since June 1992 and to the euro since 1 January 1999, within a narrow fluctuation band of +/-2.25%. This has been supported by prudent macroeconomic policies which are primarily aimed at containing inflationary pressures and keeping deficits on the current account of the balance of payments at manageable levels. Such practice has proved viable. It is indicative that actual daily fluctuations of the value of the Cyprus pound vis-à-vis the ECU around the central rate since the day of the peg have been much lower than the variation allowed for by the bands; the maximum positive variation has been +1% and the maximum negative variation has been 0.7%. Moreover, it is worth stressing that according to a background paper on the external competitiveness of the Cyprus economy prepared by the IMF, the current exchange rate level in Cyprus is in line with savings-investment fundamentals.

c) Results for 1999 / Forecasts for 2000/2001

Real GDP increased by an estimated 4.5% in 1999 driven by strong growth in tourism and financial services but domestic demand slowed sharply. Cyprus' real GDP growth is forecast by EIU to slow gradually to about 4% in 2000-01.

Despite a slight increase to 3.6% in 1999, the unemployment rate remained low.

Domestic demand is forecast to pick up after a slowdown in 1999, but this will be offset by a sharp fall in the contribution to growth of the foreign balance, from 3.3% in 1999 to just 0.4% in 2000, reflecting stronger import growth which will balance the continuing strong growth in the tourism sector. The recovery in domestic demand is expected to be driven mainly by stronger consumption growth and rising expenditure on gross fixed investment, notably in construction, as a result of planned tourism and infrastructure projects.

Consumer price inflation averaged 1.7% in 1999 but rose sharply in the final quarter of the year, reaching 3.7% in December. The surge continued in the first four months of 2000 with the rate rising to 4.8% in April. The rise reflects an increase in excise duty in October 1999, higher international energy prices and the continued weakness of the Cyprus pound against the US dollar. In 2000, inflation is forecast by EIU to average about 4.2%, as inflationary pressures are expected to remain strong during the remainder of the year.

The current-account deficit is estimated to have fallen to 2.7% of GDP in 1999, from 6.3% in 1998, signalling a reduction in the deficit of the merchandise balance as a percentage of GDP and a larger than expected surplus on the services balance. The reduction in the merchandise trade deficit was mainly the result of a fall in the value of imports, pushed down by the weakness of domestic demand and lower military spending. The higher surplus on the invisibles balance reflected a sharp rise in net earnings from tourism in 1999. According to EIU, the current-account deficit is expected to widen to around 3.5-4% in 2000-01; the forecast reflects mainly an acceleration in imports growth (as a result of a recovery in domestic demand and higher international oil prices), and the weakness of the Cyprus pound against the US dollar.

Forecast summary (EIU)

(% unless otherwise indicated)

 1998(a)1999(b)2000(c)2001(c)
Real GDP growth5.04.54.04.0
Industrial production growth2.81.01.54.9
Unemployment rate (average)3.33.63.83.8
Consumer price inflation
Average2.21.64.23.0
Year-end0.93.74.11.9
Government balance (% of GDP)-5.6-4.5-5.2-5.3
Current-account balance (US$m)-561-247-329-388
(% of GDP)-6.3-2.7-3.7-3.8
Total foreign debt (year-end; US$ bn)11.711.511.612.4
Exchange rates (av)
CP:US$0.5180.5430.5990.557
CP: Y1000.3960.4770.5570.534
CP: EUR0.5800.5780.5800.579

(a) Actual. (b) EIU estimates (c) EIU forecasts (d) Ecu before 1999.

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© Enlargement: 2000-08-08