Cyprus toughens steps on deficit, sees milder recession

NICOSIA Thu Oct 10, 2013 10:26am EDT

NICOSIA (Reuters) - Cyprus on Thursday announced tougher 2014 fiscal targets than those set by international lenders, and said a recession on the bailed-out island may not be as deep as initially feared.

The small euro zone country came close to financial collapse in March after a fumbled attempt at economic rescue forced a major bank to shut and deposits were seized at a second lender. It now has a 10 billion euro economic adjustment programme from the International Monetary Fund and the European Union.

A draft budget approved by the island's cabinet on Thursday sees spending for 2014 slashed by 10 percent versus 2013 figures, focused on cutting benefits and pensions.

The 2014 primary deficit, the gap between spending and revenue excluding interest payments, was expected to be 3.0 percent of gross domestic product compared to 4.25 percent outlined in the adjustment programme prepared by lenders.

The lenders expect the country to register an 8.7 percent drop in output this year, and 3.9 percent in 2014.

According to finance ministry documents, the recession could be milder than the 8.7 percent 2013 baseline scenario, based on economic output in the first two quarters. It did not elaborate on this brighter outlook nor did it alter the baseline scenario for 2014.

"We wish we could spend more, and borrow to foster growth, but unfortunately we are paying for mistakes of the past," said Finance Minister Harris Georgiades.

"The basic characteristic of the budget is significant savings on expenditure. We are operating in a difficult economic environment," he said.

The budget, the first since the island was bailed-out, requires parliamentary approval. It is likely to be tabled in the coming week, and approved by the end of December.

Bailout money from lenders is mainly geared towards fiscal needs of the island. Its two major banks, heavily exposed to Greece, had to plug the gap themselves and did so by plundering uninsured deposits exceeding the EU-insurable threshold of 100,000 euros ($135,200).

Rising unemployment, weak demand, capital controls and the lingering shock of Cyprus's near-meltdown has crimped economic output, with the downturn expected to be sharp this year.

Based on the gameplan from international lenders, Cyprus will increase its VAT rate by one percentage point to 19 percent in 2014, extend a staggered income-tax levy on earnings and introduce further excise duties on fuels.

The troika of lenders from the IMF, the ECB and the EU is due to start a second inspection visit to Cyprus in late October, focused on privatization plans.

(Editing by Stephen Nisbet)