The International Monetary Fund (IMF) has called on Cyprus to adopt a cautious fiscal approach despite its strong economic performance, urging the government to prepare now for rising long-term costs linked to an ageing population.
In its 2026 Article IV assessment, the IMF estimated that additional fiscal pressures between 2030 and 2050 could exceed 4% of GDP, around €1.2 billion. While acknowledging the sharp reduction in public debt, the Fund warned against premature fiscal easing and stressed the need to build financial buffers.
“Over the long term, fiscal space should be preserved to address high, rising and long-lasting spending pressures,” the IMF said. It added that pension obligations, growing healthcare costs and worsening demographic trends could require significant fiscal adjustment in the medium to long term.
The Fund also pointed to structural features such as cost-of-living wage indexation (the Automatic Cost of Living Adjustment, or ATA), guaranteed minimum pensions and supplementary benefits as factors that could complicate future adjustment efforts. It welcomed proposals to accumulate financial assets in the Social Insurance Fund as a pre-emptive response.
Gradual approach to fiscal policy
The IMF advised the government to contain growth in the public wage bill and ensure that any fiscal easing is gradual and aligned with long-term growth objectives.
“A more gradual easing is preferable to easing of poor quality,” it said.
The report criticised the anticipated fiscal loosening in 2026, including a drop in the primary surplus and the expansion of cost-of-living measures. It expressed concern over the extension of reduced and zero VAT rates on food and electricity, as well as horizontal fuel tax measures, describing them as “costly, poorly targeted and distortionary”.
Instead, the IMF recommended targeted and temporary support measures for vulnerable households, combined with investment in energy efficiency and infrastructure. It estimated that removing zero VAT on selected food items and the 5% reduced rate on electricity could generate revenue equal to 0.2% of GDP.
Redirecting those funds into targeted transfers would reduce inequality up to six times more effectively than current tax measures, the Fund said.
Structural risks behind strong performance
Although Cyprus remains one of the best-performing economies in Europe, the IMF highlighted persistent structural weaknesses that could weigh on future growth.
These include legacy non-performing loans outside the banking system, weak credit intermediation, heavy reliance on oil for energy and long-term fiscal pressures from demographic change.
Policy priorities should focus on improving tax collection and spending efficiency, prioritising high-productivity public investment, especially in energy transition, and avoiding costly measures that weaken policy targeting or flexibility.
The IMF also stressed the need for structural reforms to boost productivity and support investment. These include addressing skills mismatches, enhancing digital capabilities and improving the efficiency of the judicial system, a key factor for enforcing contracts and resolving insolvency cases.
Advancing energy sector reforms and major infrastructure projects is also critical to reducing costs and strengthening energy security. The Fund added that improving anti-money laundering supervision, particularly beyond the banking sector, would help mitigate reputational risks.
Government response
Cypriot authorities broadly agree that growth is likely to slow in the short term and inflation may rise due to the conflict in the Middle East. However, they argue that the country is entering this period from a position of strength, with high primary surpluses, low public debt and a resilient banking system.
Officials defended recent cost-of-living measures, saying they are temporary, fiscally contained and do not derail the downward trajectory of public debt. They also pointed to plans to strengthen the Social Insurance Fund through financial asset accumulation as a proactive response to ageing pressures.
The government views the 2025–26 tax reform as a correction of distortions and expects any short-term revenue losses to be gradually offset over time.
