Cyprus has avoided the fallout from Greece's mounting debt crisis but its fiscal deficit could still rise way above the EU ceiling of three per cent of GDP if government austerity measures fail, analysts warn.
In a bid to lead by example and trim the public sector's bloated pay roll, President Demetris Christofias announced a 10 per cent salary cut for himself, the cabinet and other top officials on Monday night.
He made the pledge during a televised press conference night to mark two years in power as the divided EU country's first communist president.
Economists argue that the Cypriot economy, technically in recession since last June, was undone not by Greece but by a plunge in tourists, especially from Britain, by Britons selling their holiday homes and a decline in Russian investment.
"Greece has an indirect effect through the presence of Cyprus banks there and stock prices tend to be affected. But it has no real effect on economic activity," European University of Cyprus research analyst Pambos Papageorgiou said.
"The UK is Cyprus's most important economic partner, Russian companies also have offices here and there is investment in Russia through Cyprus."
The Cyprus government is aware that its eurozone economy could come under tighter scrutiny from Brussels as it tries to tackle a fiscal deficit that analysts say could reach seven percent of GDP in 2010 if public spending is not restrained and more revenue generated.
The finance ministry said last week that the stagnant property market and fall in tourism receipts, by 16.7 percent, created a revenue shortfall in 2009 of €1 billion.
"We face a similar problem to Greece with our growing deficit. But we are nowhere near as bad," said Papageorgiou.
Mr Papageorgiou said there were structural differences between the public sectors of EU partners Cyprus and Greece that should make it easier for Nicosia to impose cuts.
"The Greek civil service is very politicised and there is a higher level of corruption. It's much lower in Cyprus."
He added that the Cypriot government, apart from cutting the salaries of the president and his ministers, should make changes to the public pay roll and avoid imposing too many taxes so as not to stifle investment.
"I predict we will have almost zero growth this year, so it is dangerous to try and raise too much revenue. Public finances must be improved, but excessive tax measures must be avoided."
Finance Minister Charilaos Stavrakis is expected to announce a raft of measures aimed at saving €500 million and has been consulting with political partners to win consensus on a stability pact that will be sent to Brussels.
He is confident economic recovery can be kickstarted with the package.
But the planned freeze on public sector wages and cuts to entry-level wages by 10 per cent could result in strike action.
Plans to overhaul tax evaluation on real estate, to hike VAT on services for which the normal 15 per cent rate is not applied and potentially reduce or means test a range of social benefits could also aggravate public discontent.
Economist Costas Apostolides agreed that Cyprus's economic woes relate more to what is happening in Britain and said reducing taxation, especially in the property and construction industry, would help to get things moving.
"We have stronger economic links to the UK than Greece with a dependence on tourism and property," which have both been badly hit by the global recession.