By Michalis Persianis
Despite the limited prospects for resolving the Cyprus problem, the hope for developments dictates that the involved parties prepare for the day after a solution. Based on relevant theory and historical examples, this column argued last week that granting strong authority over the internal economy to the Central Authority will matter more for the sustainability of any solution than granting a wide spectrum of powers.
Furthermore, the necessity for strong powers across a small range of issues remains critical regardless of the form the solution takes, such as how loose or strong a federation will be, how loose or strict a confederation might turn out, or even how a unitary state would be structured based on the 1960 arrangement or Estonia's 1992 model.
In any case, the transition to the new reality will be difficult. For obvious and prominent issues like property and compensation, proposals and studies largely identify solutions. They show that while the difficulties are indeed great, they are not insurmountable, and significant convergences already exist. An issue that does not receive due attention, however, is the overall robustness and sustainability of the economy in the Occupied area.
It is within this context that the issue of "public" finances in the Occupied area falls. This issue must be analyzed more carefully, and solutions must be sought to ensure the sustainability of a Cyprus solution, regardless of the form that settlement takes.
A first look at the "public finances" of the occupied area shows that if its fiscal position is not immediately insolvent, this is largely due to continuous funding from Turkey combined with domestic refinancing. The debt-to-GDP ratio shows a large decrease, but that stems mainly from galloping inflation in the Turkish lira, which erodes the debt. Furthermore, issues of short-term treasury bills (DiBS) and self-financing cover only about three-quarters of annual expenditure.
Recovery but inflation
After the pandemic, the economy of the Occupied area recovered rapidly, recording real GDP growth of 13.3%, 7.3%, and 8.5% for the years 2022 through 2024. This recovery was accompanied by extreme inflation, which receded to 39.5% in 2025 after reaching 94.5%, 83.6%, and 53.3% in the three preceding years.
Despite domestic revenue recording a significant increase driven partly by inflation, expenditure is growing even faster, resulting in continuous fiscal deficits.
The increase in spending is driven by current expenditure and payroll, which cumulatively absorb about 75% of total outlays. Thus, the issue discussed in the government-controlled areas, namely high inelastic expenditure as a percentage of total spending, appears even more acute in the Occupied area. This structure limits fiscal space for investment to about 9% of expenditure and makes correction difficult without reforms in payroll costs, pensions, subsidies, and loss-making public entities.
"Public debt"
Total public debt is much larger than the stock of treasury bills and bonds appearing in official data, as there are many additional obligations toward the so-called Central Bank, commercial banks, and the Provident Fund, as well as external debt held by the Treasury.
The notable reduction in debt as a percentage of GDP, from 131% in 2022 to 81% in 2024 (the last year with full data), stems mainly from the effects of inflation rather than fiscal surpluses and debt repayments. In any case, significant questions remain regarding external obligations, specifically those in foreign currency like US dollars. This creates severe weaknesses in repayment, despite official announcements that the authorities use swaps to cover exposure to exchange rate risk.
However, issues such as maturity timing, refinancing, and collateral remain unclear. On one hand, preferring short-term debt seems at first glance to resolve several swap weaknesses, resulting in the method covering exchange rate risk. On the other hand, growing reliance on short-term debt inherently creates fertile ground for severe risks.
Therefore, while authorities have adopted more complex and cautious approaches in recent years, their basic method seems to involve recycling cash needs rather than managing long-term debt. The indirect yet strong Turkish guarantee remains extremely important, as a bad auction, a further yield increase, temporary liquidity withdrawal, or an unexpected event can easily cause payment difficulties. These problems can pass through to the real economy almost immediately through banks, which act as the primary funder of the authorities.
The role of Turkey
The general picture of fiscal pressure, a wasteful state, and short-term debt can survive mainly thanks to Turkey's contribution to preserving the economic robustness of the Occupied area. This parameter will be vital in the event of a Cyprus solution, as Turkey will be asked to write off obligations. An even more difficult parameter will be making the successor state autonomous from its current dependence on Turkey, as ongoing support from Ankara will permanently translate into political influence with significant ramifications for reunification. Given the real numbers and the potential for improved know-how in the occupied area, adopting necessary reforms is not impossible, provided it forms part of the solution. The approach up to today from all parties, including the Greek Cypriot side, assuming they should not deal with the fiscal sustainability of the successor state in the Occupied area, carries risks. This comes at a time when the required corrections do not appear insurmountable, provided they are made.
Such a prospect would benefit all sides and not just the Greek Cypriot side, since Turkish Cypriots also stand to gain significantly from a reformist approach.
Today, the dependence of the Occupied area on Turkey at a fiscal level has three dimensions: cash, investment, and institutional. Turkey covers part of the annual fiscal gap, finances infrastructure and defense, and links disbursements to an action plan with technical monitoring. However, the degree of dependence has decreased significantly in recent years, and it includes defense expenditure that will likely drop to zero in the event of a Cyprus solution. Furthermore, recent protocols have included certain reforms that have a marginally positive effect on the fiscal picture of the Occupied area.
The Republic of Turkey covers about 5% to 6% of the GDP of the Occupied area through credits and donations, funding about 15% of state expenditure there. Turkey's shift from credits to donations toward the Occupied area acts as a deterrent to increasing debt, though it increases political dependence.
Regarding the latest support protocol, available information points to an intergovernmental mechanism involving evaluation by a Turkish technical delegation, determination of credits, approvals, and subsequent monitoring of implementation. The agreement foresees 75 actions across 16 reform fields and commitments regarding revenues, expenditures, and debt limits for public entities.
The role of banks
Previously, authorities tended to borrow directly from banks, with those loans typically repaid by Turkey. This habit involved central authorities as well as other bodies like local governments and state enterprises. However, indications suggest this trend has stopped, or at least been replaced by issuances of short-term treasury bills. Repayments of state NPLs by Turkey seem to have been limited or stopped altogether.
Nevertheless, the exposure of banks to short-term DiBS remains an issue that requires deeper analysis once reliable data is secured. Still, the fact that banks appear as creditors through official debt securities, likely limiting direct lending to authorities, can be viewed positively. Even so, current practice exposes banks to fiscal risk and loads them with short-term assets.
In any case, bank participation in public debt bolsters the available liquidity of the banking system, which seems to contribute to credit expansion.
While public finances remain vulnerable, significant portions of the fiscal space are not included in estimates of total obligations. Local authorities, for example, maintain obligations to banks approaching 400 million TL despite reductions during 2025, and their obligations to social security and other funds also appear significant. Another 400 million TL roughly concerns bodies like the so-called Grain Board (TÜK) and Cypfruvex, while the Eastern Mediterranean University holds additional obligations exceeding 1.24 billion TL. Total hidden obligations are estimated at 40 million euros, an amount that remains completely manageable.
The day after
The Occupied area is not on the verge of an open fiscal crisis, mainly because continuous domestic debt auctions, supported by banks and Turkish aid alongside implicit guarantees from Ankara, stave off immediate risks. However, the situation is not healthy, and fiscal structures remain fragile, especially regarding continuous short-term reliance on treasury bills (DiBS) that make managing the maturity profile extremely difficult. High external debt, short maturity profiles, rising interest, wage and transfer rigidity, public entity obligations, and a generalized lack of transparency cause vulnerability. Any delay in external financing or difficulty in refinancing will show up immediately in payments and affect the overall economy.
On the day after a Cyprus solution, reversing the dependence of the Occupied area's authorities on Turkey will be politically critical. That step will require not only financial assistance from Turkey in the form of debt write-offs, but also reformative moves within the Occupied area.
The situation shows improvement in recent years, as continuous protocols with Turkey, beyond political dependencies and other negative elements, include reform prerequisites that have partially improved the fiscal picture.
The magnitude of the required correction remains manageable because inflation in TL inflates nominal amounts, while figures in euros remain limited relative to the size of the occupied area's economy.
The total budget of the authorities in the Occupied area corresponds to 6.7% of the cumulative GDP of Cyprus (Occupied area plus government-controlled areas), while the deficit sits at 1.17% of the combined Cypriot GDP if Turkish support stops completely, or 0.88% if Turkey continues to support at current rates. Given the medium-term growth in both the local GDP of the Occupied area and the total GDP of a united Cyprus, these amounts constitute a relatively cheap price for independence from Turkey, as the cost can be fully recovered through the new, expanded GDP. However, the appetite for reform in the public finances of the Occupied area must not take a back seat, as it could pose a serious risk to the sustainability of any new order in Cyprus, regardless of the solution's final form.
