Cyprus’ Sovereign Ratings Affirmed

 Capital Intelligence Ratings (CI Ratings or CI), the international credit rating agency, has announced that it has affirmed the Republic of Cyprus’ Long-Term Foreign Currency Sovereign Rating at ‘B+’ and its Short-Term Foreign Currency Sovereign Rating at ‘B’. The Outlook for Cyprus’ ratings remains ‘Positive’.

The Ratings and the ‘Positive’ Outlook reflect the following factors: 

a)    the economy’s return to growth, combined with better-than expected fiscal outturns;

b)    the government’s commitment to post-programme reforms; and

c)    improved access to international capital markets, which has helped to lower government refinancing risk.

Cyprus’ sovereign risk profile continues to improve, with the economy recovering and the government remaining committed to post financial assistance programme reforms. Although there have been delays in some key areas, for example privatisation and foreclosures, the government is expected to press ahead with most of the reforms in order to place the economy on a sustainable path.

The economy has continued to outperform targets, with real GDP growing by 2.9% in the second quarter of 2016 supported by the resilience of some service sectors and robust tourism. With domestic demand showing signs of recovery, the pace of real output growth is expected to quicken to 2.2% in 2016 and to an average of 2.5% in 2017-18.

The public finances have strengthened further, with the general government budget deficit declining to 1% of GDP in 2015 and the primary budget surplus increasing to 2.7% of GDP from 2.5% in 2014. The budget deficit is expected to narrow further to 0.4% of GDP this year, before achieving a minor surplus in 2017-18 (provided reforms are implemented and spending growth contained). CI notes that current expenditure could increase in the short to medium term ahead of the upcoming presidential elections in 2018, with the government likely to unfreeze public sector wages in 2017. General government debt is expected to decline slightly to 105.6% of GDP in 2016, compared to 108.9% in the previous year, and is projected by CI to decline to about 91% of GDP in 2019.

Short-term refinancing risks appear manageable and the government currently appears likely to be able to access capital markets in order to secure any financing needs that may arise following exit of the EU-IMF financial assistance programme.

CI notes that bank balance sheets have improved slightly, with increased capital buffers and higher loan-loss coverage partially mitigating the high level of non-performing loans (NPLs). Moreover, the industry has been relatively successful in regaining depositor confidence following the full removal of capital controls. Deposits have shown signs of recovery in the first half of 2016, increasing by 2.1% compared to a decline of 1.6% in 2015. Despite the latest improvements in the banking sector, the outlook hinges on addressing the high level of NPLs and on fully implementing certain reforms, especially concerning foreclosures.

The political situation remains stable and policymaking predictability is expected to remain unchanged in the short to medium term. Negotiations with the leaders of the Turkish Cypriot community have picked up during 2016 and both parties seem closer to reaching a solution. That said, no solid results have been announced and CI’s baseline scenario still assumes the absence of a final agreement.

Recent improvements notwithstanding, CI notes that risks to the economic outlook remain substantial. The debt overhang in the business and household sectors is very large and the banking crisis has undermined the country’s medium-term growth prospects by eroding investor confidence and severely constraining access to credit for local businesses.

Apart from the weak banking sector, Cyprus’ ratings also remain constrained by limited competitiveness and large socio-economic challenges, with the unemployment rate in Cyprus among the highest in the EU.

The Outlook for the ratings is ‘Positive’. This means that Cyprus’ ratings are likely to be upgraded over the next 12-24 months, provided key credit metrics evolve as envisioned by CI.

The ‘Positive’ Outlook reflects the improvement in economic and fiscal performance and the stabilisation of financing risks.

Based on the above, CI’s baseline scenario continues to assume that the government’s commitment to reform is likely to remain relatively strong, regardless of whether an official financial assistance programme is in place.