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Cyprus’ Sovereign Ratings Affirmed, Outlook Remains Stable

Cyprus’ Sovereign Ratings Affirmed, Outlook Remains Stable

Capital Intelligence Ratings (CI Ratings or CI) today announced that it has affirmed the Republic of Cyprus’ Long-Term Foreign Currency Rating (LT FCR) and Short-Term Foreign Currency Rating (ST FCR) at ‘BB+’ and ‘B’, respectively. At the same time, the Outlook for sovereign’s ratings was affirmed as Stable.


Rating Rationale

The ratings and Outlook reflect CI’s expectation that the economy will start to recover in the final quarter of this year from the disruption caused by the Covid-19 pandemic. The ratings are primarily underpinned by the pursuit of generally sound macroeconomic policies and relatively high GDP per capita, as well as the benefits derived from the country’s membership of the European Union and eurozone, including access to funding mechanisms recently established to help countries recover from the coronavirus-related downturn in economic activity. The ratings are also supported by proactive public debt management – which has helped to improve the debt structure in recent years – and adequate government access to capital markets.


Economic performance is expected to weaken this year by much more than envisaged in our last review, with the adverse impact of Covid-19 driving the economy into recession. Real GDP fell by 11.9% in the second quarter 2020 as containment measures and reduced demand caused output to contract in key sectors such as tourism, construction, manufacturing and transportation. The labour market has been hit hard by the recession and following several years of steady improvement the unemployment rate is expected to reverse course and increase to 9% in 2020.


Prior to the Covid-19 shock, the Cypriot economy was growing at a satisfactory pace and the government was pursuing relatively sound macroeconomic policies. Assuming the effects of the pandemic gradually dissipate going into 2021, we expect real GDP to increase by 6.1% next year as private domestic demand begins to strengthen, tourism starts to recover (albeit to below pre-pandemic levels), and government policy continues to support economic activity, possibly with the help of EU funding. Risks to the growth outlook remain significant, however, given the uncertainty surrounding the evolution of the pandemic. Other potential risk factors affecting the outlook include the concentration of economic activity in the construction and real estate sectors, and the high debt overhang in the private sector.


Fiscal performance has suffered a temporary setback this year due in part to the implementation of government support measures to soften the impact of Covid-19 on the economy. The general government budget position is expected to post a deficit of 7% of GDP in 2020, compared to a surplus of 1.7% in 2019. The primary budget position is also expected to post a deficit of 4.6% of GDP in 2020, compared to a surplus of 4.2% in the previous year. That said, the temporary increase in current spending is expected to be phased out towards the end of the year, leading to a more favourable fiscal outlook, with the general government budget deficit declining to 1.8% of GDP in 2021.


Reflecting higher financing needs and contracting nominal GDP, general government debt is expected to increase to 120.5% of GDP in 2020, from 95.5% in 2019. However, the debt trajectory is expected to return to a favourable path in 2021, with the debt ratio declining to around 109.8%. At present, short-term refinancing risks appear manageable given the government’s sound fiscal management and good access to capital markets at favourable rates, as well as the prudent building of cash buffers to cover financing needs for the next nine months.


External strength remains moderately weak, with the current account deficit expected to widen to 7% of GDP in 2020, compared to 6.1% in 2019, as a result of the significant decline in tourism receipts. External refinancing risks are deemed manageable, while external debt is high at 390.6% of GDP in 2019. Excluding the external debt of Special Purpose Entities (SPEs), external debt is estimated at 259.7% of GDP (217.1% of CARs) in 2019.


Cyprus’ ratings continue to be supported by the country’s relatively high GDP per capita, as well as improving policy predictability and institutional strength, in tandem with broad-based legislative, economic and judicial reforms. Nonetheless, there remain delays in implementing certain judicial reforms which would facilitate speedier foreclosures in the banking sector, and little has been done to reduce the size of the large public sector. The ratings also remain constrained by high general government indebtedness, the large debt overhang in the private sector, significant external financing needs, and the weakness of the banking sector. 


CI notes that banks’ balance sheets remained resilient in the first few months of 2020. The banking sector is considered adequately capitalised, while the non-performing exposures (NPEs) ratio remained unchanged at 27.7% of gross loans as at end-April 2020. Moreover, loans in arrears over 90 days, excluding restructured facilities, rose to EUR7.62bn (23.6% of gross loans) during the same period. As part of its economic support measures, the government introduced a moratorium period on loans granted by banks to the private sector until the end of the current year.


Although banks have increased their provisioning due to the pandemic, risks stemming from the relatively low provisioning level, which stood at 55.2% of NPEs in April 2020, and the private sector’s large debt overhang still persist. Moreover, weak economic performance and increasing socioeconomic vulnerabilities could potentially pose a serious challenge to the banking system and its asset quality once the moratorium period ends. In an attempt to partially mitigate these risks, banks are becoming more active in selling NPEs to credit management institutions.


Rating Outlook

The Outlook for the ratings is Stable, indicating that the ratings are likely to remain unchanged in the next 12 months. The Outlook balances the direct adverse repercussions of Covid-19 on the economy and the public finances against the government’s prudent macroeconomic policies and CI’s expectation that the economy will rebound once the pandemic diminishes.


Rating Outlook: Upside Scenario

The Outlook could be revised to Positive should economic activity recover quickly and if the government restores its strong fiscal discipline and public debt returns to its declining trajectory.


Rating Outlook: Downside Scenario

Conversely, the Outlook could be revised to Negative in the event the public finances weaken significantly due to adverse economic conditions and/or policy shifts, or if the banking system requires further financial assistance from the government.



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