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ECONOMY

Cyprus’ Sovereign Ratings Upgraded to ‘BB’

Cyprus’ Sovereign Ratings Upgraded to ‘BB’
RATING ACTION
 
Capital Intelligence Ratings, the international credit rating agency, has announced that it has upgraded the Republic of Cyprus’ Long-Term Foreign Currency Sovereign Rating to ‘BB’ from ‘BB-’ and affirmed its Short-Term Foreign Currency Rating at ‘B’. At the same time, the Outlook for Cyprus’ ratings has been affirmed at ‘Positive’.
 
RATING RATIONALE
 
The ratings upgrade reflects the following factors: 
 
a) continued robust economic performance, with growth among the highest in the Eurozone and better than previously forecast fiscal outturns;
b) satisfactory government access to international capital markets and improved fiscal management; and
c) gradually improving conditions in the banking sector.
 
Cyprus’ economy continued its robust recovery in the first half of 2018, with real output growing by around 4%, compared to 3.9% in the same period of 2017. This was driven by the services sector (especially tourism, which continues to benefit from regional instability), as well as on-going foreign-led infrastructure projects. As a result of strong growth in domestic demand, import growth also accelerated, but the effects appear to have been partially offset by rising tourism receipts. The unemployment rate continued to fall, as it is expected to decline to 9.5% in 2018, down from a peak of 16.1% in 2014. Employment growth has been positive since 2016.
 
CI Ratings expects the economy to expand by 4.1% in real terms this year and for nominal GDP to return to its pre-crisis level. We expect real GDP growth to average 3.8% in 2018-20, helping to further reduce macroeconomic vulnerabilities and putting debt metrics on a more sustainable trajectory. Downside risks to the outlook appear to be receding with the banking sector showing more solid signs of improvement following the sale of certain assets and liabilities of the troubled Cyprus Cooperative Bank (CCB) to Hellenic Bank. Foreign direct investment is also expected to pick up in the short to intermediate term in light of initiatives to encourage international private investment in new casinos, hotels, marinas, and renewable energy projects. However, the strong growth cycle remains subject to downside risks stemming from the excessive concentration of activity in construction and real estate and from potentially volatile capital flows.
 
The public finances have strengthened further. The general government budget balance posted a surplus of around EUR327 mn (1.7% of GDP) in the first half of 2018, compared to a surplus of EUR64.5mn (0.4% of GDP) during the same period of 2017. The overall budget position is expected to register healthy surpluses averaging 1.7% of GDP in 2018-20, provided fiscal discipline is maintained. Given fiscal reforms and more favourable economic conditions, the ratio of general government debt to GDP declined to 97.5% in 2017, below CI’s previous forecast of 102.4%, and is expected to continue its downward trend reaching 86% of GDP in 2020, despite the temporary increase in 2018 related to the sale of CCB.
 
Short-term refinancing risks appear manageable and the government is currently able to access capital markets at favourable rates. The government has been active in pre-financing scheduled debt repayments and actively managing its balance sheet to benefit from favourable market conditions.
 
Despite the government’s commitment to post-financial assistance programme reforms, CI notes that there have been delays in enforcing certain new laws and in implementing specific politically-sensitive reforms, which may be partly attributable to the presidential elections that took place earlier this year. These measures include reforms to the public sector (including its size and wage bill), a new foreclosure framework, and privatisation.
 
CI notes that bank balance sheets have improved further. Moreover, the industry has been relatively successful in regaining depositor confidence. Domestic banks have continued to decrease their non-performing loan portfolio, including the partial sale of problematic loan portfolios to specialised credit acquiring companies.
 
Recent improvements notwithstanding, CI notes that risks to the economic outlook remain considerable. Despite some deleveraging, the private sector debt overhang persists, although deposits are also sizable. At 259% of GDP in 2017, the gross debt of the non-financial private sector (mostly loans from local banks) is extremely large. Household gross debt is equivalent to 119% of GDP, while non-financial corporate debt stands at 140% of GDP. 
 
Cyprus’ ratings are supported by the country’s relatively high GDP per capita, declining external imbalances, and the improvement in policymaking predictability.
 
The ratings remain constrained by the level of NPLs in the banking sector, in addition to limited competitiveness and socio-economic challenges.
 
 
OUTLOOK
 
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 significant improvement in economic and fiscal performance as well as the stabilisation of financing risks, and decreasing systemic risk in the banking system.

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