Cyprus’ Sovereign Ratings Affirmed with A Positive Outlook


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


The ratings and outlook reflect the continued strong performance of the economy, declining unemployment, improving public finances and the ongoing recovery of the banking sector. In addition, legislative and structural reforms have helped to increase Cyprus’ institutional strength. The ratings are constrained by the private sector’s large debt hangover, the still high level of non-performing exposures (NPEs) in the banking sector, as well as continued delay in implementing key – yet politically sensitive – structural reforms, including privatisation and reducing the size of the public sector.

The economy continued to recover in 2019, albeit at a slower pace, with real output growth expected at 3.6% (3.9% in 2018), exceeding its pre-crisis size in nominal terms. Growth was broad based and underpinned by robust domestic consumption. On a sectoral basis, the services (mainly professional services, health and education) and construction and real estate sectors continued to post high growth. The unemployment rate continued to decline, reaching a better than projected 8.4% in 2018, down from 16.1% in 2014. Employment growth has been positive since 2016 and youth unemployment remains on a declining trend, reaching a multi-year low of 14.5% in Q2 2019.

CI Ratings expects the economy to expand by around 3.1% in 2020-21, underpinned by strong domestic consumption, higher investment and robust net exports. Foreign direct investment is also expected to remain robust in the short to intermediate term given initiatives aimed at encouraging international private investment in hi-tech, construction, casinos, hotels and marinas, as well as energy projects linked to the natural gas exploration taking place in Cyprus’ exclusive economic zone.

However, the strong growth cycle remains subject to sizeable downside risks stemming from both local and exogenous factors. Locally, the concentration of activity in construction and real estate and the high debt overhang in the private and household sectors could weigh on the recovery of the economy and banks. Externally, the uncertainty surrounding a disorderly Brexit could dampen the short- to medium-term outlook, leading to renewed volatility and/or risk aversion in the financial markets, negatively affecting the cost of borrowing across the euro area. Moreover, increased global trade tensions and weaker than expected growth in both the euro area and Russia would also adversely affect short- to medium-term prospects.

Policy predictability and institutional strength have improved in tandem with broad-based legislative, economic and judicial reforms. Despite the improvement, however, CI notes that there are continuing delays in implementing certain reforms, such as improving the functioning of the judiciary to facilitate speedier foreclosures, reducing the public sector’s size and wage bill, and privatisation. Following negotiations with unions, the government has restated the cost of living allowance (COLA) system which was frozen in the wake of the financial crisis in 2013 – and has adjusted public sector salaries, which in turn could jeopardise fiscal discipline.

The general government budget balance – excluding the Cyprus Cooperative Bank (CCB) transaction – strengthened further in 2018, posting a surplus of 2.9% of GDP, compared to a 1.8% surplus in 2017. Including the accounting treatment of the revaluation of the CCB asset portfolio that was transferred to the books of the Asset Management Company (AMC), the budget position registered a deficit of 5.1% of GDP in 2018. The overall budget position is expected to register healthy surpluses averaging 2.7% of GDP in 2019-21, provided fiscal discipline is maintained. Risks to the fiscal outlook persist due to the limited fiscal space to accommodate unexpected large expenditures and potential spending pressures associated with increasing public sector wages, the new national health system, the ESTIA debt subsidy scheme, and government guarantees on certain former CCB assets.

General government debt is expected to decline to 95.7% of GDP in 2019, compared to 102.5% in 2018 and 97.5% in 2017. The one-off increase in 2018 was due to the cost of state support for the CCB sale. The debt ratio is expected to resume its declining trend, reaching 83% of GDP in 2021, provided that the economy grows as envisaged, fiscal discipline is maintained, and assuming no further support to the banking sector.

Short-term refinancing risks appear manageable in view of the government’s sound fiscal management, which has enabled it to build cash buffers that cover its financing needs for the next nine months. These buffers are supported by the government’s ability to access international markets at favourable rates. The government has been active in managing its balance sheet to benefit from favourable market conditions.

CI notes that bank balance sheets have improved further with NPEs declining to a still high 30.6% of gross loans in March 2019. Moreover, the industry has been relatively successful in regaining depositor confidence. Domestic banks have continued to decrease their non-performing loan portfolio through restructurings, write-offs, and the partial sale of problematic loan portfolios to specialised credit acquiring companies. Nonetheless, risks stemming from the relatively low provisioning level, which stood at 52.33% of NPEs in March 2019, and the private sector’s large debt overhang still persist.


The Outlook for the ratings is Positive, which indicates a better than even chance that the ratings will be upgraded in the next 12-24 months. The Outlook also reflects CI’s current expectation that robust economic growth and prudent macroeconomic management will continue to reduce fiscal vulnerabilities and strengthen the banking sector, minimising the need for sovereign assistance to the banking system in the event of an unexpected crisis.

The ratings could be upgraded in a year’s time if the government maintains its strong fiscal discipline and embarks on further fiscal and structural reforms, which reduce debt at a quicker pace, contain the public sector wage bill and weaken the nexus between the sovereign and the banking system, and/or the latter exhibits faster improvement with NPEs dropping to significantly lower levels and higher provisioning.


Conversely, the Outlook could be revised to Stable in the event the government fails to maintain fiscal discipline, and/or the banking system requires further financial assistance that adversely impacts the government’s balance sheet.