Fitch upgrades Cyprus to B+ citing fiscal, economic over-performance

Fitch Ratings upgraded Cyprus’s long-term foreign and local currency issuer default rating by two notches to B+ and placed it on positive outlook citing a fiscal “over-performance,” an expected declining trend of government debt, the implementation of cash-for-reforms programme including the foreclosure law and faster economic recovery.

The rating company said that after achieving “an almost balanced budget” in 2014 compared to a fiscal shortfall of 8.5 per cent of gross domestic product projected by Fitch, the government maintained “the positive momentum” this year as its balance remained in surplus up until the end of July.

The new rating is four grades below investment grade and came as Cyprus is preparing for a government bond issue, the third after the March 2013 €10bn bailout by international creditors, which will determine the successful restoration of market access less than six months before the completion of its economic and financial reform programme.

Fitch, which took its last rating action in June 2013 when it downgraded Cyprus’s sovereign rating to B-, said that it projects a fiscal gap of 1 per cent of economic output in 2015, before the government generates a 0.2 per cent and 1 per cent surplus in 2016 and 2017 respectively.

“General government gross debt is now expected by Fitch to peak at less than 108 per cent of GDP this year, before falling to around 100 per cent in 2017,” Fitch said. “This compares with a peak of over 130 per cent projected by Fitch in June 2013.”
Cyprus’s government debt remains high, however, and reduces the economy’s ability to absorb domestic or external shocks, Fitch said.

“Cyprus is back on track in its International Monetary Fund – European Union programme following delays in the fifth and sixth reviews that were pending the implementation of the foreclosure law, finally passed in May 2015,” the rating company said. “The seventh review took place in July and enabled the disbursement of €625m in funding.”

The ratings agency said that the foreclosure law, along with a new insolvency framework, lay at the heart of the banking sector’s efforts to reduce its exceptionally high stock of non-performing exposures.

“A significant programme hurdle was overcome in removing all restrictions on capital flows in April, ending two years of controls. Deposits have been broadly stable since then, although non-resident deposits declined temporarily in the run-up to the Greek crisis this summer. While direct financial links between Greek-owned subsidiary banks and Greece have been reduced significantly, the sector remains vulnerable to Greece mainly via investor confidence.”

Following the faster than anticipated return to economic growth, Fitch now estimates that the cumulative loss of Cyprus’s economic output will be 7.5 per cent compared to the 14 per cent which it projected three months after the 2013 bail-in.
“Growth has been supported by domestic demand, which in turn is buoyed by lower oil prices and an improvement in sentiment,” Fitch said. “The labour market is improving but remains weak; unemployment was still above 15% in August compared with less than 4 per cent in 2008”.

Fitch said that the high non-performing loan ratio makes the environment for Cypriot lenders “challenging” adding that the difference of overall non-performing exposures in Cyprus minus provisions were €18.8bn or 107 per cent of the economy. “Implementation risks around banking reforms remain high as the process is dependent on the political will to confront debtors, which could wane in the run-up to parliamentary elections in May 2016,” Fitch said. “Though evidence is emerging of a pickup in restructuring and NPE stock stabilisation, along with improved capitalisation and liquidity, any corresponding decline in NPEs will only emerge gradually.”
External factors, including uncertainty in Greece, a slowdown of the global and in particular Russian economy could undermine Cyprus’s adjustment.

Fitch said that further upgrades of Cyprus’s sovereign rating will depend on the stabilisation of the banking sector and a pickup in loan restructurings, a sustained market access allowing the government to borrow money at “affordable rates,” continuation of fiscal consolidation efforts aiming at reducing the government’s debt to GDP ratio and “further track record of economic recovery and narrowing of the current account deficit”.

On the other hand, a deterioration in the banking sector, weakening fiscal consolidation efforts, a return to recession or deflation, which “would have adverse consequences for public debt dynamics” and a lack of market access, which could put pressure on government and banking system liquidity, could lead to a downgrade.

Government spokesman Nikos Christodoulides said that following Fitch’s upgrade Cyprus has to continue its reform and modernisation efforts “with the same persistence and commitment”.

“This development is the result of the collective effort on the part of the Government, the Parliament, the social partners but, mainly, of the Cypriot people,” he said adding that the government’s economic policy pays off.