(Repeat for additional subscribers)
April 25 (The following statement was released by the rating agency)
Fitch Ratings has revised the Outlook on Cyprus's
Long-term foreign currency Issuer Default Rating (IDR) to Stable from Negative
and affirmed the IDR at 'B-'. The agency has also upgraded the Long-term local
currency IDR to 'B-' from 'CCC'.
Other ratings have been affirmed with Short-term foreign-currency IDR at 'B' and
Country Ceiling at 'B'. The issue ratings on Cyprus's senior unsecured
foreign-law bonds have been affirmed at 'B-' and the issue ratings on unsecured
local-law bonds have been upgraded to 'B-' from 'CCC'.
KEY RATING DRIVERS
The revision of the Outlook and the upgrade reflect the following key rating
drivers and their relative weights:
Reform implementation under the EU-IMF programme continues to progress,
supporting policy coherence and credibility. In particular, wages and prices are
adjusting downwards in contrast to previous episodes of recession. Driven by
spending cuts in the public sector, compensation per employee fell 6% yoy in
2013. In the private sector compensation per employee fell by 5.3%. Fitch
expects the government to continue to adhere to programme parameters, following
parliamentary approval on privatisation plans despite initial resistance from
some political parties.
Fiscal targets have been exceeded by a significant margin. The general
government deficit to GDP (GGD) ratio was contained at 5.4% in 2013, below the
projected 7.8% under the second Troika review of the programme and Fitch's
previous forecast of 6.7%. The outcome reflects a large fiscal correction and a
less severe-than-expected recession. Tight expenditure control contributed
significantly to the favourable outcome. Fitch has revised its fiscal deficit
projections to 5% of GDP in 2014 and 4.6% in 2015, from 7.5% and 6.9%,
The economy has proven to be more resilient than previously expected. GDP
contracted 5.4% in 2013, compared with the forecast 7.7% contraction under the
second Troika review and Fitch's previous forecast of 7% decline. Tourism and
professional services (excluding banking) have shown some resilience. Households
have also been using their savings to smooth their consumption. Fitch has
revised its GDP projections for 2014 to a contraction of 3.9%, from a 5.1%
The risk of a repeat of Cyprus restructuring its domestic law bonds, which
occurred in 2013, has reduced, resulting in the Long-term domestic and foreign
currency IDRs being equalised. This equalisation is supported by the improved
fiscal and economic performance relative to Fitch's previous expectations,
leading to stronger financing buffers within the programme.
Cyprus's external debt position has improved compared with Fitch's previous
forecast, in part due to favourable revisions to previous official data. The
improvement also reflects positive trends in capital flows, including a
significantly narrower current account deficit.
Cyprus's 'B-' Long term foreign currency and local currency IDR ratings also
reflect the following key rating drivers:
There are still significant risks to creditworthiness posed by Cyprus's
continued deep economic and financial adjustment, which is still in its early
The restructuring of the banking sector has also undermined the potential growth
of the economy and unemployment will remain elevated in the near term. The stock
of NPLs (as per Central Bank of Cyprus's new definition) on average reached 42%
of gross loans at end-December 2013, and in some banks, was above 50%. The
quality of assets may deteriorate further in the next quarters, albeit
potentially at a slower pace. Banks have taken steps to enhance their internal
arrears and restructuring processes and now face the challenge of limiting any
additional credit deterioration and recovering NPLs without affecting their
recently restored capital positions.
Public debt, at around 112% of GDP in 2013, was almost three times higher than
the 'B' median of 42% and has yet to peak. There is little further fiscal scope
to absorb any additional domestic or external shocks.
Risks to programme implementation have eased on recent performance but remain
elevated. Medium-term fiscal targets, in particular, are ambitious. Official
projections show a 3.3pp improvement in general government primary balance in
2016 to a surplus of 1.2% of GDP which could prove difficult to achieve. A
significant portion of the consolidation also remains outside the programme
period which ends in 1Q16.
Cyprus's financing requirements rise significantly after the end of the
programme period, which could be challenging for the government. According to
projections by the IMF gross financing needs, including for buffers, will rise
to EUR3.6bn in 2017 from EUR1.7bn in 2016, with maturing medium- to long- term
debt increasing to EUR2.7bn from EUR0.6bn. This includes the EUR1.8bn domestic
law bond held by Bank of Cyprus, which can be rolled over annually until 2017.
The process of lifting capital controls carries risks, and a premature exit
could trigger material capital flight with negative economic consequences.
Future developments that may, individually or collectively, lead to a negative
rating action include:
- Significant slippage from programme targets, in particular fiscal deficits, or
adverse changes to public debt dynamics, for example, caused by a
deeper-than-expected recession or political shocks
- A recession that is materially deeper or longer than assumed by Fitch which
would have adverse consequences for public debt dynamics
- Re-intensification of the banking crisis in Cyprus, for example, capital
flight from banks if capital controls are lifted prematurely
Future developments that may, individually or collectively, lead to a positive
rating action include:
- A longer track record of successful implementation of the EU-IMF programme
- Signs of a stabilisation in economic output and the banking sector
- Improvements in export performance that help facilitate the rebalancing of the
- Lifting of capital controls with no material negative economic consequences. A
removal of capital controls would also lead to an upgrade of the Country
Fitch expects the recession to be deeper and the downturn to last longer than
assumed under the EU/IMF programme. The agency expects output to contract by
around 3.9% in 2015 and 1% in 2016 and not return to growth until 2017. This
compares with the Troika programme forecast for the economy to grow from 2015.
Fitch assumes moderate slippage from Troika fiscal targets in the medium term,
especially in 2016 when the primary balance is expected under the programme to
improve significantly. The official programme targets a primary balance surplus
of 4% of GDP by 2018 from a deficit of 2% in 2013. It is likely that the fiscal
adjustment will need to be greater to achieve the ambitious long- term targets
for the primary balance, especially as downside risks to growth remain high.
Fitch's debt dynamics projections assume the government concludes the asset swap
of a portion of the outstanding government debt held by Cyprus Central Bank
(EUR1bn), generates proceeds from privatisation (of at least EUR1bn within the
programme period and EUR0.4bn outside) and dividends from the central bank
Public debt has improved slightly from the previous rating review. Fitch expects
gross general government debt (GGGD) to peak at 126% of GDP in 2016 (compared
with over 131% in the previous review) and to gradually decline to 117% by 2020.
The improvement is due to better growth projections and smaller fiscal deficit
forecasts in the near term.
Fitch currently assumes that the fiscal costs of bank recapitalisation will not
exceed the EUR2.5bn specified under the Troika programme, which includes a
contingency buffer of EUR1bn.
Fitch assumes that there will be no material escalation in developments between
Russia and Ukraine that would lead to a significant external shock to the
Cypriot economy. Tourism from Russia has been rising and Russians account for a
sizeable share of foreign deposits in banks. Our projections also do not include
the impact on growth of potential future gas reserves off the southern shores of
Cyprus, the benefits from which are several years into the future, although now
less speculative. A second test drill is planned for autumn. Similarly while
talks to resolve the Cyprus issue has resumed after a two-year break we do not
expect a solution any time soon.
Fitch assumes Cyprus and the euro zone as a whole will avoid long-lasting
deflation, such as that experienced by Japan from the 1990s. However, given the
nominal adjustment underway in Cyprus, downward price pressures will be
significant over the medium term. This will hinder the balance-sheet adjustment
of the public and private sectors.
Fitch assumes the gradual progress in deepening fiscal and financial integration
at the euro zone level will continue; key macroeconomic imbalances within the
currency union will be slowly unwound; and euro zone governments will tighten
fiscal policy over the medium term. It also assumes that the risk of
fragmentation of the euro zone remains low.
Link to Fitch Ratings' Report: Cyprus - Rating Action Report