(The following statement was released by the rating agency)
June 25 - Fitch Ratings has downgraded the Republic of Cyprus's Long-term foreign and local
currency Issuer Default Rating (IDRs) to 'BB+' from 'BBB-'. The Short-term IDR has also been
downgraded to 'B' from 'F3'. The Outlook on the Long-term IDRs is Negative. Fitch has
simultaneously affirmed the eurozone Country Ceiling for Cyprus at 'AAA'.
The downgrade of Cyprus's sovereign ratings reflects a material increase in the amount of
capital Fitch assumes the Cypriot banks will require compared to its previous estimate at the
time of the last formal review of Cyprus's sovereign ratings in January 2012. This is
principally due to Greek corporate and households exposures of the largest three banks, Bank of
Cyprus, Cyprus Popular Bank (CPB) and Hellenic Bank and to a
lesser degree the expected deterioration in their domestic asset quality.
BANKING SECTOR SUPPORT
In addition to the EUR1.8bn (10% of GDP) required for Cyprus Popular Bank ('BB+'/Rating
Watch Negative), Fitch assesses that Cypriot banks will require further substantial injections
of capital, potentially up to EUR4bn (23% of GDP). While most of the increase in losses is
associated with Cypriot banks' Greek exposure, the reported non-performing loan ratio for
domestic Cypriot loans has also risen notably over the past year as the Cypriot economy has
contracted and unemployment has risen. Even assuming that Greece remains in the eurozone,
Cypriot banks will have to bear significant further loan losses as the Greek economy continues
to contract over the medium term as well as the deterioration in domestic asset quality.
Fitch acknowledges that its estimates of the losses and capital needs of Cypriot banks are
subject to considerable uncertainty and are conservative. Nonetheless, in Fitch's opinion,
Cypriot banks will require substantial injections of capital in order to secure confidence in
their financial viability. Fitch judges that the scope for further capital-raising from the
private sector is limited and thus assumes that the capital will have to be provided by the
government. With the fiscal cost of bank support potentially as high as EUR6bn, general
government debt is likely to exceed 100% of GDP compared to the agency's previous forecast of
FISCAL PERFORMANCE AND FINANCING
The budget has underperformed government expectations in the first half of 2012. Though
corrective measures are likely to be introduced, the official deficit/GDP target of 3% is likely
to be missed and is forecast by Fitch to reach 3.9% of GDP. Nonetheless, the fiscal adjustment
necessary to stabilise the government debt to GDP ratio is moderate relative to several European
peers. That said, significant fiscal reform will be required to absorb the economic and
financial costs of an aging population and as part of a broader structural reform effort
necessary to enhance productivity and international competitiveness,
Fitch judges the near-term liquidity risk faced by the sovereign to be low. Bond maturities
are moderate in 2012 and 2013 and fiscal financing is secure for the remainder of 2012. In 2013
the government has EUR2.25bn of refinancing needs, including a EUR1.5bn EMTN redemption in July
2013. Fitch expects Cyprus to secure a bilateral loan, likely from the Russian Federation
('BBB'/Stable), which will be sufficient to cover the gross budgetary funding requirement up to
end-2013. However, the agency also expects that Cyprus will have to secure a loan from the
EFSF/ESM to fund the broader recapitalisation of the banking sector. The lack of market access
to affordable term finance underscores the constrained financing flexibility of the sovereign to
respond to adverse shocks.
The near to medium-term economic outlook for Cyprus is weak. Fitch expects the economy to
stagnate this year and next and thereafter to recover only slowly as macroeconomic imbalances
unwind and the headwinds from the on-going eurozone and Greek crises persist. However, as these
imbalances are resolved, Fitch's expects the underlying fundamentals of the economy to support a
resumption of economic growth over the medium-term. Combined with still moderate effective
interest cost and on the assumption that the government reduces the budget deficit below 3% of
GDP in 2013 and beyond, government debt sustainability is within reach.
The Outlook on Cyprus remains Negative, indicating a heightened risk of further downgrades.
The Negative Outlook primarily reflects the risks associated with a further worsening of the
eurozone crisis, notably further contagion from Greece.
In the event of a Greek exit from the eurozone, Fitch would review Cyprus's sovereign
ratings. In such a stress scenario, Fitch's preliminary estimates are that Cypriot banks could
require significantly more capital than currently incorporated into Cyprus's 'BB+' sovereign
ratings. However, Fitch also recognises that there could be scope for the sovereign to limit the
liability arising from the banks in this scenario. Nonetheless, the uncertainty surrounding the
outlook for Greece is a material negative factor in the rating and Outlook for Cyprus.
Progress on deficit reduction, recapitalisation of the banking sector and reform to address
medium-term challenges arising from an aging population and low productivity growth would
support a stabilisation of the rating. Combined with a resolution of the eurozone crisis,
Cyprus's underlying fundamentals would re-assert themselves and support a return to investment