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Fitch Affirms Cyprus at 'BB-'; Outlook Positive
April 21, 2017 / 8:08 PM / in 8 months

Fitch Affirms Cyprus at 'BB-'; Outlook Positive

(The following statement was released by the rating agency) LONDON, April 21 (Fitch) Fitch Ratings has affirmed Cyprus's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'BB-'. The Outlooks are Positive. The issue ratings on Cyprus's senior unsecured bonds have also been affirmed at 'BB-'. The Country Ceiling has been affirmed at 'BBB-' and the Short-Term Foreign- and Local-Currency IDRs and issues at 'B'. KEY RATING DRIVERS The economic recovery, now in its third year following the 2013 banking crisis and ensuing bail-out programme, is supportive of the ongoing financial sector, fiscal, and economic adjustment. GDP grew by 2.8% in 2016, up from 1.7% in 2015, and led by strong domestic demand across sectors. Tourism enjoyed record growth, with a near 20% increase in arrivals. Fitch projects GDP growth of 2.7% in 2017 and 2.5% in 2018, aided by the labour market recovery and a strong pipeline of investments. A number of factors continue to weigh heavily on Cyprus's credit profile. The banking sector's exceptionally weak asset quality poses a significant downside risk to the recovery. Very high gross general government debt (GGGD), at 107.8% of GDP in 2016 relative to the 'BB' median of 46%, and net external debt (NXD) at over 150% of GDP (estimate as of 3Q16) relative to the 'BB' median of 18%, limit the private and public sectors' abilities to finance economic activity and deal with external or domestic shocks, and imply that there may be the prospect of further economic rebalancing over the medium term. The banking sector is benefiting from improved macro conditions, as evidenced by higher liquidity, with deposits up 6% in February versus a year earlier. The Bank of Cyprus, placed into resolution in 2013 and recapitalised partly through a bail-in of depositors, fully repaid its remaining ECB emergency liquidity assistance balance in January. Overall sector deleveraging is ongoing, with assets down to 3.8x GDP in 2016 from almost 6x in 2009. The ratio of non-performing exposures (NPEs) to total loans was 46.2% at end-2016, still the highest of Fitch-rated sovereigns, and up from 45.3% a year earlier. Measuring the stock of NPEs (excluding the shrinking loan book) shows a EUR3 billion or 11% decline from 2015. A narrower measurement of NPEs (90-day past due) shows a decline in the ratio, to 33.9% in 2016 from 35.8% a year earlier. Unreserved problem loans, represented by gross NPEs minus system-wide provisions also improved, albeit from an extremely elevated level, to EUR14 billion from EUR16 billion (79% of GDP from 93% a year earlier). Banks' efforts to manage their loan books have accelerated since the new foreclosure framework was introduced in 2015, as reflected in a higher number of restructurings. Early feedback on the restructuring process has been uneven across banks; with the overall current re-default rate estimate of 28% indicating some initial progress towards resolution of NPEs. However, this remains tentative and highly reliant on a macroeconomic and property market recovery. The property sector is illiquid, but indicators point to a stabilisation in prices and pickup in activity (sales contracts up 38% and building permits up 18% in 2016 versus 2015). The budget recorded a surplus of 0.4% of GDP in 2016 compared with a deficit of 0.1% a year earlier (excluding the bank recap). GGGD-to-GDP ended the year at 107.8%, reflecting the accumulation of cash reserves. Fitch expects the cyclical recovery to support small fiscal surpluses of 0.1% of GDP in 2017 and 0.4% in 2018, leading to a decline in GGGD-to-GDP to around 100% by 2018. Risks to the fiscal outlook are tilted to the downside, as presidential elections and the expiry of wage settlements in 2018 could lead to fiscal relaxation. The financing outlook is comfortable, with cash buffers covering needs until 1Q18. The current account deficit widened to 5.3% of GDP in 2016, from 2.9% a year earlier. The result is distorted by the inclusion of special purpose entity flows (NPEs, mainly non-resident shipping industry), and authorities estimate that excluding these entities, the current account would have recorded a deficit of around 0.5% of GDP, narrowing from 1.5% in 2015. For 2017 and 2018, Fitch projects the deficit (including NPEs) to remain elevated at around 5% of GDP, reflecting growth of consumption-led imports and a modest recovery in oil prices. Estimated at over 150% of GDP as of 3Q16, NXD reflects the highly indebted private and public sectors. Also, the NXD figure was revised up substantially following the shift of external statistics compilation to the BPM6 framework in June 2014, owing to the inclusion of capital-intensive ship-owners as Cypriot economic units irrespective of the location of their activities. Negotiations for a deal between Greek and Turkish Cypriots to reunify the island have resumed in April following a two month halt. The likelihood of success, terms and economics of a potential Cyprus reunification remain uncertain. A reunification would benefit both sides in the long term by boosting the economy, but would entail short-term costs and uncertainties. Focus on reaching an agreement, the economic recovery, and exit from bailout programme could have reduced the urgency and diverted political capital away from structural reform implementation, where progress has been slow; and in some areas has stalled, including the privatisation of the telecom operator and the public administration wage reform package. Presidential elections could further delay progress in politically sensitive areas. Cyprus's rating is supported by a high level of GDP per capita, a skilled labour force, and strong governance indicators relative to 'BB' peers. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns a score equivalent to a rating of 'BBB+' on the Long-Term FC IDR scale. In accordance with its rating criteria, Fitch's sovereign rating committee decided to adjust the rating indicated by the SRM by more than the usual maximum range of +/-3 notches because of Cyprus's experience of financial crisis. Consequently, the overall adjustment of five notches reflects the following: - Public Finances: -1 notch, to reflect very high government debt levels. The SRM is estimated on the basis of a linear approach to government debt/GDP and does not fully capture the higher risk at higher debt levels. - External Finances: -2 notches, to reflect Cyprus's vulnerability to external shocks as a small open economy, its high net external debt relative to peers (not captured in the model), and the fact that benefits of euro reserve currency (included in the model) as part of the eurozone were not fully passed on to Cyprus as evident in its loss of market access during the crisis. - Structural Features: -2 notches, to reflect the risks posed by the large and weak banking sector on public finances (as a potential contingent liability), the economic recovery, and macro stability. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES Future developments that may, individually or collectively, lead to an upgrade include: - Marked improvement in overall asset quality of the banking sector - Further track record of economic recovery and reduction in private sector indebtedness - Decline in the government debt to GDP ratio - Narrowing of the current account deficit and reduction in external indebtedness - A sustained track record of capital market access at affordable rates The Outlook is Positive. Consequently, Fitch does not currently anticipate developments with a high likelihood of leading to a downgrade. However, future developments that may, individually or collectively, lead to negative rating action include: - Failure to improve asset quality in the banking sector - Deterioration of budget balances or materialisation of contingent liabilities resulting in a stalling in the decline in government debt to GDP - A return to recession - A loss of capital market access. KEY ASSUMPTIONS In its debt sensitivity analysis, Fitch assumes a primary surplus averaging 2.1% of GDP, trend real GDP growth averaging 2%, an average effective interest rate of 3.3% and GDP deflator inflation of 1.7%. On the basis of these assumptions, the debt-to-GDP ratio would have peaked at almost 108% in 2016, and will edge down to around 85% by 2025. Gross debt-reducing operations such as future privatisations are not considered in Fitch's debt dynamics. 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. Contact: Primary Analyst Maria Malas-Mroueh Director +44 20 3530 1081 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Michele Napolitano Senior Director +44 20 3530 1882 Committee Chairperson Ed Parker Managing Director +44 20 3530 1176 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on Applicable Criteria Country Ceilings (pub. 16 Aug 2016) here Sovereign Rating Criteria (pub. 18 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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