21/03/2022 12:14
Fitch Ratings has affirmed Cyprus's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook.
According to a statement, Cyprus's rating is underpinned by governance indicators and GDP per capita levels well above the median of its 'BBB' category peers. Institutional strengths and policy credibility are backed by eurozone membership. These strengths are balanced by high levels of private and public sector indebtedness, large external imbalances, and vulnerabilities in the banking sector.
"The Stable Outlook reflects our view that while the Cypriot economy is highly exposed to Russia through its tourism and investment linkages, near-term risks are mitigated by a strengthened government fiscal position, and continued normalisation of spending after the pandemic shock. Meanwhile, medium-term growth prospects remain positive on the back of the government's Recovery and Resilience Plan (RRP).", the agency notes.
Risks to GDP Outlook
The Cypriot economy rebounded strongly in 2021, expanding 5.5% after negative growth of 5.0% in 2020. The fall-out from the Russia-Ukraine conflict will hit the tourism sector, while the effects of sanctions on Russia and its impact on financial flows into Cyprus and its professional services sector is less certain. We have lowered our real GDP growth forecast for 2022 by 0.6ppts, to 3.1%, with risks predominately on the downside.
Exposure to Russia
Russia is the second-largest source of tourists for Cyprus (approximately 20%). For 2022, we have assumed a complete absence of this market. However, we still anticipate higher tourism activity relative to last year, reflecting further easing of pandemic travel restrictions across other key markets (e.g. UK, Germany, Greece). Cyprus is a small net importer of Russian goods (0.1% of GDP, 2019). However, a high energy import dependency (93% vs EU average of 60%, Eurostat) leaves it exposed to the current global commodity price shock. Financial linkages between Cyprus and Russia are significant, largely reflecting the activities of Special Purpose Entities (SPEs). Generally, SPEs have a limited impact on the domestic economy, but they affect demand for professional services (e.g. legal and financial). Meanwhile, the exposure of Cypriot banks to Russia has greatly reduced.
Strengthened Fiscal Position
Cyprus's general government deficit narrowed to 1.8% of GDP in 2021 (vs -5.6% in 2020), significantly outperforming the government's deficit target of 4.9%. The lower deficit was driven largely by higher-than-expected tax receipts. Fitch estimates that expiry of last year's Covid-19 support measures (3.1% of GDP) will lead to further narrowing of the fiscal deficit in 2022 to 0.9% of GDP.
Discretionary measures outlined in the 2022 Budget reflect mainly spending (0.8% of GDP) under the government's RRP, financed with grants (0.6% of GDP) and loans (0.2% of GDP). Temporary tax cuts for consumer fuel prices and VAT on electricity will have a negative impact on government revenues. Against the uncertain backdrop of high inflation, and outlook for the tourism sector, near-term fiscal risks remain elevated.
High Debt Ratio Resumes Downward Path
"We estimate general government debt declined by 11.1pp in 2021 to 103.9% of GDP, from a peak of 115% of GDP in 2020. A large drawdown of government deposits (equivalent to 4.2% of GDP, to a still high 16.5% of GDP end-2021), as well as higher economic growth, led the decline in debt. Our forecast of primary fiscal surpluses in 2022 and 2023 will lead to further declines in debt, to 96.4% in GDP in 2022 and 92.7% in 2023. Despite having a debt ratio substantially higher than the current median of 'BBB' peers (60.3% of GDP, 2021), debt sustainability is underpinned by a low share of short-term debt (1.2%) and a long average weighted debt maturity (7.9 years)", it adds.
Banking Sector Vulnerabilities
Banking sector metrics have improved despite the pandemic shock. Cypriot banks' capitalisation is high (average common equity Tier 1 ratio for the sector at 17.5% in December 2021), but the sector faces challenges over its remaining non-performing loan (NPL) stock, 45% of which have arrears of at least five years according to the European Commission.
Notable progress has been made in the sale and write-off of legacy NPLs (ratio at 9.8% of total loans in December 2021, compared to 26.1% in December 2019). The Cypriot authorities plan to facilitate the future sale of outstanding NPLs through its state-owned asset management company, KEDIPES, although this is still awaiting approval from the European Commission. Meanwhile, proposals for a potential change to the foreclosure framework, could undermine future progress in the resolution of NPLs.