Fitch rating agency has upgraded Cyprus’ long - term credit rating to BBB- from BB+ assigning stable outlook, elevating the Cypriot economy to investment-grade after seven years in junk.
The agency cited buoyant fiscal revenue associated with prudent fiscal policy, a projected declining public debt trajectory and economic growth.
“Cyprus is benefitting from a strong economic recovery with real GDP reaching pre-crisis level and the economy forecasted by Fitch to grow 4% in 2018 and 3.8% in 2019, supported by large foreign-financed investment projects in construction and tourism, and robust private consumption,” Fitch said.
The agency notes that buoyant fiscal revenue and prudent fiscal policy mean we expect Cyprus will record a fiscal surplus of 2.7% of GDP in 2018, compared with a target of 1.7% in the April 2018 Stability Programme Update and a current `BBB` median fiscal deficit of 2%.
“We forecast the fiscal surplus will remain high at 2.4% and 2.2% of GDP in 2019 and 2020, respectively, compared with 3.1% and 2.9% targeted in the 2019 Draft Budgetary Plan,” the agency added, noting that robust economic growth will boost fiscal receipts, while previously adopted hiring freeze and collective agreements will likely limit growth in the wage bill.
The agency said Cyprus`s gross general government debt (GGGD)/GDP will remain on a firm downward trajectory, despite a one-off expected increase in 2018, due to the placement into Cyprus Cooperative Bank (CCB) of €3.19 billion government bonds (15.5% of GDP) to facilitate the acquisition of part of the state-owned bank by Hellenic Bank (HB), GGGD/GDP is set to increase to 104.4% at end-2018 from 95.7% in 2017.
“However, we expect large primary surpluses, robust growth and contained nominal effective interest rates will reduce GGGD/GDP to 70% of GDP by 2027,” the agency said.
On the banking sector, the agency said the ratio of non-performing exposures (NPEs) to total loans decreased to pro-forma 40.3% in the first half of 2018 from 44% in 2017, partly supported by the announced securitisation by Bank of Cyprus (BoC) of EUR2.7 billion gross NPEs, which is still subject to regulatory approval by the European Central Bank.
It noted that the acquisition by HB of CCB`s good assets and the subsequent transfer into a run-off entity of CCB`s EUR5.7 billion NPEs portfolio are estimated to have led to a further decrease in NPEs to 30% in September 2018, that would “support a substantial decrease in contingent liabilities stemming from the banking sector, although these remain large.”
The agency highlights further “decisive steps” taken by the government to address legacy issues within the banking sector, such as legislative amendments aimed at facilitating NPEs securitisation and sales of loans, and strengthening foreclosure and insolvency toolkits were adopted by the parliament in July, as well the government intention to launch a subsidy scheme to defaulting borrowers (Estia scheme) in January 2019, which implies loan restructurings and state subsidies to incentivise loan repayment.
It notes however that the so far use of foreclosure instruments have been negligible and the degree of implementation of the scheme and enforcement of the new legislative package remains uncertain.
Fitch notes that additional fiscal costs could arise from potential calls on the government-guaranteed Asset Protection Scheme, covering unexpected losses on EUR2.6 billion of CCB`s assets acquired by HB, whereas state subsidies related to the Estia scheme and increased debt servicing costs following government support to CCB are estimated at a yearly 0.5% of GDP by the government and are already captured in our forecasts.
However, Moody’s points out that the Cyprus banking sector remains extremely weak, as “very weak asset quality and high NPE ratios are still weighing on new lending and profitability.”
Although following CCB transaction and the loan sales by Bank of Cyprus unreserved loans will decrease to an estimated EUR3.8 billion (19% of GDP) this could lead to some capital shortfall if losses are crystallised and higher-than-expected haircuts incurred on collateral.
“This level of unreserved NPEs is significantly relative to the banks` common equity Tier 1 capital, highlighting their vulnerability to asset quality shocks,” the agency added.
Fitch said gross government debt-reducing operations such as future privatisations and potential proceeds from natural gas reserves are not considered in Fitch`s baseline scenario.
The agency also noted it does not “expect substantial progress with reunification talks between the Greek and Turkish Cypriots over the next quarters.”
“The reunification would bring economic benefits to both sides in the long term but would entail short-term costs and uncertainties” Fitch said.