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Cypriot bond yields defiantly high

12/01/2015 06:48
Cyprus continues to pay a relatively high premium on its debt despite the marked improvement in its budget balance and the stabilization of its banking sector.

Bond investors price the risk of lending to Cyprus as the highest in the Eurozone after Greece.

The Greek government 10-year bond yield stands at above 10% while that of Cyprus at above 5%.

From the eight Eurozone countries that have a "total government debt to gross domestic product" ratio above 90%, Cyprus is ranked seventh with a ratio of 102,2% as at end of 2013.

Two of the three countries that were under economic adjustment programs and have now concluded them, Portugal and Ireland, continue to have debt ratios of 128% and 123,3% respectively, much higher than Cyprus' and yet enjoy much lower yields at 2,54% and 1,08% respectively.

The "government deficit to gross domestic product" ratio for Cyprus, which is another important determinant of bond yields, has improved considerably during 2014. For the first eleven months the budget balance records a surplus and for the whole year the government projects a deficit of below 2,5% and a primary surplus.

Consequently, it seems that other crucial factors might be at play.

Among the factors that seem to distinguish Cyprus from other Eurozone countries is the level of private debt, which, at 350% of GDP, remains among the highest in the Eurozone. With non-performing loans nearing 50% and with the banks lacking adequate mechanisms to deal with troubled borrowers, markets might be pricing the possibility of future support for troubled borrowers or banks.

Moreover, the implementation of Cyprus’s adjustment program itself has run into difficulties lately with the executive and the legislature disagreeing over the foreclosures law.

This resulted in the IMF not disbursing its tranche of €86 mil and in Troika's postponement of its next program evaluation of late January. The last evaluation was undertaken in July.

The risk of a potential derailment of the program reversed the declining course of the bond yield that lasted till early December as the 10-year bond yield dropped to 4,8% from 8,2% at the beginning of 2014. Since then it has climbed to 5,266%. The increase seems to have accelerated in the last few days.

The political situation also seems to take its toll as Turkey constantly violates Cyprus exclusive economic zone in an ongoing effort to achieve the end of natural gas exploration.

This, coupled with the continuing Turkish occupation of part of the island increases the country risk for Cyprus.

The capital controls that are still in place since March 2013 constitute an additional risk and further differentiate Cyprus from other Eurozone members.

The illiquidity of the Cyprus bond market seems to also generate more exit-related risk for investors.

The persistence of high bond yields complicates the government's plan to tab international bond markets in 2015 for the first time since last June, when it borrowed at 4.75%.

In an effort to normalize the situation the government is trying to present to the parliament the insolvency law in its entirety so as to facilitate the voting of the foreclosures law the soonest possible.

Such a development would put the reform program back on track which would in turn most probably ease investors' concerns and thus decrease bond yields. It would also ease concerns about the possible migration of banks’ balance sheet problems to the state coffers.