International credit rating agency, Capital Intelligence (CI), has upgraded the Republic of Cyprus’ Long-Term Foreign Currency Sovereign Rating to ‘B’ from ‘B-’ and affirmed its Short-Term Foreign Currency Rating of ‘B’.
The Outlook for the ratings is ‘Stable’.
According to CI, the upgrade of Cyprus’ ratings reflects an increased likelihood that the delayed tranche of financial assistance from the European Stability Mechanism (ESM) and International Monetary Fund (IMF) will be released in the near term.
The upward revision also indicates stronger signs of stability in the local banking system, with all but one of the major banks passing the recent stress tests and asset quality review carried out by the European Central Bank (ECB).
“The one bank that had a capital shortfall is already in the process of raising common share capital from private investors, which is expected to more than cover the shortfall before year-end,” an official report explains.
Better-than-expected economic and fiscal performance which has prompted favourable revisions to growth, budget deficit and debt forecasts is also cited as a main prerequisite to the upgrade.
“Near term refinancing risks appear to have receded further following the Eurogoup’s statement earlier this month,” CI notes, “which acknowledged that the Cypriot authorities had made sufficient progress towards establishing an effective legal framework for private debt restructuring and indicated that disbursements of ESM-IMF funds would resume provided that planned changes to the foreclosure process are not altered or delayed.”
The Eurogroup’s statement followed the ruling of the Supreme Court of Cyprus at the end of October that opposition-promoted bills to limit the scope of government-backed legislation on the foreclosure of mortgaged properties were unconstitutional.
Changes to the foreclosure regime are expected to help reduce the high level of non-performing loans (NPLs) in the banking system and support the resumption of lending to businesses and households.
CI further notes that banks’ balance sheets continued to strengthen as capital buffers increased and deposits stabilised.
In view of the latest results of the comprehensive assessment of the ECB, CI views that risks posed by the banking sector to the economy and the sovereign have declined to some extent.
Economic contraction continues to be more moderate than expected in CI’s last report due to the resilience of some service sectors and the mobilisation of household savings.
Real GDP contracted by a lower than expected 3.2% year-on-year in H1 2014. The IMF has revised − for the second time − its 2014 forecast for the Cypriot economy, and now expects real output to shrink by 3.2% rather than 4.2%.
The economy is tentatively expected by CI to return to positive growth by the end of 2015. “Progressive improvement in economic and fiscal performance could reflect positively on improving debt sustainability in the medium to long-term,” its report indicates.
“The public finances are improving and the budget has outperformed the quantitative targets set by the troika,” it continues. The general government budget primary deficit is expected to fall to 0.3% in 2014, compared to 2.0% of GDP in 2013, while the overall budget deficit is expected to decline to 4.4% of GDP in 2014, from 5.4% of GDP in 2013.
The public finances are expected to continue improving over the intermediate term, and the primary balance is currently expected by CI to post a modest surplus by 2015 – a year earlier than previously expected − provided no fiscal slippage occurs.
“Notwithstanding the above developments, the economy remains fundamentally weak and risks to the economic outlook remain substantial,” CI cautions. The debt overhang in the business and household sectors is very large, it continues, and the banking crisis has undermined the country’s medium-term growth prospects by eroding investor confidence and severely constraining access to credit for local businesses.
Moreover, Cyprus’ ratings remain constrained by large socioeconomic challenges and limited competitiveness. The unemployment rate in Cyprus is one of the highest in the EU, as the economy struggles to adjust to a more sustainable, job-creating growth pattern.