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Standard & Poor’s downgrades Cyprus’ credit rating

STANDARD & Poor’s cut Cyprus’ long-term sovereign credit rating by a notch to ‘BBB’ from ‘BBB+’ yesterday, referring to the banking system’s exposure to the Greek sovereign debt.

In its press release, Standard & Poor’s said “In our opinion, the contingent liabilities posed to the Cypriot government by the Cypriot banking system’s exposure to Greece continue to weigh heavily on the ratings on Cyprus.”

“We believe that a Greek default scenario with private sector involvement (PSI) or “haircuts” higher than previously agreed by commercial creditors would necessitate the recapitalization of some domestic banking institutions.”

“We also believe the effect of a Greek government default could reverberate through Cyprus’ economy in the form of private-sector funding costs increasing beyond our previous expectations, thereby reducing investment and overall domestic demand.”

“Furthermore, weaker economic growth could worsen the Cypriot government’s debt dynamics and reduce the willingness of its political leaders to press forward with fiscal and labour market reforms.”

“We estimate the exposure of Cypriot banks to Greek debt (sovereign, corporate, and bank combined) at about 165% of Cyprus’ GDP.”

Commenting on the €2.5 billion bilateral loan agreement with the Russian government, S&P said that “this could help alleviate funding pressures well into 2012”.

However, it cautioned that temporary measures “would not structurally improve Cyprus’ public finances” and that “one-off agreements could reduce the willingness of social partners to agree to the planned fiscal consolidation measures”.

The move came only hours after EU leaders reached an agreement in which banks holding Greek debt would accept a 50 per cent “haircut” write-off.

Government response

Reacting to the S&P decision, in a statement, the government of the Republic of Cyprus “acknowledges the challenges which the Cypriot economy is facing due to the negative developments from Europe’s debt crisis”.

For this reason, it adds, “the Government intends to act promptly and decisively to take all necessary measures to achieve fiscal consolidation and to handle the challenges of the banking system in cooperation with the Central Bank”.

It urges the political parties to vote in favour of the 2012 Budget as well as all measures for fiscal consolidation “to give the message to markets that the Republic of Cyprus is determined to handle the challenges in an effective and decisive manner”.

On August 26th the House of Representatives approved the first of two packages of austerity measures aiming at fiscal consolidation. Presenting the 2012 state budget, Finance Minister Kazamias said it contains structural measures aiming to avert negative developments to the Cypriot economy.

It provides for total revenues of 6.22 billion euro, compared with 5.64 billion of 2011 and total expenditures, excluding loan payments, of 7.54 billion euro compared with 8.01 billion of the 2011 state budget.

The budget also includes provisions for a 10% reduction in entry-level salaries for civil servants, abolition of 1,100 vacant positions in the civil service, continuation of the freezing of procedures to fill up vacancies and for reducing by 200 million euro social benefits both by lowering the level of benefits and by introducing income criteria for certain benefits.