Cyprus ratings lowered as bailout talks continue

STANDARD & Poor’s Ratings Services said yesterday that it had lowered its long-term sovereign credit rating on the Republic of Cyprus to ‘BB’ from ‘BB+’.

At the same time, it affirmed its short-term sovereign credit rating on Cyprus at ‘B’.

The agency expects that Cyprus will negotiate a financial support package of €11 billion, or just over 60% of Cyprus’ GDP. As a consequence, it estimates Cyprus’ net general government debt burden will increase by nearly 12% of GDP on average in 2012 and 2013, peaking at over 105% of GDP in 2013.

Meanwhile, S&P believes that Cyprus’ short-term financing pressures are increasing as its negotiations with the European Union, ECB, and IMF (Troika) are unlikely to conclude before September, and significant uncertainty remains over securing bilateral funds.

In its statement, Standard & Poor’s said that “We continue to hold the view that the government of Cyprus will negotiate a financial support package to recapitalize its banking system to meet the European Banking Association’s regulatory minimum. We also expect that, through a conditional lending program, the Troika will provide Cyprus with a credible back-stop to further bank losses, as well as budgetary support.

“We are therefore fully factoring into our ratings on Cyprus our estimates of a likely financial support package. However, even with official assistance – which we view as vital if Cyprus is to avoid default–we believe the government will remain in a weak fiscal position due to a banking system that has been unable to cope without government support as a result of its exposure to Greek customers.

“We estimate that Cyprus needs the equivalent of just over 60% of its GDP to recapitalize its banks, absorb further bank losses, and meet 2012-2014 borrowing requirements. In our base case, we forecast an average increase in general government debt of over 10% of GDP in 2012 and 2013, peaking at 108% of GDP in 2013.

“While we believe that lending rates from the Troika (or from bilateral sources such as the Russian government) will be relatively low, we expect that the increased burden of financing a gross general government debt stock of 108% of GDP, and the expected continuation of budgetary cuts will weigh significantly on Cyprus’ near-term growth prospects. This drag will come over and above the negative impact on domestic demand from financial sector deleveraging.”

S&P went on to say that it expects Cyprus’ creditors to impose what it called “significant” conditions on their loans, in line with recent European Commission stability program proposals and that “the most contentious discussions will centre on public sector wage cuts, changes to (or even the abolition of) the automatic wage indexation mechanism, and potential modifications to Cyprus’ advantageous tax environment.

“Should the government implement the conditionality fully, the implications would likely be positive for Cyprus’ creditworthiness as these would aim to reform public finances and reduce large economic imbalances.”