ON FRIDAY Standard & Poor’s Global Ratings raised its long- and short-term foreign and local currency sovereign credit ratings on Cyprus to ‘BBB-/A-3’ from ‘BB+/B’ with a stable outlook.
In its announcement S&P explained the rationale behind its decision:
The Cypriot economy will continue to grow at a solid pace through 2021, our forecast horizon, enabling the government to alleviate its debt burden.
Measures by Cypriot policymakers to markedly reduce the stock of nonperforming assets in the banking system via financial support and legislative changes have improved the sector’s health and are likely to facilitate further recovery efforts.
Any additional financial state support to the banking sector will only moderately affect the sovereign balance sheet.
The ratings are also supported by policymakers’ efforts to consolidate public finances and restore the health of the banking sector. In 2018, the government injected about 15% of GDP into the country’s second-largest bank, the majority state-owned Cyprus Co-operative Bank (CCB), to strengthen its balance sheet and carve out its nonperforming assets into a residual entity. This will significantly reduce the banking sector’s non-performing exposures (NPEs) to an estimated one-third of total loans from one-half before.
We also expect that various other legislative changes will support Cypriot banks’ efforts to further reduce bad assets over the medium term. We assume additional support to the banking sector via the government’s balance sheet from now through 2021 will be moderate.
Commenting on the upgrade President Anastasiades tweeted “The return after 6.5 years to investment grade is the strongest confirmation of the prudent management that we followed and continue to follow, our economy is recovering with the best omens being confirmed.”
S&P warns of vulnerabilities & risks
In its announcement S&P warned that vulnerabilities still persist from high levels of private sector debt. Despite recent developments, the banking sector’s stock of NPEs remains large and its ability to attract financing at reasonable costs is likely to remain challenged for a while. Nevertheless, we expect that the underlying recovery will support the sector’s efforts to strengthen. The Cypriot private sector balance sheet is among the most indebted in Europe, at about 240% of GDP (at end-2017; not including special purpose entities).
Despite solid economic growth, private sector debt is likely to remain high over the medium term, although tapering slowly via repayments–currently financed by savings, restructuring, ongoing write-offs, and debt-for-asset swaps with banks.
S&P also notes that the increasing concentration of the economy in tourism and construction activities presents another potential risk.