articles | 11 June 2015

DBRS confirms Cyprus at B (low) with stable trend

DBRS, Inc. has confirmed the long-term foreign and local currency issuer ratings for the Republic of Cyprus at B (low).

The rating agency has also confirmed the short-term foreign and local currency issuer ratings at R-5, with the trend on all ratings remains Stable. 

DBRS said that “at B (low), the ratings reflect the depth of Cyprus’ challenges and continued heavy reliance on external funding. Fiscal performance has exceeded expectations, and authorities have successfully reformed domestic bankruptcy and foreclosure laws. This has enabled a material improvement in the debt profile and the government’s liquidity position, which benefits from ECB policies. However, parliamentary opposition has resulted in delays in enacting critical reforms.”

“Effective restructuring of non-performing loans, now 157% of GDP, is crucial. A deep decline in property prices from current levels could pose significant challenges for the banks. Initial signs of economic stabilisation are emerging, but the recovery remains reliant on external demand.”

Continued strong economic and fiscal performance could lead to an upgrade, DBRS said.

Accelerating progress on NPL resolution, privatisation and efforts to encourage foreign investment could also provide support to the ratings. Additional efforts to extend the debt maturity profile and limit gross financing needs in the post-programme period are also likely to have a positive impact.

On the other hand, the rating agency warned that a prolonged period of weak growth, particularly if combined with fiscal policy slippages or additional bank support costs, could result in downward pressure on the ratings.

“External factors, including political developments between Cyprus and Turkey and between the EU and Russia, could also have an impact on creditworthiness,” it said, adding that though direct financial linkages have been significantly reduced, developments in Greece could also have an impact.

DBRS echoed opinion expressed by other rating agencies that “given the Republic’s strong performance under the 10 billion Eurogroup/IMF programme thus far, Cyprus is unlikely to need the full amount of support available under its existing programme.”

The low tax environment remains attractive to foreign corporations and although Cyprus’ advantages are not unique and could be eroded by external competitors or by regulatory changes in creditor countries, DBRS expects the business services sector to remain an important source of employment and income for the Cypriot economy.

Cyprus’ geographic location makes the island a relatively convenient summer tourist destination for Europeans. Rising household incomes in Eastern Europe should continue to provide a stable source of growth in tourist arrivals. The declining rouble and Russian recession have had a significant impact on overall tourism receipts, but this has been partially offset by increased tourism from the UK and other countries.

Within the next decade, exploitation of offshore natural gas deposits could provide a major new source of income for the island’s economy. The government estimates that current proven reserves are likely to bring in net revenue of close to €20 billion over the next 20 years (over 110% of 2013 GDP).

“If managed prudently, the associated financial inflows could help to significantly reduce Cyprus’ vulnerability to shocks,” DBRS said, adding that, “related investment and lower domestic energy costs could have ancillary benefits for the Cypriot economy. The pace of development of the gas sector could nonetheless be affected by relations with Turkey.”

However, the rating agency warned, “in spite of these strengths, Cyprus faces several near-term challenges. General government debt is expected to peak at 108% of GDP next year. Although the fiscal adjustment appears largely complete at this stage, continued fiscal discipline and stronger economic growth will be essential to bring debt down to more manageable levels over time. Gross financing requirements through mid-2016 should be comfortably met through official financing, and the government hopes to take advantage of lower market interest rates to extend debt maturities and minimise financing needs in the post-programme period (2016-18).”

Private sector debt ratios are also at historically high levels and suggest that growth will be constrained by further deleveraging. Real estate prices are still declining and the ultimate impact of the decline on household wealth, domestic savings, and bank solvency is not yet clear.

DBRS concluded that it “expects only gradual improvements from efforts to extend the tourist season and remains concerned that competition from other Mediterranean locations may dampen growth in the sector. If growth in tourism and business registration slows significantly, the economy could face gradually declining output for years to come as the domestic deleveraging process continues. Russian demand is particularly important, though additional shocks from Europe could also have negative effects on Cyprus.”

Source: Financial Mirror

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