Fitch reports that Cyprus is experiencing a strong improvement in the performance of and outlook for its public finances. They say that the budget is on track to record a surplus of 1% of GDP in 2017, after 0.4% in 2016, compared with the BB median of a 3.2% deficit. Additionally, Gross General Government Debt (GGGD) is forecast to fall just below 100% of GDP in 2017 from 108% at end-2016, owing to strong nominal GDP growth, the budget surplus and a one-off effect from early debt repayment. Their medium-term assumptions of 2% GDP growth and gradually increasing effective interest rates would lead GGGD to decline to around 80% in 2022.
The Cyprus News Agency reports that GDP growth has consistently outperformed forecasts over recent years, with Fitch now estimating an average 3.5% GDP growth in 2017 and 2018, in light of the broad-based recovery in the first half of 2017 (3.6%) and improving confidence indicators, compared with around 2.5% a year ago when Cyprus was upgraded to BB-. Fitch reports that the recovery is also reflected in the labour market, where unemployment rate has declined to 10.6% in 2Q17 from a post-crisis peak of 16% in 2014. Moreover, Fitch says that Cyprus is gradually rebuilding its track record of market access: it issued a seven-year bond in June 2017 at a 2.8% yield and current cash reserves exceed the sovereign`s total 2018 financing needs.
The banking sector`s weak asset quality remains a key weakness for Cyprus`s credit profile and a downside risk to the recovery. The ratio of non-performing exposures (NPEs) to total loans was recorded at 44.1% in June 2017, compared with 46.4% in December 2016.
According to Fitch, the three largest banks (Bank of Cyprus, Hellenic Bank and Cyprus Coop Bank) have had ambitious strategies since 2015, including debt-to-equity swaps, restructuring and establishment of servicing platforms but the resolution of NPEs remains slow. However, liquidity conditions have improved, reflected in the full repayment of ECB emergency liquidity assistance balance earlier this year.
Fitch also records that Cyprus`s ratings are supported by high GDP per capita, a skilled labour force, and strong governance indicators with the country`s current account deficit widening to 4.9% of GDP in 2016 from 1.5% a year earlier. For 2017 and 2018 Fitch forecasts deficit (including SPEs) to remain close to 5%, due to a pick-up in domestic demand, including investment with high import elasticity.
Future developments that may, individually or collectively, lead toan upgrade include:
- Reduction of private sector indebtedness and banking sector NPEs that materially reduce the sovereign`s contingent liabilities;
- Track record of declining GGGD/GDP ratio; and
- Narrowing current account deficit and reduction in external indebtedness.
Fitch notes that the Outlook is positive, hence, it does not currently anticipate developments with a high likelihood of leading to a downgrade.