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DBRS upgrade welcomed by Cyprus, natgas revenue at €20bln

28 June, 2014

The government has welcomed Friday’s upgrade by the Dominion Bond Rating Service (DBRS) of Cyprus’ long-term foreign and local currency issuer ratings from CCC to B (low).
Government spokesman Nikos Christodoulides said that “the upgrade reflects DBRS’ view that near-term default risks have eased considerably with the authorities’ strong implementation of their macroeconomic adjustment programme,” and “progress on stabilising the financial system.”
It also notes that “investment into the gas sector combined with the adoption of a sound fiscal framework that utilises additional revenues to strengthen the sovereign balance sheet could also have positive effects,” Christodoulides added.
He stressed that the government remains committed to maintaining the fiscal goals it has set as well as implementing measures and policies for growth that will lead to the full recovery of the Cyprus economy.
DBRS said in its report on Cyprus that “the upgrade reflects DBRS’ view that near-term default risks have eased considerably with the authorities’ strong implementation of their macroeconomic adjustment programme, progress on stabilising the financial system, and the economy’s outperformance relative to earlier program forecasts. Nonetheless, at B (low), the rating underscores the depth of Cyprus’ challenges and heavy reliance on EU funding."
It added that "high public sector debt combined with elevated real interest rates raises significant questions regarding debt sustainability. The process of deleveraging across the public, corporate and household sectors could be prolonged, leaving the economic recovery heavily reliant on external factors. Meanwhile, delays in the resolution of non-performing loans (NPLs) could reduce recovery values and add to final bank recapitalisation costs."
According to the report, "continued outperformance relative to programme targets combined with strong and durable support from external demand could lead to upward pressure on the Republic’s ratings. Investment into the gas sector combined with the adoption of a sound fiscal framework that utilizes additional revenues to strengthen the sovereign balance sheet could also have positive effects. On the other hand, a prolonged period of shrinking output, particularly if combined with fiscal policy slippages or additional bank rescue 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 Cyprus’ creditworthiness," it added.
DBRS also said that "in the long-term, exploitation of offshore natural gas deposits should provide a major new source of income for the island economy," adding that the government estimates that current proven reserves are likely to bring in net revenue of close to EUR 20 bln over the next 20 years (over 120% of 2013 GDP).
"If managed prudently, the associated financial inflows could help to significantly reduce Cyprus’ vulnerability to shocks. In addition, related investment and lower domestic energy costs could have ancillary benefits for the Cypriot economy. The pace of development in the gas sector could nonetheless be affected by relations with Turkey," it noted.
According to DBRS, "in spite of these strengths, Cyprus faces several near-term challenges. Private sector debt ratios are at historically high levels and suggest that growth will be constrained by further deleveraging. Household and corporate balance sheets have been damaged in the crisis, including through the bail-in of uninsured depositors."
"Real estate prices are still declining and the ultimate impact of the decline on household wealth and on bank solvency is not yet clear. Financial institutions will need to significantly reduce outstanding domestic credit or identify significant new sources of funding. Consequently, Cyprus’ small and relatively undiversified economy will remain highly dependent on external demand for the foreseeable future. DBRS 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," it added.