Cyprus sovereign ratings raised on better fiscal prospects

Standard & Poor's Ratings Services said it had raised the long-term sovereign credit rating on the Republic of Cyprus to 'A+' from 'A.' The 'A-1' short-term rating and 'AAA' T&C assessment were also affirmed. The outlook is stable.
"The upgrade reflects the improved prospects for fiscal performance," Standard & Poor's credit analyst Ana Mates said. "The government recorded a 3.3% of GDP general government surplus in 2007, and we expect a smaller surplus this year (1.0%) and in the near term."
A significant portion of the improvement in 2007 was due to very favorable revenue intakes, largely due to capital gains tax and corporate tax. The lower surplus in the near term is due to the temporary nature of some of the improvements in government revenues. The government's medium-term objective of a balanced budget will in large part depend on the progress made in implementing the medium-term budgetary framework, which will be vital to restrain expenditure growth.
Weighing on the improved fiscal flexibility are contingent liabilities, which are large and rising in tandem with the expansion of Cyprus' dynamic financial sector. Levels of financial intermediation in Cyprus are at the high end of the range for rated sovereigns. After extremely high credit growth in 2007, domestic credit to the private sector and nonfinancial public enterprises (NFPEs) is estimated at around 200% of GDP. We estimate that, under a reasonable worst-case scenario, gross problematic assets in the Cypriot banking system could range between 25%-40% of domestic credit to the private sector and NFPEs, or about 80% of GDP.
"The stable outlook balances our expectation that the government's commitment to budgetary consolidation will reduce the debt burden against competitiveness challenges and high off-budget and contingent liabilities," Ms. Mates said. "Maintaining expenditure discipline through a less favorable economic environment would support further improvements in creditworthiness, as would additional progress in the implementation of the medium-term fiscal strategy. Conversely, a return to the high deficits of the recent past would likely weaken the government's credit standing. We expect domestic credit growth to converge toward EMU average levels over the medium term. However, persistent divergence of credit growth versus the EMU could worsen imbalances, increase contingent liabilities, and lead to downward pressure on the ratings."