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By Shavasb Bohdjalian
Standard and Poor’s decision to downgrade Cyprus’ credit rating by two notches, to BB+ rating, or junk level is due to fears about a Greek default and eurozone issues, rather than the government’s recent fiscal measures.
Finance Minister Kikis Kazamias accused the rating agency of having a hidden agenda but in reality this does not appear to be the case. The agency cited the significant exposure of Cypriot financial institutions to Greek national debt and the political, financial and monetary crisis within the eurozone as the reasons behind the downgrade.
S&P downgraded 15 other eurozone nations including France and Austria, with both nations losing their AAA rating and joining the United States and Japan, which previously saw their ratings cut.
Kazamias complained that S&P had completely ignored the fact that Cyprus was one of the few countries that had fully covered its financing requirements for 2012 and had also ignored the publication of results demonstrating the existence of significant gas reserves in the Exclusive Economic Zone (EEZ) of Cyprus.
Kazamias is very correct in pointing that the long term prospects of Cyprus have improved following the discovery of significant gas reserves in Block 12 of the EEZ, but we all know well that the benefits of the gas find will start to materlialise from 2015 or 2018 the earliest and there is no guarantee that the recent measures implemented by the government will actually succeed in lowering the deficit to below 3%.
European Commissioner Olli Rehn praised Cyprus for adopting measures for consolidating its finances but if consumption weakens further, the government will need to rush through additional measures, probably sometime in September to meet its promised targets if the VAT hike does not generate the targeted revenue.
There is a good chance that Cyprus may experience the same problem that Greece has been facing, whereby there is no end in sight to the vicious circle of new austerity measures and tax hikes, which weaken the growth rate and in turn push the deficit higher, resulting in the need for new and even harsher austerity measures.
If the other rating agencies follow S&P’s lead and downgrade Cyprus to junk status, this will force the ECB to refuse to accept Cyprus government bonds as collateral for future loans and even more devastating, oblige the Cypriot banks to repay the cheap loans that they have taken from the ECB by pledging their Cyprus bond holdings as collateral. Hopefully, the ECB may do an exemption for Cyprus as it did in the case of Greece.
The S&P’s immediate focus is on the EFSF Fund. France’s downgrade weakens the backing for the EFSF and more importantly may weaken investor confidence in the EFSF, which now risks losing its AAA status. Equally important, markets will now watch to see how the negotiations in Athens with the IIF over the Greek bond swap plans make progress.
Negotiations with the banks on a bond swap scheme designed to reduce Greece's colossal debts are expected to restart on Wednesday with Athens warning of catastrophe if they fall apart, according to Reuters.
Without a deal, a planned EUR130 bln Greek bailout of which the bond swap is a vital part will be fundamentally holed, raising the prospect of default in March when massive bond payments are due. That, rather than the long-anticipated S&P downgrades, looks to be the bigger worry for investors.
According to an analysis by BNP Paribas, there is a major risk that failure to reach a voluntary PSI deal will be perceived as raising risk of Greek euro exit this year, and that this will weigh negatively on the euro.
If Greece does in fact default or fails to reach a deal with its private investors, then a possible exit out of the eurozone will have a devastating impact on Cyprus, considering the sizeable exposure of Cyprus banks to Greek bonds, their massive loan portfolio in Greece and the fact that they generate about a third of revenue from their operations in Greece.
S&P is well justified in downgrading Cyprus now in view of its concerns about Greece. In the event however, that Greece manages to find an acceptable formula to remain in the eurozone and somehow, a default is avoided, then it would only be fair to expect S&P to adjust its ratings on Cyprus higher, but in the meantime, we have to endure the pain.
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(Shavasb Bohdjalian is a certified Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, regulated by CySEC, license #114/10 and approved by the Cyprus Stock Exchange to act as Nominated Advisor for listings on the Emerging Market. The views expressed above are personal and do not bind the company and are subject to change without notice)
