Rating agency Moody’s changed its Cyprus economy outlook to positive from stable, citing reduction of sovereign exposure to event risks stemming from the banking sector and improving fiscal strength beating previous expectations.
However, Moody’s affirmed Cyprus’ long-term rating to Ba2, two notches below investment-grade, and remains the only rating agency to maintain Cyprus` rating to junk.
“The primary driver of the positive outlook is that Cyprus’ bank-related exposure to event risk continues to decline,” Moody’s said.
It noted that policy action by the government and actions by the banks will likely lead to a further large reduction in non-performing exposures (NPEs) over the coming 18 months.
Recalling that NPEs in the Cypriot banking sector declined to 30.6% of gross loans in March 2019 from their peak of 49.8% in May 2016, Moody’s “expects that number to continue to fall, and quite possibly to halve, over the next 12-18 months.”
The agency cites two factors. Namely the government scheme ESTIA, launched on 2 September, aiming to subsidize repayment of NPEs collateralized by primary residences by one third with these loans “the most difficult area of NPEs.”
According to Moody’s, ESTIA will assist repayment of NPEs amounting to € 1.1 billion held by Bank of Cyprus and Hellenic Bank rated by the agency.
“These NPLs amounted to 11% of total NPEs in the banking sector as of March 2019.”
“The banks will complete further major asset sales over the period,” noting that amendments approved by Parliament on forecloses “would hinder the process somewhat.”
Moody’s said, “Cyprus`s debt metrics are improving at a faster pace than we had previously anticipated and from a lower level.”
And the impact of the resolution of Cyprus Cooperative Bank had a less pronounced impact on the country’s debt burden last year, increasing to only 102.5% compared to Moody`s previous expectations of 107% of GDP.
The government was forced to issue €3.2 bln in bonds in the second half of 2018 to facilitate the sale of nationalized Cooperative Cyprus Bank to Hellenic Bank, which lead to a spike in the country’s national debt above 100%.
“The government has returned to running large primary and fiscal surpluses , and we expect this trend to continue.”
That debt is expected to fall to 97% of GDP this year and, due to sizeable primary surpluses and ongoing low funding costs, it will continue to fall by around 5 percentage points per annum, to around 75% by the end of 2023.
“While Cyprus faces rising spending pressures coming from health care, public sector wages, and Estia, we believe that the debt burden will continue to decline, albeit at a slower pace, even were these pressures to increase expenditure levels.”
Cyprus’ rating to Ba2 was down to “improvements in its economic resilience in recent years and the government`s track record of fiscal outperformance in the wake of the country`s banking crisis.”
Cyprus’ challenges arise from its small and relatively undiversified economy, as well as from high levels of government, non-financial corporate, and household debt, increased spending pressures which potentially could weigh on fiscal prospects, the island’s weaker institutions compared to other EU peers and the still-large financial sector remains burdened by the second-highest NPE ratio in the EU.
Moody’s would consider upgrading Cyprus’ sovereign rating if NPEs continued to fall to levels substantially below 20%, reflecting a material improvement in the strength of the banking system and reducing contingent liability risk and if there is “greater clarity” that the debt burden will continue to fall steadily to below 90% over the coming 1-2 years.
“While a downgrade is currently unlikely, as reflected by the positive outlook, the issuer’s credit profile could weaken if growth or fiscal policy decisions were to cause a reversal of the supportive fundamental debt trend.
Failure to bring down the stock of NPEs in the banking sector would also put downward pressure on the rating.”
