Scope: Cyprus enjoys strong growth but liabilities persist

4 mins read

Strong growth prospects and sustained fiscal discipline places Cyprus on a firm declining path but contingent liabilities, healthcare and public sector wage-related costs, as well as weaker external conditions, pose risks to the outlook, Scope rating agency said.

Scope noted that Cyprus is set once again to outperform its budgetary targets for 2019, with the government primary surplus recorded at 6.9% of GDP in the 11 months to November, above the 6.2% target set out in its 2019 draft budget.

Cyprus’ average primary surplus, excluding the one-off impact of the sale of Cyprus Cooperative Bank, amounted to 4.5% of GDP over the period of 2015-19, by far the highest in the euro area, Scope said.

“The fiscal performance of Cyprus over the past five years has been remarkable and reflects the substantial consolidation policies pursued by the government following the crisis,” said Alvise Lennkh, lead analyst for Cyprus at Scope.

“We view the government’s commitment to maintaining this strong fiscal trajectory positively as high public debt levels remain a key credit constraint for the country.”

He noted that Cypriot public debt amounted to 98% of GDP in Q3 2019, which, on top of private debt equivalent to 261% of GDP, leaves the economy vulnerable to shocks.

Scope expects the country to continue posting strong primary surpluses in view of current budgetary plans, which should result in a significant deleveraging of the public sector, with public debt-to-GDP ratio estimated to drop to around 65% of GDP by 2024, the strongest reduction among euro area countries.

However, the fiscal outlook for Cyprus – a small, open economy – faces multiple downside risks that could slow the pace of consolidation, namely the contingent liabilities stemming from the banking sector present a considerable risk to public finances.

“While the stock of NPLs has fallen markedly from a peak of €28 bln during the crisis to around €6 bln currently, the risk that these remaining vulnerabilities crystallise and shift from banks to the government’s balance sheet remains a key concern for us,” Lennkh said.

The second risk to public finances stems from a Supreme Court ruling relating to crisis-era cuts in public-sector wages and pensions, which were deemed unconstitutional by the lower courts.

“This could lead to a significant fiscal cost for Cypriot authorities – estimated at €800 mln for a period of four years, or about 4% of GDP – if the initial decision is upheld and more civil servants submit claims,” said Scope analyst Thibault Vasse.

The government’s commitment to cover any deficits arising from the newly-installed General Health System could result in some fiscal slippage.

“The system posted a surplus in 2019 but concerns remain regarding its long-term sustainability,” said Vasse.

Furthermore, Scope said Cyprus’s very open economy will have to face a less supportive external environment in the coming years.

“The slowing growth of its major trading partners, an uncertain global trade outlook and Brexit-related uncertainties will test the robustness of the country’s growth model.”

The economy relies on sectors, such as tourism, construction, real estate, banking, and professional services, which are either dependent on external demand or foreign financing,

“An external shock to any of these sectors would have implications for the country’s economic growth, fiscal performance as well as financial stability,” said Scope.