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CI raises Cyprus outlook on lower fiscal risk, better NPLs

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Capital Intelligence has revised upwards the sovereign ratings for Cyprus due to a “faster than projected decline in general government debt due, consistent primary fiscal surpluses, as well as proactive debt management.”

The rating agency said it also took into account the progress made in clearing up non-performing loans (NPLs) in the banking system, as a result of which, government contingent liabilities from the banking sector have declined significantly in recent years.

CI Ratings said the outlook on Cyprus’ long-term foreign currency rating (LT FCR) was raised to ‘positive’ from ‘stable’ and affirmed the sovereign’s LT FCR and short-term FCR (ST FCR) at ‘BBB-’ and ‘A3’, respectively.

“The government continues to manage its debt maturity profile in order to reduce refinancing risks, maintaining an increasing cash buffer to counter short-term shocks and external adversities. Other fiscal risks appear to be manageable at present, notwithstanding the challenging external environment and still tight global financial conditions.

The rating agency said Cyprus’ ratings continue to be supported by the demonstrated resilience of the economy and high GDP per capita. The ratings also take into account the benefits of European Union and eurozone membership, including the availability of financial support from the Recovery and Resilience Facility (RRF).

It said the ratio of general government debt to GDP fell to 77.3% in 2023 from 85.6% in 2022, reflecting a higher than projected primary budget surplus of 4.2% of GDP (3.4% in 2022) and the repayment of bonds and loans to the tune of EUR 1.4 bln (4.7% of GDP).

CI Ratings said it expects government debt dynamics to remain favourable over the coming years, with the debt-GDP ratio continuing to decline, albeit to a still moderate-to-high 66.2% (165.2% of revenues) in 2025.

“Debt maturities – which are estimated at EUR 2.4 bln (7.6% of GDP) for 2024 and EUR 1.8 bln (5.2% of GDP) for 2025 – are within the repayment capacity of the government and do not pose any refinancing challenges at present.”

General government budget performance remained very strong in 2023, with the budget position (on a cash basis) posting a higher than projected overall surplus of 2.9% of GDP (compared to 2.4% in 2022).

“CI expects the general government budget to remain in surplus in 2024-25, averaging 3.1% of GDP.”

Risks to the fiscal outlook persist and outcomes could be weaker than envisaged if fiscal discipline declines or spending on subsidies, social welfare, and public sector wages increases. Other risks to the budget stem from the cost of the national health system (GESY) and a potential decline in tax revenues if downside risks to GDP growth materialise.

“At present, CI considers the impact of high-risk premia and tight eurozone monetary policy on the public finances as being manageable due to the decline in general government debt and the high proportion (70%) of fixed-rate debt in total debt.

Refinancing risks remain stable

“Short-term refinancing risks have remained stable since our last review. This is due to the government’s sound fiscal management, favourable debt maturity structure, and timely access to capital markets, as well as the prudent building of cash buffers that cover over 200% of gross financing needs for at least the next 12 months.”

The rating agency said banking sector strength has improved considerably in recent years, but is still considered moderate.

According to the Central Bank of Cyprus, the aggregate NPL ratio of credit institutions declined further to 8.3% of total loans in November 2023 (from 9.5% in 2022), while accumulated provisions increased to 51.0% in the same month (from 47.5%).

Moreover, restructured loans declined to 7.2% of total loans in November 2023, compared to 11.2% in 2022.

“Notwithstanding the above developments, asset quality risks persist given the still elevated debt overhang in the household and corporate sectors, which stood at a high 200.5% of GDP in September 2023 (albeit down from 248% a year earlier).

“Banking sector capital adequacy is currently sound, with an average CET-1 ratio of 21.4% at end-September 2023. Cypriot banks have made substantial progress in deleveraging, with the assets of the banking sector declining to 215.2% of GDP in November 2023, from 229.5% a year earlier.”

Despite persistent external adversities, economic growth remains positive, albeit moderating. Real GDP is estimated to have expanded by 2.5% in 2023, compared to 5.1% in 2022, reflecting moderating growth in the economy’s main sectors, especially hotels and restaurants, construction, wholesale and retail trade, as well as information and technology.

Moving forward, CI expects real GDP to increase by an average of 2.6% in 2024-25, benefitting from improving domestic demand and continued investment in numerous economic activities, supported in part by RRF funding and foreign private capital inflows. GDP per capita is high at EUR 32,097 in 2023 and is considered a supporting factor for the ratings.

“The ratings could be upgraded by more than one notch in 12-24 months should the government implement comprehensive structural reforms that would see improved revenue mobilisation, increasing institutional strength and speedier resolution of transferred NPLs.”