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CI upgrades Cyprus sovereign, outlook remains ‘positive’

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Capital Intelligence has upgraded the sovereign ratings for Cyprus based on improving public finances, persistent budget surpluses and a rapid decline in general government debt.

CI Ratings said it has upgraded the country’s long-term foreign currency rating (LT FCR) and short-term (ST FCR) to ‘BBB’ and ‘A2’, respectively, from ‘BBB-’ and ‘A3’, with the outlook for the ratings remaining ‘positive’.

Justifying the upgrade, the rating agency said that the debt to GDP ratio is projected to drop below 60% in 2026 and the government continues to manage its debt maturity profile in order to reduce refinancing risks, while maintaining an increasing cash buffer to counter short-term shocks and external adversities.

A significant decline in macro-financial imbalances was also considered, with the size of the banking sector declining to around 200% of GDP, and the cumulative debt overhang in the non-financial corporate and household sectors halving in recent years.

The rating action also reflects the “demonstrated resilience of the Cypriot economy against increasing geopolitical risk factors, as well as the significant progress made in strengthening bank balance sheets by clearing up non-performing loans (NPLs) and reducing reliance on wholesale and cross border funding. As a result, government contingent liabilities from the banking sector have declined markedly in recent years.”

CI Ratings said Cyprus continues to be supported by high GDP per capita, as well as the benefits of European Union and eurozone membership, including the availability of financial support from the Recovery and Resilience Facility (RRF).

According to Finance Ministry data, the ratio of general government debt to GDP declined to 72.4% in July 2024, from 77.3% at end-2023, thanks to a higher than projected primary budget surplus of 3.1% of GDP (2.0% during the same period of 2023) and robust economic growth.

CI Ratings said it expects government debt dynamics to remain favourable over the next years, with the debt to GDP ratio continuing to decline to a moderate 59.2% of GDP (138.5% of revenues) in 2026, placing government debt within the Maastricht Treaty threshold of 60% for the first time since 2010.

CI views that the targets outlined in the government’s medium-term debt strategy for 2024-26 are attainable and continue to ensure debt sustainability.

These targets include: maintaining the time to maturity on marketable debt at seven years, capping short-term debt at original maturity to 2% of GDP, as well as keeping the government’s gross financing needs at a maximum of 10%, while maintaining a cash buffer covering at least nine months of these financing needs.

In CI’s view, debt maturities – which are estimated at €1.8 bln (5.5% of GDP) for 2025 and €2.5 bln (7.0% of GDP) for 2026 – are within the repayment capacity of the government and do not pose any refinancing challenges at present.

Budget performance ‘very strong’

General government budget performance remained very strong in the first seven months of 2024, with the budget position (on a cash basis) posting a higher than projected overall surplus of 2.2% of GDP (compared to 1.2% in 2023).

As a result, CI expects the general government budget position to post a surplus of 2.9% of GDP in 2024, despite the adjustment of public sector wages.

Short-term refinancing risks continue to decline.

This is due to the government’s sound fiscal management, favourable debt maturity structure, and low gross financing needs (3.7% of GDP in 2024), as well as the prudent building of cash buffers of almost 10% of GDP that cover over 200% of gross financing needs for at least the next 12 months.

Risks to the fiscal outlook remain balanced, “however, outcomes could be weaker than envisaged if fiscal discipline declines or spending on subsidies, social welfare, and public sector wages surpasses the projected increase in revenue. Other risks to the budget stem from a potential decline in tax revenues if downside risks to GDP growth materialise,” the rating agency warned.

Banking sector strength has continued to improve, but is still considered moderate.

According to the Central Bank of Cyprus (CBC), the aggregate NPL ratio of in Cyprus declined further to 6.9% of total loans in June 2024 (from 7.9% in December 2023), while accumulated provisions increased to 55.0% (from 49.5%) in the same period.

Moreover, restructured loans declined to 5.6% of total loans in June 2024, compared to 6.7% and 11.2%, respectively, in the same period of 2023 and 2022.

Capital adequacy is currently sound, with an average CET-1 ratio of 24.4% at end-June 2024.

Cypriot banks have made substantial progress in deleveraging, with the assets of the banking sector declining to 200.5% of GDP in July 2024, from 219.5% a year earlier.

CI Ratings added that asset quality risks continue to decline in line with the increase in employment and real wages, and the significant deleveraging of the household and corporate sectors.

The cumulative debt overhang in both sectors has declined by around 50% in the past decade, reaching a still high 175.6% of GDP in March 2024, compared to 204.9% in March 2023 and 341.0% in December 2013.

Despite persistent external adversities, economic growth remains positive.

Real GDP to grow 3% in 2024-26

Real GDP expanded by 3.6% in H1 24, compared to 2.6% in H1 23, reflecting robust growth in the economy’s main sectors, especially hotels and restaurants, construction, wholesale and retail trade, and Information and Communication Technology (ICT).

Moving forward, CI expects real GDP to increase by an average of 3.0% in 2024-26, 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 €32,097 in 2023 and is considered a supporting factor for the ratings.

External strength is moderate owing to large current account deficits and very high external debt. The current account deficit is expected to narrow slightly to 7.8% of GDP in 2024 (from 10.1% in 2023), while external debt, excluding Special Purpose Entities (SPEs), declined to 184.7% of GDP in March 2024, from 196.4% in December 2023.

Notwithstanding the above, the ratings remain constrained by very high external financing needs, high – albeit declining – external debt, as well as the relatively slow pace of resolving the non-performing assets that were transferred outside the banking sector.

Moderate institutional weaknesses and increasing geopolitical risk factors also continue to weigh on the ratings, Capital Intelligence concluded.