Positive outlook for Cyprus economy, according to rating agency

Capital Intelligence Ratings (CI Ratings) has revised its long-term foreign currency rating (LT FCR) outlook for the Republic of Cyprus from stable to positive, while affirming the country’s LT FCR and short-term FCR (ST FCR) at BBB- and A3 respectively.

According to a statement from CI Ratings, the revision in outlook reflects the faster-than-anticipated reduction in the government’s debt due to consistent primary fiscal surpluses and proactive debt management.

“The government continues to manage its debt maturity profile to reduce refinancing risks while maintaining an increasing cash buffer to address short-term shocks and external vulnerabilities,” the agency said.

The assessment also takes into account progress made in resolving non-performing loans (NPLs) in the banking system.

As a result, the state’s contingent liabilities from the banking sector have significantly decreased in recent years, CI noted.

Other fiscal risks seem manageable currently, despite the challenging external environment and still restrictive global financial conditions.

Cyprus’ ratings continue to be supported by the proven resilience of its economy and high per capita GDP, according to the rating agency.

The assessments also consider the benefits of EU and eurozone membership, including access to financial support through the Recovery and Resilience Facility (RRF).

According to CI Ratings’ data, the general government debt-to-GDP ratio decreased to 77.3 per cent in 2023 from 85.6 per cent in 2022, reflecting a higher-than-forecast primary budget surplus of 4.2 per cent of GDP (compared to 3.4 per cent in 2022) and the repayment of bonds and loans amounting to €1.4 billion (4.7 per cent of GDP).

Moreover, CI expects the dynamic of public debt to remain favourable in the coming years, with the debt-to-GDP ratio continuing to decline, albeit to a still moderate-to-high 66.2 per cent (165.2 per cent of revenues) in 2025.

Debt maturities, estimated at €2.4 billion (7.6 per cent of GDP) for 2024 and €1.8 billion (5.2 per cent of GDP) for 2025, are within the government’s repayment capacity and do not currently pose refinancing challenges.

The government’s budget performances remained strong in 2023, with the fiscal position (on a cash basis) recording an overall surplus higher than anticipated, at 2.9 per cent of GDP (compared to 2.4 per cent in 2022).

In addition, CI Ratings expects the general government budget to remain surplus in 2024-25, averaging 3.1 per cent of GDP.

Regarding risks to Cyprus’ fiscal outlook, it notes that they still exist, and outcomes could be weaker than forecast if fiscal discipline is relaxed or expenditures on subsidies, social welfare, and public sector wages increase.

Other risks to the budget stem from the cost of the national healthcare system (Gesy) and a potential decline in tax revenues if downside risks to GDP growth materialise.

Currently, the agency believes that the impact of high-risk premiums and the eurozone’s strict monetary policy on public finances is manageable due to the reduction in general government debt and the high proportion (70 per cent) of debt at fixed interest rates in total debt.

Short-term refinancing risks remained stable since the agency’s last review. “This is due to the government’s sound fiscal management, favourable debt maturity structure, timely access to capital markets, and prudent creation of cash reserves covering over 200 per cent of gross financing needs for the next 12 months at least,” the report stated.

Despite persistent external adversities, economic growth remains positive, albeit moderated, as noted in the assessment.

Real GDP is estimated to be at 2.5 per cent in 2023, compared to 5.1 per cent in 2022, reflecting restrained growth in key sectors of the economy, particularly in hospitality, construction, wholesale and retail trade, as well as information technology and technology.

Elsewhere, the agency noted that the strength of the banking sector has significantly improved in recent years but is still considered moderate.

According to the Central Bank of Cyprus (CBC), the total non-performing loan (NPL) ratio of credit institutions operating in Cyprus further decreased to 8.3 per cent of total loans in November 2023 (from 9.5 per cent in 2022), while the cumulative provisions increased to 51 per cent in the same month (from 47.5 per cent).

Additionally, restructured loans decreased to 7.2 per cent of total loans in November 2023, compared to 11.2 per cent in 2022.

Despite the above developments, risks to asset quality persist, it adds, as household and corporate debt remains elevated, standing at a high 200.5 per cent of GDP in September 2023 (though reduced from 248 per cent a year earlier).

The capital adequacy of the banking sector is currently healthy, with a CET-1 ratio averaging 21.4 per cent at the end of September 2023.

Cypriot banks have made significant progress in deleveraging, the agency said, with the banking sector’s assets-to-GDP ratio decreasing to 215.2 per cent in November 2023, from 229.5 per cent a year earlier.

Moving forward, CI Ratings expects real GDP to increase by an average of 2.6 per cent in 2024-25, benefiting from improved domestic demand and continued investment in various economic activities, partly supported by the EU funding and inflows of foreign private capital.

The GDP per capita is high at €32,097 in 2023 and is considered a supportive factor for the ratings.

The current account deficit is expected to have increased to 10.1 per cent of GDP in 2023, while external debt, excluding special purpose entities (SPEs), decreased to 195.8 per cent of GDP in September 2023, from 222.7 per cent in December 2022.

The rating could be upgraded by more than one notch in 12-24 months, the agency states, if the government implements comprehensive structural reforms leading to improved revenue mobilisation, increased institutional strength, and faster resolution of legacy NPLs.

Upside pressure on the ratings could also stem from a lower-than-expected current account deficit and a faster reduction in government and external debt.

Conversely, the outlook could be revised to stable over the next 12 months if fiscal performances weaken and the dynamics of public debt reverse, for example, due to a change in policy direction, reduced fiscal discipline, or significantly weaker economic performances, or if adverse shocks lead to mild deterioration in public or external finances.