(The following statement was released by the rating agency) LONDON, October 24 (Fitch) Fitch Ratings has revised Cyprus's Outlooks to Positive from Stable, while affirming its Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'B-'.The issue ratings on Cyprus's senior unsecured foreign and local currency bonds have also been affirmed at 'B-'. The Country Ceiling and the Short-term foreign currency IDR have been affirmed at 'B'.
KEY RATING DRIVERS The revision of Cyprus's Outlooks reflects the following key rating drivers and their relative weights: HIGH Developments in public finances continue to materially exceed Fitch's previous expectations. The fiscal deficit in 1H14 (prior to any data revisions) was smaller than projected, reflecting a combination of higher tax revenues and lower-than-expected expenditure across most items. Due in part to a shallower recession than previously forecast, the strong budget execution should help narrow the headline fiscal deficit to 3.3% of GDP in 2014, significantly below the 5% projected by Fitch in April. National accounts data revisions in October also partly contributed to the lower deficit forecast for 2014. This year an additional 2.3% of GDP of new fiscal adjustment measures were implemented by the government on top of the 4.5% of GDP already implemented in 2013. Nevertheless, it will still be challenging to meet the over-arching objective of a primary budget surplus of 4% of GDP by 2018, though recent outturns provide some encouragement. The positive carry-over effect of projected FY14 outperformance is reflected in Fitch's future budget projections. Statistical and methodological changes to national accounts data, including ESA2010, narrowed the fiscal deficit in 2013 to 4.9% of GDP from 5.4%.
The smaller budget deficits also significantly improve public debt dynamics. The general government debt-to-GDP ratio (GGGD) is now expected to peak a year earlier in 2015 and decline more rapidly than under previous forecasts. The recent accounting, statistical and methodological changes have also significantly lowered the debt ratio. For 2013, GGGD has been reduced to 102.2% from the previous 111.5%. This is significantly below 175% for Greece (B/Stable), its closest peer. Fitch now expects GGGD for Cyprus to peak at 113% (April forecast: 126%) and fall to 107% (April: 123%) by 2018. The economy performed better than expected in 1H14 but economic conditions remain challenging with output continuing to decline. GDP is likely to contract by 3% at most this year, which is less severe than Fitch's April projection of a 3.9% drop. The tourism sector and private consumption continue to be more resilient than expected. Households have been spending out of their savings, but there is uncertainty over the sustainability of this trend. MEDIUM The government issued new debt this year, smoothing the maturities of its debt beyond the programme period. At the last review in April, projected redemptions of marketable debt (excluding short-term debt) and loans in 2017 jumped to over EUR2.5bn. The most recent profile shows a significant improvement with redemptions falling to EUR1.5bn that year, albeit this remains a significant hurdle. Market conditions permitting, the government could issue debt again to further smooth the post-programme maturity profile. However, Fitch does not expect the government to substitute official funding with market funding for budgetary financing during the programme period. The recent budget over-performance has also improved the cash position and helped ease near-term liquidity risk for the government. There are no major bond redemptions due until November 2015.
The affirmation of Cyprus's IDRs at 'B-' also reflects the following key rating drivers: There are still significant risks to creditworthiness posed by Cyprus's continued deep economic and financial adjustment.
The restructuring of the banking sector is progressing, with some signs of stabilisation in bank deposits despite the lifting of all domestic payment restrictions. However, the environment remains challenging, in particular with regard to poor asset quality. The stock of non-performing loans (NPLs, as per Central Bank of Cyprus's new definition) on average reached over 50% of gross loans in August 2014 for banks active in the local market, representing 157% of the country's GDP. The quality of assets may deteriorate further in the next quarters, albeit potentially at a slower pace. Banks have taken steps to enhance their internal arrears and restructuring processes and now face the challenge of limiting any additional credit deterioration and recovering NPLs without affecting their recently restored capital positions.
Public debt, at around 102.2% of GDP in 2013, was more than double the 'B' category median of 42% and has yet to peak. The high debt ratio reduces the fiscal scope to absorb any additional domestic or external shocks.
Risks to programme implementation have eased on recent performance but remain elevated. A significant portion of the consolidation also remains outside the programme period, which ends in 1Q16, and medium-term fiscal targets, in particular, are ambitious. There are signs of positive economic adjustment. Growth in employee compensation has fallen below growth in productivity, leading to an improvement in labour costs. The current account deficit has narrowed to less than 2% of GDP in 2013 from over 6% in 2012, albeit primarily reflecting a contraction in domestic demand and imports.
RATING SENSITIVITIES Negative: future developments that may, individually or collectively, lead to a negative rating action include: - Significant slippage from programme targets, including an inability to put the programme back on track from the current political impasse on the foreclosure law, which threatens the sovereign's short term liquidity position - A recession that is materially deeper or longer than assumed by Fitch, which would have adverse consequences for public debt dynamics - Re-intensification of the banking crisis in Cyprus, for example, capital flight from banks from the lifting of external capital controls or significant capital needs arising from the ECB Comprehensive Assessment that cannot be met by private sources.
Positive: future developments that may, individually or collectively, lead to a positive rating action include: - A longer track record of successful implementation of the EU-IMF programme including, for example, further outperformance relative to programme targets - Further signs of a stabilisation in economic output and the banking sector, including a credible strategy to deal with the large NPL overhang - Improvements in export performance that help facilitate the rebalancing of the economy - Lifting of remaining capital controls with no material negative economic consequences. Removal of all capital controls would also lead to an upgrade of the Country Ceiling KEY ASSUMPTIONS Fitch expects the recession to last longer than assumed under the EU/IMF programme. The agency expects output to contract by around 0.8% in 2015 and return to growth in 2016, a year earlier than previously thought. This compares with the Troika programme forecast for the economy to grow from 2015.
Fitch assumes the government will closely implement budget consolidation measures. Fitch's debt dynamics projections assume the government concludes the asset swap of a portion of the outstanding government debt held by the Central Bank of Cyprus Bank (EUR1bn), and generates proceeds from privatisation (of at least EUR1bn within the programme period and EUR0.4bn outside).
The debt dynamics projections also include the fiscal and financial sector buffers that are built into the programme.
Public debt has improved slightly from the previous rating review. Fitch expects gross general government debt (GGGD) to peak at 113% of GDP in 2015 (compared with over 126% in the previous review) and to gradually decline to 100% by 2020. The improvement is due to better growth projections and smaller fiscal deficit forecasts in the near term, and changes to national accounts data on accounting, as well as statistical and methodological changes.
Fitch assumes that there will be no material escalation in developments between Russia and Ukraine that would lead to a significant external shock to the Cypriot economy. Tourism from Russia has been rising and Russians account for a sizeable share of foreign deposits in banks. Our projections also do not include the impact on growth of potential future gas reserves off the southern shores of Cyprus, the benefits from which are several years into the future, although now less speculative. A second test drill will be undertaken soon. Fitch assumes the eurozone will avoid long-lasting deflation, such as that experienced by Japan from the 1990s. Fitch also assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key macroeconomic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term.
Fitch expects the delay in disbursing the latest IMF tranche over the introduction of new foreclosure legislation to be resolved by early next year. The 6th programme tranche (EUR433m) was not disbursed in September 2014 due to the bills that were passed by parliament in September being incompatible with the programme's condition that a new and effective foreclosure framework be introduced. Contact: Primary Analyst Enam Ahmed Director +44 20 3530 1624 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Douglas Renwick Senior Director +44 20 3530 1045 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: [email protected]
Additional information is available on www.fitchratings.com Applicable criteria, 'Sovereign Rating Criteria' dated 12 August 2014 and 'Country Ceilings' dated 28 August 2014, are available at www.fitchratings.com.
DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.
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