Country risk: Cyprus is stronger than its ratings claim

By:
Jeremy Weltman
Published on:

Three years on from securing a bailout, the island nation is still addressing the fallout. Yet the economy is growing, political continuity is assured and credit rating agencies are playing catch-up.

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Maintenance work: Shipping receipts have improved, but there’s still a lot
of work to be done

The financial crisis left Cypriot policymakers with a huge debt mountain as the economy crumbled. As the risks increased, the sovereign borrower plummeted to 63rd in Euromoney’s country risk rankings from 186 countries worldwide.

The crisis took its toll politically and economically.

General government gross debt climbed to just shy of 109% of GDP at the end of 2015, underpinned by the huge liabilities the state incurred after the collapse of the banking system.

However, last year marked a turning point. GDP rose by 1.6% in real terms, the general government deficit narrowed to 1% of GDP from 8.9% in the previous year, and the unemployment rate receded from its peak in the previous year.

Improved shipping and tourism receipts, and low energy import costs spurred the turnaround, and the real-estate market has stabilized.

The ruling Conservatives kept ahead of rivals in the legislative elections held in May, and while turnout was low and parliament is more fragmented, there is still a consensus behind the reforms to restore Cyprus back to health.

Its country risk score has, therefore, improved to 56.63 in the second quarter, based on the preliminary results, 3.6 points higher than Q2 2015 and 7.2 since reaching a low in early 2014.

Lying midway in the third of five tiered categories, at 50th in the global rankings, the Cyprus score is really more in line with a BB+ to A- rating, higher than its actual ratings.

Fitch on B+ (positive), Moody’s B1 (stable) and Standard & Poor’s BB- (positive) are all behind the curve.

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Remaining cautious

To a certain extent, the rating-agency lethargy is justified. There are political risks passing legislation and, as Bernard Musyck, an associate professor at Frederick University, Cyprus, says: "The looming non-performing loan (NPL) problems are still a worry."

At 150% of GDP, this NPL problem is certainly of consequence, with public debt still sky-high.

However, bank stability is considered stronger than in Spain or Portugal. The government has moreover managed to deliver a primary budget surplus of 1.8% of GDP, or 2.8% excluding banking-sector recapitalizations, thanks to public expenditure control including the freeze on pensions and wages.

Economic prospects are favourable too. The European Commission is predicting 1.7% real-terms GDP growth this year, and 2% for 2017, underpinned by domestic demand and exports.

"The country recorded an impressive 2.7% year-on-year growth rate in Q1 2016," says Dimitria Rotsika, economist with Piraeus Banking Group.

The termination in March of the economic adjustment programme for Cyprus two months early sent a positive signal to the financial markets just three years after capital controls were imposed, along with the one-off deposit "haircuts" and bailout agreement.

Political opponents have managed to overcome their differences to legislate for the reforms required to improve the public finances and deal with the legacy of debt, including new foreclosure and insolvency laws, and new real-estate ownership rules along with a 50% reduction in tax on immovable property.

Cyprus still requires care and attention, but seems to be finally on the mend.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.