Cyprus' economic resilience earns high credit rating confirmation

International rating agency Morningstar DBRS has confirmed Cyprus’ BBB (high) long-term credit rating with a stable trend, noting that favourable economic prospects balance downside risks.

“The Stable trend balances favourable economic and fiscal developments against important downside risks,” the agency said in a press release.

According to the Canada-based agency, Cyprus has registered a real GDP growth rate of 2.5% in 2023 which compares favourably with Euro area’s average of just 0.4%, bolstering public finances and supporting the further reduction of Cyprus’ debt-to-GDP ratio to 77.4% in end-2023.

“Cyprus’ BBB (high) ratings are supported by a stable political environment, the government’s sound fiscal and economic policies in recent years, and a favourable government debt profile,” the agency added.

Morningstar noted that the economic outlook remains favourable, with private consumption likely to benefit from a further rebound in real wages and solid employment growth, whereas investment activity is projected to be bolstered by the inflow of Next Generation EU funds and several major investment projects particularly in the tourism and residential real estate sectors.

The agency also cites the Central Bank of Cyprus (CBC) December projections that the real GDP growth will strengthen moderately to 2.6% in 2024 and 3.1% in 2025.

Morningstar however pointed out that “at the same time, the growth outlook is exposed to important downside risks such as an escalation of the military conflict in Ukraine and a prolonged disruption in trade in the Red Sea.”

On the fiscal side, Morningstar noted that the general government budget surplus rose to 2.9% of GDP in 2023 from 2.4% in 2022 on the back of strong revenue growth, noting that the fiscal outlook is projected to remain favourable as public revenues are likely to benefit from still strong economic growth, as the government’s draft 2024 budget published in October 2023 forecasts general government surpluses of 2.8% of GDP both in 2024 and in 2025.

The agency said that moderate budgetary pressures are likely to emanate from the revision of the cost of living allowance which leads to a larger automatic adjustment of public sector wages and public pensions to inflation, deficits of the State Health Organization and from the expansion of KEDIPES, the state-owned asset manager, which will acquire eligible primary residences (market value below EUR 250,000) which have been used as collateral in NPLs, and to let those residences to vulnerable households.

It cautioned however, that “the materialization of economic downside risks constitutes an important risk factor for the fiscal outlook as weaker-than currently economic growth dynamics would weigh on government revenues.”

With regard to Cyprus’ public debt, Morningstar pointed out that the debt-to-GDP ratio continued to decline over the past year, decreasing to 77.4% of GDP in 2023, while continued budgetary surpluses and favourable debt dynamics are projected to lead to a further marked decrease in the debt ratio.

“Potential short-term funding risks are mitigated by the government’s still large cash buffer that amounted to 9.5% of GDP in December 2023,” the rating agency added.

On Cyprus’ financial sector, Morningstar, inter alia, noted that financial stability is supported by the banking sector’s strong capitalization and strong liquidity position.

But it pointed out that the legacy stock of non-performing loans (NPLs) in the banking system from the 2012-2013 crisis remains a credit weakness.

“Although the NPL ratio has decreased markedly from 46.4% in December 2016 to 7.9% in December 2023 mainly due to sales and write-offs of problem loans, it is still substantially higher than in most other Euro Area economies,” the agency said.

Moreover, the agency described Cyprus’ political environment as stable.

“The election of Nikos Christodoulides as President in February 2023 has not led to major policy changes particularly with regard to fiscal policy and the reforms embedded in Cyprus’s recovery plan,” it added.

Stating that these reforms aim to enhance the efficiency of the judicial system and of the public administration, to combat corruption, and to boost the economy’s green and digital transition, the agency pointed out that “the implementation of the plan will depend on the government’s ability to garner sufficient support in parliament to pass legislation.”

Concerning Cyprus' reunification talks supported by the United Nations (UN), Morningstar DBRS said it currently assumes that “the chances of a significant breakthrough remain limited.”

Cyprus has been divided since 1974, when Turkey invaded and occupied its northern third.