Fitch Ratings upgrades Cyprus to investment grade

Fitch Ratings has upgraded Cyprus's long term foreign currency issuer default rating (IDR) to 'BBB-' from 'BB+' with a stable outlook. This means that Cyprus is back into investment grade territory. The move comes a month after a similar upgrade by Standard and Poor's.  

Fitch Associate Director Marina Stefani said in a statement that buoyant fiscal revenue and prudent fiscal policy mean that Cyprus will record a fiscal surplus of 2.7% of GDP in 2018.

''We forecast the fiscal surplus will remain high at 2.4% and 2.2% of GDP in 2019 and 2020, respectively, compared with 3.1% and 2.9% targeted in the 2019 Draft Budgetary Plan''.

Robust economic growth Fitch said will boost fiscal receipts, while previously adopted hiring freeze and collective agreements will likely limit growth in the wage bill.

Fitch explains that Cyprus's gross general government debt (GGGD)/GDP will remain on a firm downward trajectory, despite a one-off expected increase in 2018.

Following the placement into Cyprus Cooperative Bank (CCB) of EUR3.19 billion government bonds (15.5% of GDP) to facilitate the acquisition of part of the state-owned bank by Hellenic Bank (HB), GGGD/GDP is set to increase to 104.4% at end-2018 from 95.7% in 2017. However, Fitch expects large primary surpluses, robust growth and contained nominal effective interest rates will reduce GGGD/GDP to 70% of GDP by 2027.

The ratio of non-performing exposures (NPEs) to total loans decreased to 40.3% in the first quarter of 2018, from 44% in 2017, partly supported by the announced securitisation by Bank of Cyprus (BoC) of EUR2.7 billion gross NPEs, which is still subject to regulatory approval by the European Central Bank. ''The acquisition by Hellenic Bank of CCB's good assets and the subsequent transfer into a run-off entity of CCB's EUR5.7 billion NPEs portfolio are estimated to have led to a further decrease in NPEs to 30% in September 2018''.

Fitch highlighted that this will support a substantial decrease in contingent liabilities stemming from the banking sector, although these remain large.

According to Fitch analysts the government has taken further decisive steps to address legacy issues within the banking sector. Key legislative amendments aimed at facilitating NPEs securitisation and sales of loans, and strengthening foreclosure and insolvency toolkits were adopted by the parliament in July.

The government intends to launch a subsidy scheme to defaulting borrowers (Estia scheme) in January 2019, which implies loan restructurings and state subsidies to incentivise loan repayment. So far, use of foreclosure instruments has been negligible and the degree of implementation of the scheme and enforcement of the new legislative package remains uncertain. 

Fitch recounts that Cyprus is benefitting from a strong economic recovery with real GDP reaching pre-crisis level and the economy forecasted by Fitch to grow 4% in 2018 and 3.8% in 2019, supported by large foreign-financed investment projects in construction and tourism, and robust private consumption.

''Cyprus's ratings are supported by a high level of GDP per capita, strong governance indicators and a favourable business environment significantly above 'BBB' rated peers' and closer to 'A' category peer levels''.

The report also notes that private sector debt and non-performing exposures remain high, however, at 226% (excluding special purpose entities) and 97% of GDP in 1Q18, respectively, and constrain credit growth. Household and corporate debt stood at 105% and 121% of GDP and a large part of the recent decline in such debt stemmed mostly from high GDP growth, debt-to-asset swaps, loan write-offs, rather than loan repayment.

Fitch is anticipating that private sector deleveraging will accelerate, however, as enforcement of new legal amendments, improving earnings and recovering house prices foster debt repayment. Economic growth will likely remain resilient to a faster resolution in NPEs as rising wages, a dynamic labour market and high household savings will help preserve disposable income and smooth consumption.

Cyprus's financing flexibility has improved substantially since the country exited the macroeconomic adjustment programme in March 2016. The government improved access to capital markets by issuing Eurobonds in June 2017 and September 2018. Cyprus has a large cash buffer, which accounts for 11% of GDP and covers more than the government's medium-term debt management strategy of prefunding the next nine months of gross financing needs.