Moody’s upgrades Cyprus bonds from Caa3 to B3
Moody’s Investors Service has upgraded the Cyprus government bond rating to B3 from Caa3 and the outlook to ‘stable’ from ‘positive’ on progress in addressing the country’s key challenges with respect to macroeconomic stability, fiscal consolidation and banking sector stability.
Moody’s believes that Cyprus remains in a similar position to other defaulted sovereigns. The underlying problems that led to the country’s initial default are not yet fully resolved and the likelihood of redefault will remain elevated for a sustained period of time, with no forecast of a substantial economic recovery before 2016.
The rating agency said that the upgrade reflects two key drivers:
1) The consolidation of the government’s fiscal position, as illustrated by an expected return to a primary budget surplus from 2014, and the expectation that public debt relative to GDP will level off in 2015.
2) The stabilisation of Cyprus’s financial sector through the recapitalisation of troubled banks, which, to some extent, lowers the risk that bank-related contingent liabilities will crystallise on the government’s balance sheet.
However, Moody’s warned in its latest upgrade that the Cyprus government bond rating remains constrained by substantial credit challenges, including a weak economic outlook and the very high and still rising non-performing loans (NPLs) in the banking sector, which generate further negative risks to the government’s balance sheet.
Concurrently, Moody’s on Friday raised the bond ceilings to B1/NP from Caa1/NP, and the deposit ceiling to Caa1/NP from of the financial sector with the banks’ balance sheets bolstered through increased capital buffers, external deleveraging (through sales of non-core activities overseas) and improvements in their funding profiles. As a consequence, the sovereign’s susceptibility to shocks emanating from the banking sector has decreased to some extent.
The rating agency also notes that the authorities have strengthened the regulatory and supervisory framework, in particular by implementing measures intended to aid banks in dealing with their high NPLs, for instance through the reform of loan foreclosure procedures as set out in a law enacted on 6 September and that was recently enforced by the Supreme Court as it ruled out amendments aimed at diminishing this law.
Looking ahead, Moody’s said upward pressure to the government bond rating could result from further fiscal progress under the Troika programme, e.g. if the government’s primary surplus were to exceed targets and reach 4% earlier than planned (i.e. before 2018). In addition, evidence that the risks to growth and to the banking sector are unlikely to crystallise would imply upward pressure: higher economic growth and/or a more rapid reversal in the upward trend for banks’ NPLs would be credit positive.
Conversely, downward pressure could emerge if the government’s commitment to meeting the Troika programme’s conditionality and restoring macro-financial stability were to weaken, in particular if the expected low resumption of growth fails to materialise.