Moody’s raises bond rating to B1

Moody’s Investors Service upgraded Cyprus’ government bond rating by two notches to B1 from B3 on Friday, maintaining a ‘stable’ outlook, with the short-term rating affirmed at Not-Prime (NP).

As is common in such cases, a Moody’s upgrade of the long-term ratings of the three main banks could follow. The Bank of Cyprus long term rating is Caa3, issued on May 28, Hellenic Bank’s rating is Caa2 issued on June 12, and RCB carries a rating of Caa1 issued in November last year.

The rating agency said that the key drivers for the bond rating upgrade are the faster than expected economic recovery and the expectation of a continued more broad-based growth that extends beyond exports. Moreover, the economy has demonstrated resiliency to external risks, emanating from Greece (Caa3, stable) and Russia (Ba1, negative). After three years of contraction, real economic growth is expected to reach 1.2% in 2015 and 1.4% in 2016. Moreover, medium-term growth is expected to be more balanced, supported by a recovery in domestic demand helped by a stabilisation of the financial sector, improved competitiveness and the implementation of structural reforms.

Moody’s added that consistent outperformance on fiscal targets have led to a quicker reversal in the public debt ratio. A combination of better than expected growth and also strong budget execution underscore fiscal outperformance. The rating agency expects fiscal discipline to continue post programme exit and through parliamentary elections next year.

Under Moody’s baseline scenario, the government debt burden will now reach below 100% by next year and around 80% of GDP by 2020. Moreover, it expects the country to successfully exit the economic adjustment programme (financed by the European Stability Mechanism, ESM, and the IMF) by mid2016, further supported by the build-up of significant liquidity buffers.

Concurrently, Moody’s has raised the localcurrency and foreign-currency bond ceilings to Baa1 from Baa3. The short-term foreign-currency bond ceiling has been raised to Prime-2 (P-2) from P-3, while the short-term foreign-currency deposit ceiling has been raised to P-2 from NP.

The more balanced growth pattern is also driven by the stabilisation in the financial sector, which has resulted in a slight uptick in corporate credit growth this year. While still very weak (with a weighted average Baseline Credit Assessment of caa3), the financial sector reflects stable liquidity trends and increasing prospects for a return to profitability. Importantly, deposits remain stable at a systemic level despite the full lifting of capital controls on April 6.

Moody’s also expects that recent laws implemented in the financial sector, namely the insolvency and foreclosure framework, will support the gradual reduction of non-performing loans (NPLs) in the system, which are currently at a high 47% of total loans. That said, Moody’s notes that both the corporate and household sectors continue to have high, albeit reducing debt burdens.

Downward pressure on Cyprus’s B1 government bond rating could emerge if the government’s commitment fiscal discipline reduces, especially once the EC/IMF programme concludes. Evidence that the banking sector needs further recapitalisation support from the government would also exert downward pressure on the rating.

The Cooperative Central Bank announced last week that the government-owned lender, bailed out with a EUR 1.5 bln injection last year, may need a further EUR 150-200 mln in fresh capital from the 99% shareholder.