Debt, NPLs, Brexit a ma­jor chal­lenge for Cyprus

Financial Mirror (Cyprus) - - FRONT PAGE -

DBRS Rat­ings Lim­ited (DBRS) has con­firmed the Repub­lic of Cyprus’s longterm for­eign and lo­cal cur­rency is­suer rat­ings at B and the short-term for­eign and lo­cal cur­rency rat­ings at R-4. The trend on all rat­ings is ‘sta­ble’.

The rat­ings re­flect Cyprus’s Eu­ro­zone mem­ber­ship, which has en­sured fi­nan­cial sup­port, as well as its at­trac­tive­ness as a busi­ness ser­vices cen­tre and a tourist des­ti­na­tion, the solid fis­cal per­for­mance achieved un­der the eco­nomic ad­just­ment pro­gramme, and its favourable pub­lic debt ma­tu­rity pro­file. How­ever, the rat­ings also un­der­score the depth of Cyprus’s chal­lenges, given its high lev­els of pub­lic and pri­vate sec­tor debt, siz­able non­per­form­ing loans, per­sis­tent ex­ter­nal im­bal­ances and the small size of its rel­a­tively un­di­ver­si­fied econ­omy.

As eco­nomic con­di­tions sta­bilised in 2015, out­put re­turned to growth. The re­cov­ery ap­pears likely to strengthen grad­u­ally, sup­ported by tourism, sta­bil­i­sa­tion in the hous­ing sec­tor and im­prov­ing con­di­tions in the labour mar­ket. The Sta­ble trend re­flects DBRS’s view that the eco­nomic re­cov­ery, while ex­pected to be broadly steady, could face some risks in the near term given its re­liance on ex­ter­nal de­mand.

Con­di­tions in the global econ­omy could prove less sup­port­ive and volatil­ity in fi­nan­cial mar­kets could in­ten­sify. In par­tic­u­lar, a UK vote to leave the EU could af­fect the re­cov­ery of the Cypriot econ­omy given its strong trade and fi­nan­cial links to the UK.

Cyprus ben­e­fits sig­nif­i­cantly from its mem­ber­ship in the Eu­ro­zone. Pol­icy mea­sures im­ple­mented in the process of EU ac­ces­sion in 2004 and adop­tion of the Euro in 2008, and more re­cently, un­der the eco­nomic ad­just­ment pro­gramme, have helped strengthen do­mes­tic in­sti­tu­tions and en­hance Cyprus’s at­trac­tive­ness as a busi­ness cen­tre and tourist des­ti­na­tion. EU bud­get trans­fers and long-term in­fra­struc­ture fi­nanc­ing from the Euro­pean In­vest­ment Bank also con­trib­ute to in­vest­ment.

More­over, in March 2016, Cyprus con­cluded the three-year pro­gramme agreed with the Euro­pean Com­mis­sion, the Euro­pean Cen­tral Bank and the IMF. The IMF con­trib­uted EUR 1 bil­lion, while the EU pro­vided EUR 6.3 bil­lion of the EUR 9 bil­lion ini­tially agreed. The pro­gramme al­lowed Cyprus to con­sol­i­date its pub­lic fi­nances and re­struc­ture its bank­ing sec­tor.

The at­trac­tive­ness of Cyprus as a busi­ness ser­vices cen­tre is not only sup­ported by strength­ened in­sti­tu­tions and poli­cies, but also by its low cor­po­rate tax en­vi­ron­ment. Al­though Cyprus’s ad­van­tages could be eroded by ex­ter­nal com­peti­tors or by reg­u­la­tory changes in cred­i­tor coun­tries, DBRS ex­pects the busi­ness ser­vices sec­tor to re­main an im­por­tant source of em­ploy­ment and in­come for the econ­omy. Cyprus has also taken ad­van­tage of its geo­graphic lo­ca­tion that makes the is­land an at­trac­tive tourist des­ti­na­tion for Euro­peans.

Cyprus’s ro­bust fis­cal per­for­mance in re­cent years pro­vides ad­di­tional sup­port to the rat­ings. The govern­ment achieved a rel­a­tively quick im­prove­ment in the bud­get po­si­tion, with the head­line fis­cal deficit de­clin­ing from 5.8% of GDP in 2012 to 1.0% in 2015 and the pri­mary deficit shift­ing to a sur­plus of close to 2%. Fis­cal man­age­ment has also been strength­ened, which to­gether with some pri­vati­sa­tions, should help main­tain the fis­cal ad­just­ment. The fis­cal po­si­tion is ex­pected to con­tinue to im­prove over the com­ing years.

Pub­lic debt ma­tu­rity struc­ture is also favourable. The govern­ment has ben­e­fited from lower mar­ket in­ter­est rates and ex­tended debt ma­tu­ri­ties, thus re­duc­ing re­fi­nanc­ing risks. The av­er­age debt ma­tu­rity was 8.5 years at the end of 2015. In par­tic­u­lar, ESM loans – with a weighted av­er­age ma­tu­rity of nearly 15 years - are not set to be re­paid un­til 2025.

Nev­er­the­less, Cyprus faces sev­eral credit chal­lenges. Gen­eral govern­ment debt is es­ti­mated to have peaked at 108.9% of GDP in 2015. Al­though the fis­cal ad­just­ment ap­pears largely com­plete at this stage, con­tin­ued fis­cal dis­ci­pline and stronger eco­nomic growth will be es­sen­tial to bring debt down to more man­age­able lev­els over time. More­over, a pro­longed de­te­ri­o­ra­tion in mar­ket con­di­tions could present sig­nif­i­cant chal­lenges given Cyprus’s re­liance on ex­ter­nal fund­ing.

Pri­vate sec­tor debt ra­tios are also at his­tor­i­cally high lev­els and sug­gest that growth will be con­strained by delever­ag­ing. House­hold and cor­po­rate bal­ance sheets have been dam­aged in the cri­sis, through the bail-in of unin­sured de­pos­i­tors and the fall in real es­tate prices. At the same time, Cypriot banks’ non-per­form­ing loans for house­holds and cor­po­ra­tions are ex­tremely high, at around 55% of to­tal loans, al­though im­por­tant ef­forts have been taken to speed the res­o­lu­tion of NPLs.

Ex­ter­nal im­bal­ances pose an­other chal­lenge. Al­though the cur­rent ac­count deficit has nar­rowed sig­nif­i­cantly in re­cent years, to be­low 4% of GDP, a per­sis­tent cur­rent ac­count deficit and a siz­able net ex­ter­nal li­a­bil­ity po­si­tion of al­most 130% of GDP, to­gether with re­liance on ex­ter­nal bor­row­ing, leaves the coun­try ex­posed to ex­ter­nal shocks.

The small and rel­a­tively un­di­ver­si­fied econ­omy is also ex­pected to re­main heav­ily de­pen­dent on ex­ter­nal de­mand for the fore­see­able fu­ture. Com­pe­ti­tion from other Mediter­ranean locations may dampen growth in the sec­tor and ad­di­tional shocks from Europe could also have neg­a­tive ef­fects. If growth in tourism and busi­ness reg­is­tra­tions slows sig­nif­i­cantly, growth prospects could be af­fected, as the do­mes­tic delever­ag­ing con­tin­ues.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.