The re­cent S&P up­grade: What does it re­ally mean for Cyprus?

Financial Mirror (Cyprus) - - FRONT PAGE -

The first long-awaited up­grade of the Cyprus econ­omy by the rat­ing agen­cies for this Fall has fi­nally ar­rived with the re­cent up­grade from S&P by one notch (from BB- to BB).

Now, we are only two notches away from the in­vest­ment­grade (IG) mar­ket, which is a far cry from the rat­ings that we had back in 2013 dur­ing the bank­ing cri­sis (CCC+), five notches below the lat­est rat­ing. We are still part of the ‘junk’ (high-yield) sec­tor, but if things go well or as planned, then dur­ing 2017 we might re­turn to the ‘elite club’ of the coun­tries that be­long to the IG mar­ket. I also ex­pect that the other two im­por­tant rat­ing agen­cies (Moody’s and Fitch) will also be up­grad­ing the sov­er­eign soon - the rat­ing by Moody’s is B1 (four notches away from the IG mar­ket), while for Fitch it is B+ (again, four notches away from the IG mar­ket).

Look­ing at the re­cent his­tory of rat­ings, Cyprus first joined the high risk/high re­turn ‘junk’ mar­ket on Jan­uary 13, 2012 with the down­grade by S&P. Within the next few months, the rest of the main rat­ing agen­cies also down­graded us into the ‘junk’ sec­tor. Fur­ther down­grades took place un­til 2013, un­til we sta­bilised the eco­nomic sit­u­a­tion and we started hav­ing grad­ual up­grades.

So, why did we have the lat­est up­grade? Well, ac­cord­ing to S&P the rea­son for the up­grade is the im­prove­ment in the gen­eral eco­nomic con­di­tion of the coun­try. The real rate of growth will be higher than what was originally ex­pected (2.7% ex­pected for this year, and pro­jected at around 2.5% for the pe­riod 2017-2019), while the bud­get ac­count will be bal­anced or even with a sur­plus in the com­ing years, which can lead to de­clin­ing lev­els of pub­lic debt.

Fur­ther­more, the un­em­ploy­ment rate is ex­pected to fall below 12% by 2018, in­creas­ing house­holds’ dis­pos­able in­come and pri­vate con­sump­tion.

In terms of the bank­ing sec­tor, the sit­u­a­tion has sta­bilised and although the level of non-per­form­ing loans (NPLs) is still very high, is grad­u­ally de­clin­ing through the re­struc­tur­ing process. We should ex­pect fur­ther up­grades in the fu­ture as long as the rate of re­duc­tion of the NPLs ac­cel­er­ates, the govern­ment im­ple­ments the struc­tural re­forms (pub­lic ser­vice, health care, pri­vati­sa­tions, etc.) while a pos­si­ble re­uni­fi­ca­tion of the is­land can lead to ac­cel­er­ated growth rates, de­spite the ini­tial chal­lenges.

I would add an­other rea­son for the up­grade – the cor­rect de­ci­sion taken by the govern­ment to test the mar­kets right after our exit from the MoU (in June) with a suc­cess­ful 7-year is­suance of a govern­ment note. S&P fol­lowed the mar­ket with the up­grade. Note here that in some cases rat­ing agen­cies fol­low the mar­ket, in other cases the mar­kets show us the way. that a rep­utable and im­por­tant or­gan­i­sa­tion gave a vote of con­fi­dence to the Cyprus econ­omy. These up­grades can be the driv­ing force for more in­vest­ments on the is­land (whether it is for buy­ing govern­ment debt, or in­vest­ing in pri­vate projects).

An up­grade im­plies lower risk for the in­vestors there­fore this trans­lates to a lower cost of fi­nanc­ing for the coun­try, which can lead to a re­duc­tion in the level of pub­lic debt. Right now, the yield on the 10-year govern­ment note that ex­pires in Novem­ber 2025 is at 3.6%, which is at his­tor­i­cal low lev­els but has room for a lot of im­prove­ment (for ex­am­ple, Ger­many’s AAA-rated 10-year notes pro­vide a yield of 0%!, while the 5-year note pro­vides a -0.5% an­nual re­turn!).

Go­ing back to the IG mar­ket will also pro­vide the added ad­van­tage of join­ing the ‘elite club’ of the IG-rated coun­tries which in­creases the pool of prospec­tive in­vestors, while at the same time gives us the chance to re­turn to the Quan­ti­ta­tive Eas­ing (QE) pro­gramme of the Euro­pean Cen­tral Bank (ECB). Be­ing part of the QE pro­gramme can lead to higher lev­els of liq­uid­ity in the do­mes­tic mar­ket while it will fur­ther push down­wards the yield of our govern­ment bonds.

Con­clud­ing, I would ar­gue that these rat­ing up­grades and the re­turn to the IG mar­ket are nec­es­sary (but not suf­fi­cient) if we want to fi­nally say that the cri­sis is well and truly be­hind us.

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