Cyprus re­turn to in­vest­ment grade is well de­served, but no room for com­pla­cency

Financial Mirror (Cyprus) - - CYPRUS - By Yian­nis Tirkides

The Cyprus sov­er­eign re­ceived an up­grade from S&P Global to in­vest­ment grade re­cently, for the first time since Jan­uary 2012 when first down­graded be­low that level.

For a lit­tle bit of his­tory and per­spec­tive, Cyprus was down­graded a to­tal of 12 notches from the mid­dle of 2010 to the mid­dle of 2013, and then re­ceived up­grades of seven notches in all, leav­ing a deficit of five notches for restor­ing the ini­tial po­si­tion.

It has been a long path through cri­sis and re­ces­sion to re­cov­ery. While an in­vest­ment grade is an i mpor­tant achieve­ment in its own right, not least be­cause of the ben­e­fits it brings, but also for the psy­cho­log­i­cal boost it means for the coun­try and its peo­ple, it is not the end of the road. We should and do as­pire for a much higher rat­ing on the scale, which would mean the fur­ther stream­lin­ing of poli­cies to spe­cific tar­gets and nec­es­sary re­forms.

The up­grade to in­vest­ment level by it­self brings sig­nif­i­cant ben­e­fits. It means the coun­try qual­i­fies for the Euro­pean Cen­tral Bank’s mon­e­tary pol­icy op­er­a­tions and for its as­set pur­chases in the con­text of its quan­ti­ta­tive eas­ing pro­gramme. Hence, pres­sures on the sov­er­eign’s bor­row­ing costs, long and short, will ease fur­ther and the cor­re­spond­ing in­ter­est rate spreads will like­wise nar­row more. This will be help­ing to re­duce debt ser­vice costs and will also even­tu­ally sup­port, though this might take some more time, lower bor­row­ing costs for cor­po­rates in com­mer­cial debt mar­kets.

Where does the up­grade to in­vest­ment level come from? Well, it comes from the per­for­mance of the coun­try and the econ­omy from the depths of the cri­sis to eco­nomic ad­just­ment, the re­struc­tur­ing that en­sued and the re­cov­ery we see to­day.

A lot has




three main


the gov­ern­ment, the banks, and the reg­u­la­tory in­fra­struc­ture.

In the gov­ern­ment sec­tor there has been a sig­nif­i­cant ad­just­ment. On a net ba­sis, be­tween 2012 and 2017, the bud­get ad­just­ment has been in ex­cess of 8% of GDP. This came through mostly as ex­pen­di­ture cuts.

De­spite all the mea­sures that were taken, rev­enue in­creases started to show more clearly in 2017 only, as the re­ces­sion and de­clin­ing nom­i­nal in­comes cur­tailed such gains ear­lier. This means that as the econ­omy con­tin­ues to per­form as an­tic­i­pated and as mod­est in­fla­tion kicks in, the rev­enue side will be driv­ing the bud­get sur­pluses in the medium term even as ex­pen­di­tures start to rise.

How­ever, the struc­ture of pub­lic spend­ing poses prob­lems as some func­tional ar­eas re­main heav­ily un­der­funded while oth­ers are ab­sorb­ing dis­pro­por­tion­ate bud­get out­lays.

A ra­tio­nal­i­sa­tion will be needed through the po­lit­i­cal process which is a longer term is­sue.

De­spite the sig­nif­i­cant in­crease of pub­lic debt as a re­sult of the gov­ern­ment in­ject­ing EUR 3.2 bln into the Cyprus Co­op­er­a­tive Bank to fa­cil­i­tate its res­o­lu­tion and the sale of its per­form­ing as­sets, the un­der­ly­ing debt dy­nam­ics re­main favourable. Debt dy­nam­ics are aided by sus­tained and siz­able pri­mary bud­get sur­pluses in re­cent years, strong eco­nomic growth, and low in­ter­est rates.

Strong eco­nomic growth re­quires in­vest­ments which in turn re­quire a sta­ble macroe­co­nomic en­vi­ron­ment and ease of do­ing busi­ness. Eco­nomic per­for­mance and sound pub­lic fi­nances add to the cred­i­bil­ity of the gov­ern­ment, which trans­lates to eas­ier ac­cess to bond mar­kets at more favourable terms.

In the bank­ing sec­tor also, there has been con­sid­er­able re­struc­tur­ing and im­prove­ment. Banks have down­sized their bal­ance sheets to a large ex­tent, by re­fo­cus­ing their ac­tiv­i­ties in their core mar­kets, delever­ag­ing on pri­vate sec­tor in­debt­ed­ness and by re­duc­ing their large non-per­form­ing ex­po­sures.

Be­tween end-2012 and July-2018 gross loans out­stand­ing dropped by 20% in the house­hold sec­tor and by 30% in the cor­po­rate sec­tor. De­pen­dence on emerg­ing liq­uid­ity as­sis­tance has now been en­tirely elim­i­nated and re­placed by con­sid­er­able ex­cess liq­uid­ity, mea­sured on the ba­sis of net loans to de­posits with net loans be­ing gross loans less pro­vi­sions. Non-per­form­ing ex­po­sures dropped from EUR 30 bln in April 2015 to about 20 bln in April 2018. The sale of the Cyprus Co­op­er­a­tive Bank in the sum­mer en­tails the trans­fer of EUR 5.7 bln of gross non-per­form­ing ex­po­sures to the resid­ual en­tity out­side of the bank­ing sys­tem.

At the same time, Bank of Cyprus’ sale of EUR 2.7 bln will also re­duce gross non-per­form­ing ex­po­sures in the bank­ing sys­tem. To­tal non-per­form­ing ex­po­sures will thus drop to EUR 11-12 bln by year end or 34% of to­tal loans.

Fur­ther­more, of the re­main­ing non-per­form­ing ex­po­sures a sig­nif­i­cant part has been re­struc­tured and ex­pected to be­come per­form­ing as the re­quired con­di­tions are met. The re­cently leg­is­lated ESTIA scheme will help vul­ner­a­ble bor­row­ers to re­struc­ture their mort­gage loans and there­fore ac­cel­er­ate the re­duc­tion of their non-per­form­ing ex­po­sures.

In terms of the reg­u­la­tory in­fra­struc­ture, the re­cent changes in leg­is­la­tion re­gard­ing fore­clo­sures and in­sol­vency will en­able banks to re­duce the strate­gic de­fault­ers and thus re­duce non-per­form­ing ex­po­sures faster.

Fur­ther re­duc­tions in non-per­form­ing ex­po­sures in the bank­ing sec­tor and also in the stock of pub­lic debt will be need over the next cou­ple of years be­fore ad­di­tional up­grades will be­come pos­si­ble. Whilst the coun­try is al­lowed to cel­e­brate the re­turn to in­vest­ment grade sta­tus, we can­not grow com­pla­cent. There is still a lot that re­main to be done in or­der to re­duce vul­ner­a­bil­ity and in­crease re­silience. The au­thor is Man­ager, Eco­nomic Re­search at Bank of Cyprus. The views ex­pressed are per­sonal and may not nec­es­sar­ily re­flect those of the bank

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