Fitch Affirms Cyprus at 'B-'/'CCC'
Mon Nov 11, 2013 11:39am EST
LONDON, November 11 (Fitch) Fitch Ratings has affirmed Cyprus's Long-term foreign currency and local currency Issuer Default Ratings (IDRs) at 'B-' and 'CCC' respectively.
The issue ratings on Cyprus's senior unsecured foreign-law and local-law bonds are also affirmed at 'B-' and 'CCC' respectively. The Outlook on the Long-term foreign-currency IDR is Negative.
The Country Ceiling is affirmed at 'B', and the Short-term foreign currency IDR is affirmed at 'B'.
KEY RATING DRIVERS
The affirmation of Cyprus's ratings reflects the following key rating drivers:
- An external EU-IMF programme supports the sovereign's near term liquidity position, although downside risks are substantial.
- The economic outlook remains bleak despite growth so far in 2013 performing better than Fitch's previous expectations.
The agency currently expects GDP to contract 7% this year compared with its previous forecast of nearly 9% and after declining 2.4% in 2012.
The economy is likely to remain in deep recession in 2014 with the downturn lasting longer than assumed under the EU-IMF programme.
- Initial record of implementation under the EU-IMF programme has been good, with fiscal outperformance relative to targets in 2013.
However, there remains a high risk of the multi-year programme going off track due to downside risks to economic performance or a weakening in political commitment to the programme.
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Fitch continues to expect gross general government debt/GDP to peak slightly above 130% of GDP, though a year later in 2016 than in our July projections.
In our baseline projections, we expect debt ratio to fall only gradually in the second half of the decade, owing to some slippage from ambitious fiscal targets in the medium term and weaker growth.
Public finances will therefore remain vulnerable to shocks well beyond the programme period which is scheduled to end in 2016.
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Confidence in the banking sector will take time to be restored. Deposits are still declining and restructuring of banks is on-going. Banking sector recapitalisation has, however, progressed and Fitch does not expect any additional public funds to be used to support the banking sector beyond the EUR1.5bn budgeted for capitalisation of cooperatives and the EUR1bn buffer in the EU-IMF programme.
Restrictions on bank transfers are being gradually lifted. However, the process of lifting capital controls carries risks, and a premature exit could trigger material capital flight with negative economic consequences.
-There are some initial signs of positive economic adjustments. Growth in employee compensation has fallen below growth in productivity, leading to an improvement in labour costs.
The current account deficit has narrowed to around 2% of GDP in 2013 from over 6% in 2012, albeit primarily reflecting a contraction in domestic demand and imports.
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The one-notch differential between the local currency IDR (CCC) and the foreign currency IDR (B-) reflects Fitch's assessment of the greater vulnerability of bonds issued under domestic law relative to foreign-law bonds, as demonstrated by the 2013 restructuring of domestic law bonds, which revealed a preferential treatment of foreign-law sovereign bonds.
RATING SENSITIVITIES
The Negative Outlook reflects the following risk factors that may, individually or collectively, result in a downgrade of the ratings:
- Significant slippage from programme targets, in particular fiscal deficits, or adverse changes to public debt dynamics, for example, caused by a deeper-than-expected recession or political shocks
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A recession that is materially deeper or longer lasting than assumed by Fitch which would have adverse consequences for the public debt dynamics - Intensification of the banking crisis in Cyprus, for example, capital flight from banks if capital controls are lifted prematurely
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A further restructuring of Cyprus's marketable liabilities could, depending on the terms, trigger a second rating default event if Fitch were to judge this a distressed debt exchange Future developments that may, individually or collectively, lead to the Outlook being revised to Stable include:
- A longer track record of successful implementation of the EU-IMF programme
- Signs of a stabilisation in the economic output and the banking sector
- Improvements in export performance that help facilitate the rebalancing of the economy
-Lifting of capital controls with no material negative economic consequences. Exit from capital controls would also lead to an upgrade of the Country Ceiling.
KEY ASSUMPTIONS
Fitch expects the recession to be deeper and the downturn to last longer than assumed under the EU/IMF programme.
The agency expects output to contract by around 5% in 2015 and 1.5% in 2016 and not return to growth until 2017.
This compares with the EU-IMF programme forecast for the economy to grow from 2015.
Fitch assumes moderate slippage from EU-IMF programme targets,
especially in 2016 when the primary balance is expected under the programme to improve sharply to a surplus 1.2% of GDP from a deficit of 2.1% of GDP.
According to the government it has yet to specify slightly below 4% of GDP of fiscal adjustment measures required to achieve a primary balance surplus of 4% of GDP by 2018 under programme assumptions (though it has already identified measures over 7% of GDP).
It is likely that the fiscal adjustment will need to be greater to achieve the ambitious long term targets for the primary balance, especially as downside risks to growth remain high.
Fitch's debt dynamics projections also assume the government concludes the asset swap of a portion of the outstanding government debt held by Cyprus Central Bank (EUR1bn), generates proceeds from privatisation (of at least EUR1bn within the programme period and EUR0.4bn outside) and from sales of gold reserves from the central bank (EUR0.4bn).
Fitch currently assumes that the fiscal costs of bank recapitalisation will not exceed the EUR2.5bn specified under the EU-IMF programme, which includes a contingency buffer of EUR1bn.
The banking sector has been recapitalised, including via the conversion of uninsured deposits in the island's largest lender, the Bank of Cyprus.
Official funding will only be used to recapitalise the cooperatives, with EUR1.5bn secured in a special account. Hellenic Bank is now the island's second largest lender after Cyprus Popular Bank was put under special administration and recently completed its recapitalisation privately.
The capital needs of the banking sector were estimated under very conservative assumptions under the Pimco assessment of the sector earlier this year.
Despite expectations of further deterioration of asset quality the capitalisation of banks should, therefore, remain above regulatory requirements through the programme period.
Fitch has not factored possible hydrocarbon receipts into its projections; these therefore represent an upside risk beyond the near term.
While the authorities claim government revenues to range between EUR18.5bn (102.9% of GDP) to EUR29.5bn (164.1% of GDP) in drilling block 12 off the southern coast of Cyprus alone, the economic viability of extraction remains uncertain and beyond the horizon of the programme.
Fitch assumes there will be progress in deepening fiscal and financial integration at the eurozone level in line with commitments by policy makers.
It also assumes that the risk of fragmentation of the eurozone remains low, and that Cyprus remains a member of the eurozone.
Contact: Primary Analyst Enam Ahmed Director +44 20 3530 1624 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Douglas Renwick Senior Director +44 20 3530 1045 Committee Chairperson Ed Parker Managing Director +44 20 3530 1176 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:
[email protected]. Additional information is available on
Fitch Ratings - Global rating agency dedicated to providing value beyond the rating through objective and balanced credit opinions, research and data. Applicable criteria, 'Sovereign Rating Criteria' dated 13 August 2012 and 'Country Ceilings' dated 09 August 2013, are available at
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