Fitch affirms Cyprus at 'BBB'; outlook stable

Fitch Ratings has affirmed Cyprus' Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook.

It said the island’s ratings reflect income per capita levels and governance indicators that are well above the 'BBB' median, and also compare favourably with the 'A' median; and institutional strengths and policy credibility supported by EU and Eurozone membership.

“These strengths are balanced by still high levels of public and private sector indebtedness, vulnerabilities in the financial sector, and a backdrop of regional political tensions related to the division of the island,” it added however.

According to Fitch, the general government balance will remain in surplus over the next two years, despite some balance-decreasing measures to address the cost of living crisis, such as the adjustment in the wage indexation mechanism for public sector wages from half to two-thirds of the previous year's inflation rate (expected impact of 0.1% of GDP this year and 0.3% of GDP next year).

“We expect the fiscal surplus to decline from 2.1% of GDP last year, to 1.7% this year and then remain broadly unchanged at 1.8% in 2024,” it said. “A risk to the public finance projections is the potential impact of the Mortgage-to-Rent scheme (expected to be introduced although the timing is uncertain). However, the conditionality of the scheme implies a limited likely impact on the public finances.”

General government debt as a share of GDP declined sharply last year by just under 15pp to 86.5%, due to the budget balance turning to a surplus and double-digit nominal GDP growth. “We forecast a continued, albeit slower decline of the debt ratio to 80.9% this year and 73.2% in 2024. This would still leave the debt ratio substantially higher than the 'BBB' median forecast (around 56%).”

Fitch said it assumed that the Cypriot authorities will preserve a sizeable liquid asset buffer, and regularly issue bonds to cover, at least in part, upcoming debt amortisations. “While yields on Cypriot bonds remain high, we expect the interest burden to increase at a moderate pace, and the average interest rate on debt to increase from 1.7% in 2022 to 2.1% in 2024.”

As for the country’s macroeconomic resilience, Fitch said it was anticipating a slowdown. “The Cypriot economy expanded strongly in 2022, with real GDP increasing by 5.6%, despite the surge in commodity prices and the impact of sanctions on Russia in the context of strong interlinkages between the Cypriot and Russian economies. We expect growth to slow to 2.5% this year (up from 2.1% in our review in March), as domestic demand is constrained by rising interest rates and still high prices impact real incomes. Real GDP growth over the whole year will be 2.5%. Growth will increase to 2.8% in 2024.”

Fitch also said that asset quality in the Cypriot banking sector has continued to improve, with the non-performing loan (NPL) ratio declining to 9.3% in March, from 11.4% a year earlier. “The share of Stage 2 loans has remained stable since the start of the year, at 12%, implying that the risk of a large inflow of new NPLs has not yet materialised,” it said. “Banking sector solvency has improved, driven by increased profitability in an environment of higher interest rates, with the common equity Tier 1 capital ratio increasing to 17.7% by end-2022, from 17.1% a year earlier.”

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