CI Ratings upgrades Cyprus' sovereign ratings, revises outlook to stable

Capital Intelligence Ratings (CI Ratings or CI) announced that it has upgraded the Republic of Cyprus’ Long-Term Foreign Currency Rating to ‘BBB+’, from ‘BBB’. At the same time, CI Ratings has affirmed the sovereign’s Short-Term FCR at ‘A2’. The Outlook for the ratings has been revised to Stable from Positive following the upgrade.

The agency said the upgrade reflects the marked improvement in fiscal strength, including a sustained decrease in short- to medium-term fiscal risks. This is driven by higher-than-expected general government budget surpluses, low gross financing needs, and a faster than projected decline in government debt, with the debt-to-GDP ratio now projected to fall to around 56% by 2026.

Proactive management of the debt maturity profile has helped reduce refinancing risks, while a growing cash buffer provides a strong safeguard against potential short-term shocks and external adversities, it added. 'The upgrade also reflects the decline in contingent liabilities stemming from the banking sector, underpinned by a significant reduction in macro-financial imbalances and the improving strength of Cypriot banks," CI noted. "The banking sector’s size decreased to 190.4% of GDP in 2024, and the cumulative debt burden in the non-financial corporate and household sectors has halved in recent years. These developments, coupled with the continued clearing of non-performing loans (NPLs), have strengthened the stability of the financial system, reducing Cyprus’ reliance on wholesale and cross-border funding."

Supported by strong and resilient economic growth

According to the agency, the ratings remain supported by strong and resilient economic growth (one of the fastest in the euro area), high GDP per capita, significant foreign direct investment inflows, as well as the benefits of European Union and Eurozone membership, including the availability of financial support from the Recovery and Resilience Facility (RRF).

The ratings are constrained by persistent external vulnerabilities, including large current account deficits and external debt, very high external financing needs, and high geopolitical risk factors. The ratings are further constrained by the still high volume of NPLs held by credit acquiring companies (CACs), the slow pace of structural reforms to address labour market vulnerabilities and productivity, as well as medium- to long-term fiscal challenges stemming from the cost of the General Healthcare System (GHS) and an ageing population, CI said.

It added that the public finances remain strong. "According to data published by the Ministry of Finance, the ratio of consolidated general government debt to GDP decreased to 65.4% in 2024," it said, explaining: "This represents a significant improvement from the earlier projection of 70.4% and the 73.6% recorded at the end of 2023."

Debt dynamics benefited from a higher-than-expected primary budget surplus of 5.7% of GDP (3.3% in the same period of 2023) and robust economic growth. Although still relatively high, central government debt – which includes debt held by the social security fund – also declined last year to 101.5% of GDP from 108.7% in 2023.

Looking ahead

Looking ahead, CI expects general government debt to decline further to 59.9% and 56.1% of GDP in 2025 and 2026, respectively. This would mark the first time since 2010 that general government debt has fallen below the Maastricht Treaty threshold of 60%. In addition, debt maturities – estimated at €1.8b (5.2% of GDP) for 2025 and €2.1b (5.8% of GDP) for 2026 – are well within the government’s repayment capacity and present no immediate refinancing challenges, the agency said.

General government budget performance was extremely strong in 2024, with the budget position (on a cash basis) posting a higher-than-projected overall surplus of 4.5% of GDP (compared to 2.0% in 2023). Taxes on income and wealth increased by 16.7%, reaching 11.3% of GDP in 2024, reflecting robust economic activity and improving wages and salaries, especially with the inflow of foreign labour to Cyprus. Moving forward, CI expects the general government budget position to register surpluses averaging 3.5% of GDP in 2025-26.

Short-term refinancing risks continue to decline. This is due to sound fiscal management, a favourable debt maturity structure, and low gross financing needs (projected at 3.1% of GDP in 2025), as well as the prudent building of cash buffers of over 11% of GDP that cover around 300% of gross financing needs for at least the next 12 months.

Risks could arise

The outlook for the public finances remains generally balanced, although risks could arise if fiscal discipline weakens or if expenditure on subsidies, social welfare and public sector wages outpaces revenue growth. Furthermore, a potential decline in tax revenues could emerge if downside risks to GDP materialise. Medium-term risks are notably tied to large-scale investment projects, including the delayed construction of the liquefied natural gas terminal, which may generate budgetary pressures of up to 1% of GDP due to state guarantees or additional costs. Similarly, the Great Sea Interconnector project could temporarily weigh on the public finances.

Other fiscal risks could arise from moderate-to-high contingent liabilities, such as state-guaranteed debt of public entities, rising GHS costs and ongoing legal cases. In 2023, liabilities from public entities stood at 9.9% of GDP, with 10.9% of this debt classified as non-performing, particularly among entities reliant on government subsidies and burdened with high operational costs. Explicit public guarantees are expected to have declined to 4.4% of GDP in 2024, and are primarily linked to the Electricity Authority of Cyprus and the Cyprus Asset Management Company (KEDIPES).

Banking sector strength continued to improve since our last review but is still considered moderate. According to the Central Bank of Cyprus (CBC), the aggregate NPL ratio of credit institutions operating in Cyprus (including the assets under the Asset Protection Scheme of Hellenic Bank) declined further to 6.6% of total loans in November 2024 (from 7.9% in December 2023), while accumulated provisions increased to 56.4% (from 49.5%) in the same period. Moreover, restructured loans declined to 5.4% of total loans in November 2024, compared to 6.7% and 11.2%, respectively, in the same period of 2023 and 2022. Capital adequacy is currently sound, with an average CET-1 ratio of 27.8% at end-November 2024.

Asset quality risks continue to decline in line with the increase in employment and real wages, and the significant deleveraging of the household and corporate sectors. The cumulative debt overhang in both of these sectors declined by around 50% in the past decade, reaching a still-high 182.7% of GDP in September 2024 (189.8% in December 2023 and 341.0% in December 2013).

NPLs continue to weigh on ratings

Notwithstanding the improvement, the large volume of non-performing assets managed by CACs continue to weigh on the ratings. These assets consist of NPLs that banks transferred to CACs during major financial cleanups following the banking crisis in 2013. Private sector NPLs held by CACs are estimated at around EUR19.7bn (equivalent to 58.9% of GDP) in June 2024.

Despite persistent external adversities, economic growth remains positive. Real GDP expanded by 3.4% in 2024, from 2.6% in 2023, reflecting robust growth in the economy’s main sectors, especially hospitality, construction, wholesale and retail trade, and information and communication technology (ICT). Moving forward, CI expects real GDP to increase by an average of 3.1% in 2025-26, benefitting from improving domestic demand and ongoing investment in numerous economic activities, supported in part by RRF funding and foreign private capital inflows. GDP per capita was high at EUR34,338 in 2024, and is considered a supporting factor for the ratings. Unemployment declined to 4.6% in 2024, from 5.4% in 2023.

External strength is moderate owing to large current account deficits and very high external debt. The current account deficit is expected to have narrowed to 4.5% of GDP in 2024 (from 10.1% in 2023), reflecting the continued increase in services’ surplus, as well as the improvement in net exports of goods. Moreover, external debt – excluding special purpose entities – declined to 176.3% of GDP in September 2024, from 190.3% in December 2023.

Rating Outlook

The Stable Outlook indicates that the ratings are likely to remain unchanged over the next 12 months. The outlook balances the significant decline in fiscal risks and robust economic performance against the large current account deficit and very high external debt.

Rating Outlook: Upside Scenario

The Outlook could be revised to Positive in the next 12-24 months should the government implement comprehensive structural reforms that would see further durable improvement in the public finances, increasing institutional strength and speedier resolution of transferred NPLs. Upward pressure on the ratings could also stem from a lower-than-projected current account deficit and a faster decline in external debt.

Rating Outlook: Downside Scenario

Conversely, the Outlook could be revised to Negative in the next 12 months should fiscal performance weaken and public debt dynamics reverse due, for example, to a shift in policy direction, a decline in fiscal discipline or significantly weaker economic performance, or if adverse shocks trigger a deterioration in the public and/or external finances.