(InCyprus) – Due to the ongoing macroeconomic normalisation, Standard and Poor’s Global Ratings has upgraded the outlook for the Cypriot economy from stable to positive. At the same time, they have confirmed Cyprus’s long-term credit rating (in local and foreign currencies) to be “BBB” and A-2 for short-term assessment.
The rating agency noted that ten years after the financial crisis, the Cypriot economy is returning to normal, the government is once again producing fiscal surpluses, which will be maintained at 1.6% on average in the years 2023 to 2022, nonperforming loans have significantly decreased from their peak during the crisis, and the deleveraging of the economy’s external sector is still ongoing.
In addition, it predicts that by 2026, net public debt would be 52% of GDP, inflation rates will be returning to normal, and medium-term growth will be slightly below 3%.
S&P notes that “the diversification of the technology sector and eventual natural gas production are likely to fuel the medium- and long-term growth,” despite the fact that there are still weaknesses on the economic, fiscal, and external fronts.
If debt reduction were to continue along its current course, supported by strict expenditure control and persistent fiscal surpluses, the rating agency says that it might increase Cyprus’ sovereign rating within the next 12 to 24 months. They note that a similar measure could take place if the current account deficit, which is currently very high, were to decrease, allaying worries about the external leverage of Cypriot citizens.
Additionally, if S&P noticed increased financial system stability, they might raise the rating. As it states, further reductions in NPLs on the balance sheets of the banking sector would indicate such an improvement, and this could lessen the risk of contingent liabilities to the government posed by the banking sector, improve the efficiency of monetary policy transmission, and improve banks’ access to debt capital markets.
On the other hand, the agency claims that if the current promising trend of economic deleveraging were to reverse and external short-term debt levels started to rise once more during the next 12 to 24 months, they might change their assessment to stable.
If structural reform work stalled and Cyprus’ NextGenEU funds experienced significant delays, rating pressure may also develop, they add.
On the other hand, the agency claims that if the current promising trend of economic deleveraging were to reverse and external short-term debt levels started to rise once more during the next 12 to 24 months, they might change their assessment to stable.
If structural reform work stalled and Cyprus’ NextGenEU funds experienced significant delays, rating pressure may also develop, they add.
The rating agency predicts that efforts by the government to turn Cyprus into a digital hub would further entrench the dominance of services in the country’s already highly open economy. In 2022, service exports outpaced product exports by 5.7 times. Total external trade in 2018 increased from 124.2% in 2019 (and just 93.6% in 2012) to 159.3% of GDP.
We believe that a key element of the most recent developments is the emphasis on building a digital centre specifically designed for gaming and finance. The agency’s press release states that these “may eventually bring in significant diversification from Cyprus’s bread-and-butter business of tourism, which still accounts for about 20% of GDP.
Cyprus’ heavy reliance on imported oil and petroleum products, according to S&P, is one major economic weakness. The greatest percentage of all EU member states in 2021, these accounted for slightly under 86% of the total energy supply. This dependence should be lessened by the recent finding of large quantities of offshore gas as well as the general trend of lowering energy intensity of Cypriot GDP.
Even yet, the drop in energy intensity between 2021 and 2010 was smaller than the EU average, which was “a little surprising given the increased importance of the services sector in GDP. The importance of shipping to Cyprus’ economy, which has complicated the calculation of national accounts as well as foreign data, could be one factor, they say.
Growth rate, Inflation, fiscal surpluses, national debt
As sanctions start to take full effect, banking conditions tighten, and consumer balance sheets deteriorate due to inflationary pressures, S&P forecasts that growth will slow to 2.4% in 2023.
In spite of collective salary hikes, inflation levels are stabilising. According to the most recent HICP inflation data, inflation dropped to 2.4% in July, which is the third-lowest level in the euro area and close to the ECB’s 2% target. However, the Cost-of-Living Adjustment (CoLA), which would raise salaries in the public sector and for occupations covered by collective wage agreements by 66.7% of the inflation rate from the previous year, might expose Cyprus to wage-price spiral dynamics, the agency warns.
According to S&P, fiscal surpluses will probably persist despite pressure on spending. Last year, the government balance improved by 4.1% to attain a surplus of 2.1% of GDP, bringing it back into the black. Although the expense of green and digital transformation, higher defence spending, and public sector wage increases are anticipated to have an impact on spending in the years to come, “we still expect the surplus to hold at 1.6% on average over 2023–2026.”
By 2026, S&P predicts net debt to decrease to 52% of GDP. With such a consolidation, Cyprus would be much closer to its EU counterparts, where the agency predicts the median net debt will be 51% of GDP in the same year.
“Our estimate of Cyprus’ net debt takes into account sizeable cash reserves of approximately €3 billion, which we anticipate will probably be kept in the near future. In particular, interest payments on Cyprus’ debt are expected to consume only 4.1% of the country’s total earnings between 2023 and 2026, according to the agency.
Banking sector
According to S&P, Cypriot banks are successfully improving their balance sheets, allowing them to maintain access to the capital markets. At the end of April 2023, NPLs made up 9% of all loans. From their peak of 49% in May 2016, this is a remarkable improvement, with the larger systemic banks showing the most development.
In 2023, systemic banks will be able to access the capital markets thanks to multiple issuances that are in compliance with new tier 1 requirements and the single resolution mechanism.
“However, because smaller banks are having trouble with transaction quantities, progress in balance sheet cleaning operations has stalled recently. In our opinion, further NPL reductions would strengthen banks’ and families’ resilience to upcoming shocks and reduce potential sovereign risks.
