Rating Action Commentary
ֳ Upgrades Cyprus to 'A-'; Outlook Stable
Fri 06 Dec, 2024 - 5:03 PM ET
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Cyprus - Rating Action Report
ֳ - Frankfurt am Main - 06 Dec 2024: ֳ Ratings has upgraded Cyprus's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'A-' from 'BBB+'. The Outlook is Stable
A full list of rating actions is at the end of this rating action commentary.
Key Rating Drivers
The upgrade of Cyprus's IDRs reflects the following key rating drivers and their relative weights
High
Rapid Decline in Public Debt: Cyprus has had one of the sharpest declines in public debt/GDP among ֳ-rated sovereigns in recent years, a trend we expect will continue over the forecast period. Given high primary fiscal surpluses (we expect them to average 4.8% of GDP in 2024-2026), strong nominal GDP growth (including the uplift provided by a recent major GDP revision) and relatively stable interest rate costs, ֳ expects debt/GDP to fall to 65.5% in 2024 from a peak of 113.5% in 2020. Under our baseline scenario, the ratio will fall to 60% in 2025 and to 55.1% in 2026, in line with the current 'A'-median and well below the current eurozone average of 89%.
Strong Fiscal Surpluses: Fiscal outturns continue to outperform our previous forecasts, underpinned by strong revenue growth in line with structural and cyclical tailwinds as well as expenditure restraint. We now forecast the general government surplus to reach 3.9% of GDP in 2024, with a primary surplus of 5.3% (the highest in the EU). Revenue growth in the first eight months of the year was close to 8% (even as effects from the GDP deflator have eased) driven in part by strong employment growth across all economic sectors and continued improvement in tax/revenue collection.
ֳ forecasts a gradual decline in fiscal surpluses to an average of 2.9% in 2025-2026 (compared with a projected 'A' median deficit of 2.7%) as revenue growth decelerates. In line with the revised EU fiscal framework, the authorities expect a relatively conservative net expenditure path over the medium term (averaging below 5% in nominal terms in 2024-2028).
Limited Fiscal Risks: We see continued strong commitment across the political spectrum to maintaining prudent fiscal policies with a focus on debt reduction, improved revenue-raising capacity and sustaining sizeable cash buffers (we forecast cash deposits to average 12% of GDP over the forecast period). There is also a renewed focus on long-term structural issues with the financing of the social security system (currently there is legacy debt with the central government of around EUR10 billion), which could help reduce long-term fiscal challenges. In our view, these developments moderate potential fiscal risks stemming from very open nature of the Cypriot economy.
Medium
Strong Growth Momentum: ֳ expects GDP growth to reach 3.8% in 2024 and average 3.1% over the forecast period. This is well ahead of current and projected eurozone growth (around 1%) and reflects strong consumption and investment momentum, as well as recovery in net exports. Growth is being driven by positive performance across all sectors of the economy, in particular information and communication technology (ICT) and other services (such as financial services) with high productivity. This dynamic is set to continue as labour markets remain solid and interest rates gradually fall.
Positive Medium-Term Outlook: Growth momentum has been driven by an expanding labour force, thanks largely to an increase in immigration, and to a lesser extent, an increase in domestic employment. We forecast the unemployment rate to continue to fall over the next couple of years (to 4.6% by 2026 from a peak of 16.1% in 2014). Combined with our expectation of continued investment momentum (in part due to faster absorption of Recovery and Resilience funds), this will sustain higher growth rates over the next two years, helping income convergence with the EU.
Improving Banking Sector: The banking sector has robust solvency, liquidity and profitability, supported by higher interest rates and a favourable macroeconomic backdrop. The common equity Tier 1 Ratio stood at 23.5% in September 2024, the highest in the eurozone, providing banks with significant buffers in the event of cyclical downturn. The non-performing loans ratio continues to fall, to 7% in 1H24 (from 7.9% at end-2023, still well above the EU average), driven by organic reduction rather than sales of bad assets.
We think the improved performance in the banking sector has reduced the risks for macro-stability and around contingent liabilities to the sovereign, even though some legacy issues are set to persist over the medium term. This lower risk is also supported by significant private sector deleveraging over the past decade, with consolidated private indebtedness (excluding special purpose entities) at 140% of GDP in 2Q24 from a peak of 279% in 2014 (and now very close to the EU average).
Cyprus' 'A-' IDRs also reflect the following key rating drivers:
Fundamental Rating Drivers: Cyprus's ratings reflect income per capita levels above the 'A' median and policy credibility supported by EU and eurozone membership. These strengths are balanced by weaker governance indicators than peers, vulnerabilities in external finances, legacy challenges in the financial sector, and a backdrop of regional political tensions related to the division of the island.
Large CAD: Cyprus's low savings relative to investments are reflected in a high current account deficit (CAD), which reached 9.5% of GDP in 2023 under revised data (the highest in the EU). In recent years the CAD has been largely driven by rising outflows of profits, which have increased rapidly as ICT and other financial services boomed. ֳ forecasts a modest narrowing of the CAD to an average of 8.5% in 2024-2026 mainly reflecting solid growth in services exports.
Robust Foreign Direct Investment: We expect foreign direct investment (FDI) to continue to more than finance the CAD deficits over the medium term, which helps moderate external vulnerability risks. FDI inflows into Cyprus are also being directed to a more diversified set of sectors and the share of reinvested earnings is rising. Nevertheless, we think reliance on large volumes of capital flows in the context of ongoing geopolitical and security risks and potential shifts in investor sentiment highlights a persistent vulnerability.
ESG - Governance: Cyprus has an ESG Relevance Score (RS) of '5[+]' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Cyprus has a high WBGI ranking at 70.7, reflecting its long track record of stable and peaceful political transitions, well established rights for participation in the political process, strong institutional capacity, effective rule of law and moderately low levels of corruption.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
- Public Finance: Significant increase in general government debt/GDP over the medium term due, for example, to a long period of a looser fiscal stance or weaker macroeconomic outlook.
-Macro/External: External shock that heighten external vulnerabilities and negatively impact economic growth.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
-Public Finance: Sustained decrease in general government debt/GDP over the medium term, for example, driven by continued fiscal surpluses.
-External Finances/Macro: Reduced vulnerability to external shocks, for example, stemming from a continuing diversification of economic activity and a narrowing of the CAD.
Sovereign Rating Model (SRM) and Qualitative Overlay (QO)
ֳ's proprietary SRM assigns Cyprus a score equivalent to a rating of 'A' on the Long-Term Foreign-Currency (LT FC) IDR scale.
ֳ's sovereign rating committee adjusted the output from the SRM score to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
- External Finances: -1 notch, to reflect vulnerability of the economy to adverse external and terms of trade shock, in particular given a large current account deficit (driven by large primary income flows). The notch also reflects the impact of net Target2 claims on Cyprus´s sovereign net foreign assets, an SRM variable. As these claims belong to the Euro system and cannot be used at the discretion of the Central Bank of Cyprus, ֳ judges that the SRM (including the variable of reserve currency flexibility and SNFA) overstates the strength of the country´s external finances.
ֳ's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. ֳ's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Country Ceiling
The Country Ceiling for Cyprus is 'AAA', six notches above the LT FC IDR. This reflects very strong constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting LC into FC and transferring the proceeds to non-resident creditors to service debt payments.
ֳ's Country Ceiling Model produced a starting point uplift of +3 notches above the IDR. ֳ's rating committee applied a further +3 notches qualitative adjustment to this, under the Long-Term Institutional Characteristics pillar, reflecting the sovereign's membership of the eurozone currency union and the associated reserve currency status. ֳ views the risk of imposition of capital or exchange controls within the eurozone as exceptionally low, but not negligible.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Cyprus has an ESG Relevance Score of '5[+]' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in ֳ's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Cyprus has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
Cyprus has an ESG Relevance Score of '5[+]' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in ֳ's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Cyprus has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.
Cyprus has an ESG Relevance Score of '4[+]'for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As Cyprus has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
Cyprus has an ESG Relevance Score of '4' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Cyprus, as for all sovereigns. As Cyprus has a fairly recent restructuring of public debt in 2013, this has a negative impact on the credit profile.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. ֳ's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on ֳ's ESG Relevance Scores, visit.
Additional information is available on
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIA
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
- Country Ceiling Model, v2.0.2 (1)
- Debt Dynamics Model, v1.3.2 (1)
- Macro-Prudential Indicator Model, v1.5.0 (1)
- Sovereign Rating Model, v3.14.2 (1)
ADDITIONAL DISCLOSURES
ENDORSEMENT STATUS
| Cyprus | EU Issued, UK Endorsed |