Fitch Ratings Agency upgrades Cypriot sovereign debt to BB+, one level below investor grade status. The boost signals confidence in the country’s recovery methods as it reshapes its banking sector following an industry crisis in 2013

Last week, Fitch announced that it had upgraded Cyprus’ Issuer Default Rating (IDR) from “BB” to “BB+”, meaning the country’s sovereign debt is now just one level away from reaching investor grade status. With Fitch, Moody’s, and S&P each posting a positive outlook for the Cypriot economy, the country appears poised to continue on the road to recovery after suffering through a banking crisis just five years ago.

Following the near collapse of its banking sector, Cyprus entered into an economic adjustment programme in 2013 overseen by the International Monetary Fund, the European Commission, and European Central Bank. The programme entailed a €10 billion line of credit from the European Stability Mechanism and €1 billion from the IMF. Cyprus exited the programme in 2016 and since then the country has participated in post-programme surveillance by the EU in order to steer its economy back to health.

In its press release, Fitch cited the improving macroeconomic conditions in Cyprus as a key reason for its recent upgrade. Specifically, the ratings agency predicts that the country will achieve a fiscal surplus of 1.1% of GDP in 2018 and 2019. It is also worth noting that Cyprus has one of the highest primary surpluses in the Eurozone, further evidence of the government’s determination to get its fiscal house in order.

There have also been significant improvements in the Cypriot labour market. While unemployment is still above pre-crisis levels, the IMF expects unemployment to fall to 10% this year from its peak of 16% in 2014. Fitch pointed out that this trend will likely help raise government revenue, thereby further improving the stability of government finances.

Cyprus’ economy has benefited from the country’s ability to attract a growing amount of foreign direct investment. Between 2015 and 2016 FDI jumped by 9.1%. This can be attributed to a friendlier business environment achieved through the adoption of a competitive corporate tax rate, more efficient licensing procedures, and the promotion of development projects.

Cyprus is in the process of implementing a “bad bank” institution to lend support to several banks that are struggling to climb out from under the weight of their of non-performing exposures (NPEs). Contrary to its name, the bad bank concept has had great success in other Southern European countries such as Spain, with the implementation of its bad bank, SAREB. In fact, Spain’s bad bank has provided so much relief that SAREB is now being used as a blueprint for European countries who suffer from similar financial woes.

Fitch noted that FDI has flowed into the construction, tourism, energy, and education sectors. Some recent, high profile investments include the construction of a high-end marina in Ayia Napa and Cyprus’ first ever luxury casino. In 2016 there was also a significant rise in the number of real estate sales to foreign purchasers. In total, foreign buyers accounted for around 27% of all sales.

Fitch did identify some areas of vulnerability in the Cypriot economy. The primary area of concern is the worryingly high level of non-performing exposures (NPEs) in the country’s banking sector. NPEs can weigh down a bank’s profits and increase its risk of insolvency. NPEs also reduce a bank’s ability to issue new loans, which can constrain growth in a country’s real economy.

While the ratio of NPEs declined somewhat from 46.4% at to 42.5% between 2016 and 2017, Fitch drew attention to the slow pace at which the issue is being resolved. It is also disconcerting that the improvement in NPEs has been uneven across Cyprus’ banks –– with the cooperative banking sector posting an NPE rate of nearly 60% –– much higher than the country’s largest banks.

That being said, the government has taken great strides to shore up the banking sector, which is still a pillar of the country’s economy. Just last the month Nicosia intervened to prevent a liquidity crisis at troubled Cyprus Cooperative Bank (CCB), depositing €2.5 billion with the institution. In order to offer the CCB further necessary relief, it intends to split the bank with a state-backed “bad bank,” which, despite the misgivings from its name, will act as a complimentary institution, specialising in the management of the CCB’s non-performing exposures.

The European Commission is currently examining whether Cyprus’ proposed bad bank, which will be called Estia, conforms to EU law. If they are given the go-ahead, Estia will take non-performing residential property loans off the balance sheets of some of Cyprus’ most troubled banks to allow them to focus on what they do best, offering loans to qualified borrowers.

In response to Fitch’s upgrade, Cypriot Finance Minister Harris Georgiades tweeted, “We still have difficulties that we must face. But our country’s progress is being recognised. And we can lift Cyprus even higher, as long as we continue the effort with confidence, consistency, and collective responsibility”. With the economy set to expand by 3.4% from 2018 to 2019 and interest rates falling, Mr. Georgiades’ optimism seems well justified.

Source: https://www.southeusummit.com/europe/cyprus/cypriot-credit-rating-gets-upgrade-fitch/