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Risk of a new Cyprus default remains elevated, says Moody’s

The risk for another default for Cyprus over the coming years remains elevated due to very substantial risks to the country’s economic performance and, as a result, the government’s finances, said Moody’s Investors Service.

On July 2 Moody’s described a €1 billion Cypriot bond swap with longer maturities as a default.

In its annual report issued on Friday, Moody’s said its low assessment of Cyprus’ economic strength reflects the country’s narrow economic base and weak growth prospects.

In April, Cyprus and its international lenders (the European Commission, the European Central Bank and the International Monetary Fund) agreed on a €10 billion bailout, which included a restructuring of the island’s distressed banking sector, featuring a haircut of uninsured deposits.

“The rating agency anticipates the resolution mechanism for the Cypriot banking sector will result in a significant downsizing of the activities of domestic banks, which will severely affect the economic performance of the island from 2013 onwards,” the agency said, adding that the recession and the extended economic restructuring would have a lasting and profound impact on investor sentiment and on Cyprus’ attractiveness as a financial and business centre, which will overshadow its traditional competitive advantages over the coming years.

“In the absence of identified strong sources of growth, Moody’s central scenario anticipates that the Cypriot economy will not return to positive growth before 2016,” Moody’s added.

Describing Cyprus’ institutional strength as low, Moody’s said it reflected significant deficiencies in the decision-making process, substantial shortcomings in the regulation and supervision of financial institutions, and passive fiscal-policy management.

Moreover, the agency noted the significant delays observed in securing the Troika’s financial assistance have, in Moody’s view, exacerbated the precarious position of the country’s financial sector, thereby increasing Cyprus’ need for financial assistance.

Moody’s assessed Cyprus’ government financial strength as very low, given its already high debt burden and the substantial size of its projected fiscal needs.

Pointing out that immediate sovereign liquidity risks have been alleviated by the EUR10 billion funding programme that was agreed in April between the Cypriot government and the Troika, and the exchange of domestic sovereign debt, Moody’s noted it maintains that the sustainability of Cyprus’ public finances was far from assured despite the measures taken in the fiscal, financial and economic domains (as required by the programme).

“The country’s sharp economic recession, which is likely to be lengthy, underpins Moody’s view that the government is highly likely to miss the programme’s fiscal targets. This is likely to also perpetuate a negative feedback loop for the economy. Given the importance of public services, this may also challenge future consensus on fiscal strategy,” the report noted.

Moody’s said it believes that Cyprus’ susceptibility to event risk is very high and mainly stems from the crystallisation of contingent liabilities as well as the country’s capital control policy.

The report noted that the agency still considers that there remain uncertainties regarding the magnitude of further recapitalisation needs for the financial sector given the expected sharp deterioration in the operating environment which will erode asset quality and  the behavioural responses of all economic actors to the shocks experienced by the financial sector, including the risk of financial disruption surrounding the timing and approach for lifting capital controls. (CNA)



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