German-based ratings agency Scope has affirmed Cyprus’ BBB- sovereign rating with a stable outlook citing the island’s continued economic recovery and fiscal consolidation as well as its euro area membership.
It did warn however, that a concentrated and externally-dependent economy presents risks to the stability and sustainability of Cyprus’ growth model, and subsequently its fiscal performance and financial stability.
The high stock of non-performing loans also continues to be a key credit weakness given the resulting vulnerabilities in the banking sector – weighing on profitability and constraining credit supply – and the risk it continues to pose to public finances in the context of a high public debt burden, Scope said.
“Finally, high levels of public and private indebtedness combined with a vulnerable external position pose risks in the case of significant changes in market sentiment and a tightening of global financing conditions. The Stable Outlook reflects Scope’s assessment that the risks Cyprus faces are broadly balanced.”
Going forward, Scope said it expects real GDP growth to average around 3 per cent over 2019-21, supported by sustained foreign investment and robust domestic demand.
Over the medium-run, growth is expected to moderate and converge towards the country’s potential of 2-2.5 per cent as the pipeline of investments gradually tapers off and improved payment discipline reduces disposable income, as recently highlighted by the IMF.
Scope also noted that the country’s growth potential remains constrained by a highly-leveraged private sector, which weighs on investment, high NPLs, which increase banks’ risk aversion and limit domestic credit supply, and lagging productivity growth, due to barriers to digital technology adoption, limited investment in productivity-enhancing areas and low R&D.
Additionally, any tension between Turkey and Cyprus remains a key geopolitical issue. Formal negotiations for reunification of the island have been suspended since July 2017 and Scope does not expect the two parties to come to an agreement in the near-term.