International credit rating agency Standard and Poor’s Global Ratings has upgraded the prospects of the Cypriot economy from stable to positive, citing the ongoing macroeconomic stabilisation.
At the same time, it reaffirmed Cyprus’ long-term credit rating at “BBB” (in local and foreign currency) and its short-term rating at “A-2”.
The American credit rating agency highlights that the Cypriot economy is normalising a decade after the country’s financial crisis. The government has returned to achieving fiscal surpluses, which are expected to be maintained at an average of 1.6 per cent during the period 2023-2026. Non-performing loans (NPLs) have significantly decreased since their peak, and the external sector of the economy continues to improve.
Moreover, it estimates that medium-term growth will be slightly below 3 per cent, the net public debt will be reduced to 52 per cent of GDP by 2026, and inflation levels are stabilising.
While vulnerabilities still exist on the economic, fiscal, and external fronts, current trends support Cyprus’s creditworthiness, according to the rating agency. It notes that “technological sector diversification and potential natural gas production could fuel medium and long-term growth.”
Specifically, S&P states that the positive prospects reflect the ongoing macroeconomic stabilisation in Cyprus after the country’s financial crisis in 2012-2013. It emphasises that “despite mounting policy pressures for increased spending, the government seems on a path to maintain stable fiscal surpluses in the coming years.”
The positive outlook also reflects, according to S&P, the strong progress made since the 2012-2013 financial crisis in reducing non-performing loans (NPLs) in the banking sector, despite the still high NPL stock compared to other eurozone countries.
S&P suggests that it could upgrade Cyprus’s credit rating within the next 12-24 months if debt reduction continues on its current path, supported by strict expenditure control and stable fiscal surpluses. It adds that an upgrade could also be possible if the currently high current account deficit shrinks, alleviating concerns about external debt leverage on Cyprus residents.
However, S&P could revise the outlook to stable if, within the next 12-24 months, external short-term debt levels start increasing again, reversing the current favourable trend of external deleveraging.
Pressure on the rating could also arise if progress on structural reforms is delayed, causing significant delays in Cyprus’s funding from NextGenEU, the agency stated.
Growth forecast for 2023
The positive outlook for Cyprus also comes with a cautious note. Standard and Poor’s Global Ratings expects economic growth to decline to an estimated 2.4 per cent in 2023 due to the stricter enforcement of sanctions, tighter financial conditions, and households’ balance sheets eroded by inflationary pressures.
The agency anticipates that medium-term growth will remain just below 3 per cent, supported by further expansion in tourism and efforts to diversify into the technology sector. However, the successful implementation of structural reforms under the Recovery and Resilience Plan is likely to be the key to unlocking further growth.
S&P raises concerns about Cyprus’ significant dependence on imported oil and petroleum products, which accounted for just under 86 per cent of its gross energy supply in 2021, the highest among all EU member states. However, recent discoveries of offshore natural gas are expected to reduce this dependency.
The diversification of the technology sector and the potential natural gas production are likely to fuel medium and long-term growth in Cyprus, according to the agency. The tourism sector, which still constitutes around 20 per cent of GDP, is expected to face milder growth levels in the coming years, partly due to the impact of inflation on households in Northern Europe.
Conversely, efforts to transform Cyprus into a technological hub, with a particular focus on fintech and gaming, may become more significant drivers of growth. These opportunities have been enhanced by the relocation of various businesses to the island since 2020, especially from Russia, Ukraine, and Israel.
S&P notes that significant natural gas discoveries made in 2022 by ENI and Total could further transform the Cypriot economy, even though production at the most advanced Aphrodite field is not expected until at least 2027.
Fiscal surplus, debt and inflation
Furthermore, S&P suggests that fiscal surpluses are likely to be maintained, even amid expenditure pressures. The fiscal balance returned to positive territory last year, improved by 4.1 percentage points to reach a surplus of 2.1 per cent of GDP.
While wage increases in the public sector, higher defence spending, and the costs of green and digital transformation may put upward pressure on expenditures in the coming years, S&P still expects the surplus to be maintained at an average of 1.6 per cent of GDP during the period 2023-2026.
Regarding public debt, the American rating agency predicts that net debt will decrease to 52 per cent of GDP by 2026, aligning Cyprus more closely with other EU member states where the average net public debt is projected to be 51 per cent of GDP in the same year.
S&P’s assessment of Cyprus’ net debt reflects significant cash reserves of approximately €3 billion, which are assumed to likely be retained in the near future. The cost of Cyprus’ debt remains manageable, with interest payments projected to occupy only 4.1 per cent of government revenues on average during the period 2023-2026.
The Cypriot banking sector
Regarding the banking sector, S&P reports that the operational environment for Cypriot banks is improving, with a reduction in funding risks.
The agency also notes that Cypriot banks have made significant progress in rebalancing their funding profiles in recent years, aided by strong deposit inflows and significant deleveraging of their balance sheets.
Deposits, according to the agency, more than fully cover loans, with the estimated loans-to-deposits ratio at 52 per cent at the end of 2022, while funding needs are limited, and banks benefit from ample liquidity.
However, it states that the Cypriot financial system continues to exhibit a relative dependence on non-resident depositors, which may be less stable in a scenario of pressure from traditional retail funding.
On this matter, the agency reports that non-resident deposits continued to decline and are estimated to constitute 16 per cent of total deposits at the end of 2022, compared to over 30 per cent in 2012.
Furthermore, S&P highlights that despite the impacts of Western sanctions on certain Russian entities and individuals and the recently increased volatility in capital markets, deposits in Cyprus have remained stable without showing clear signs of instability.
“Therefore, we observe a positive trend in the risk assessment for Cyprus’ banking sector”, it added.
