Standard & Poor’s Ratings Services has affirmed its ‘A/A-1’ foreign currency and ‘AA-/A-1+’ local currency ratings on the Republic of Cyprus.
The affirmation reflects the government’s success in consolidating its finances and a commitment to further fiscal consolidation over the medium term, structural reforms and medium-term prospects for further reform, which underpin a prosperous and resilient economy, and narrowing external imbalances. The outlook is stable.
Although the general government deficit is expected to widen modestly in 2002, to 3.0% of GDP according to Standard & Poor’s estimates, expenditure discipline and the broadening of the tax base are expected to narrow the fiscal imbalance to 0.6% in 2005, strengthening fiscal flexibility. At the same time, the general government debt burden is forecast to fall below 50% of GDP by 2005, from an estimated 57% at year-end 2002. Cyprus’ debt burden remains significantly higher than the ‘A’ median.
At US$14,860, per capita income is high compared with that in similarly rated countries. Cyprus’ economy has become increasingly resilient and flexible in recent years, on the back of a liberalisation process accelerated by the requirements of EU accession. Cyprus is expected to weather the slowdown in tourism without significant disruption to its product and factor markets. The republic is also well placed to meet the challenges of a possible solution to the long-standing partition of the island.
External imbalances are forecast to narrow over the medium term. Liquidity ratios, however, are likely to remain significantly worse than in similarly rated countries. In 2002, Cyprus’ short-term external debt and gross external financing gap (current account deficit plus long-term principal repayments and short-term debt) are estimated at 145% of current account receipts and 282% of reserves, respectively, which is substantial, reflecting nonresident deposits in the banking sector.
Leading indicators of a systemic crisis in the financial sector have eased. Credit growth has slowed to 8.4% in the year to the end of July 2002, compared with 15% in the same period the previous year. Nonetheless, the level of financial intermediation, at an estimated 119% of GDP in 2002, and the external indebtedness of the financial sector, at an estimated 33% of current account receipts, are markedly higher than in similarly rated countries.
“The stable outlook is underpinned by the narrowing of the fiscal deficit and concomitant stabilisation of the general government debt burden, prospects for further fiscal consolidation, and structural reforms in the run-up to EU accession,” says Standard & Poor’s credit analyst David Cooling.
Cyprus will benefit from the economic stability afforded by its eventual participation in the Economic and Monetary Union (EMU). Participation in EMU would effectively shield Cyprus from any balance of payments-related financial stress, and coupled with further improvements in the government finances could strengthen Cyprus’ credit standing. Conversely, a significant reversal of Cyprus’ prudent policy course could lead to an upward-trending fiscal deficit or mounting balance of payments pressures. Any of these developments could undermine the government’s credit standing.