Fitch Ratings has affirmed Cyprus' long-term credit rating at BBB with a stable outlook, indicating confidence in the country's financial stability. Despite a slowdown in economic growth, Fitch expects the government to maintain fiscal surpluses and anticipates a continued decline in public debt, albeit at a slower pace.

The agency has slightly upgraded its growth forecast for this year to 2.5% (from 2.1% in March) and projects a growth rate of 2.88% for 2024. It is worth noting that in March, Fitch upgraded Cyprus' credit rating to BBB, two notches above the investment-grade threshold.

Regarding public finances, Fitch estimates that the general government balance will remain surplus for the next two years, despite the implementation of measures to address the increased cost of living, such as raising the Automatic Wage Indexation in the public sector to 66.7% from last year's 50% allowance. Fitch anticipates that the fiscal impact will amount to 0.1% of GDP this year and 0.3% in 2024.

Moreover, the expected fiscal surplus is projected to decline from 2.1% last year to 1.7% this year, remaining essentially unchanged at 1.8% in 2024, according to Fitch. However, the agency acknowledges that there is some risk in predicting the trajectory of public finances, mainly due to the potential impact of the rent-to-income scheme, although the scheme's conditions suggest limited implications for public finances.

Regarding public debt, Fitch believes that the downward trend will continue, albeit at a slower pace compared to 2022 when the debt-to-GDP ratio decreased by 15 percentage points, driven by a surplus balance and double-digit growth in nominal GDP. The agency states that they anticipate a continued, albeit slower, decline in the debt-to-GDP ratio to 80.9% this year and 73.2% in 2024. This percentage is significantly higher than the average BBB rating of 56%, Fitch notes. 

Fitch expects that Cypriot authorities will maintain a significant stock of liquid assets and issue regular bonds to cover upcoming debt maturities. Although the yields on Cypriot debt remain high, the cost of debt servicing is expected to increase at a moderate pace, with the average cost of debt rising from 1.7% in 2022 to 2.1% in 2024.

Regarding economic growth, Fitch highlights the resilience demonstrated by the Cypriot economy in 2022, which recorded a growth rate of 5.6% despite sharp price increases, the Russian invasion in Ukraine, and the impact of sanctions on Russia, which has significant ties to Cyprus.

In addition, Fitch predicts that the growth rate will moderate to 2.5% in 2023, which, however, is higher than the previous estimate of 2.1% in March. According to Fitch, the slowdown will be driven by domestic demand, which will be constrained by rising interest rates and the continued impact of high prices on real incomes. The agency also projects a growth rate of 2.8% for 2024.

Fitch's analysis reveals positive developments within the banking system. The quality of asset data continues to improve, as evidenced by the decline in the non-performing loan ratio from 11.4% to 9.3% between March of the previous year and March of the current year. Importantly, there hasn't been a significant increase in new non-performing loans, as indicated by the stability of loans in stage 2 of the IFRS 9 framework, which represents loans with notable credit deterioration, remaining at 12%.

Furthermore, the liquidity of banks has improved, driven by enhanced profitability in an environment of higher interest rates. This is evident from the increase in the Common Equity Tier 1 ratio to 17.7% at the end of 2022, compared to 17.1% the previous year.

Looking ahead, Fitch anticipates a reduction in the current account deficit to 5.8% of the GDP by 2024. This follows a substantial expansion in 2022, reaching 9.1% due to elevated fuel prices and robust domestic demand.