Moody's Ratings has upgraded the outlook for the Government of Cyprus to positive from stable while affirming the country's long-term credit rating at Baa2.

This decision reflects Moody's confidence in the potential for strong fiscal and debt outcomes in Cyprus over the next few years. According to Moody’s, this optimistic scenario is expected to result from the continuation of prudent fiscal policies and strong medium-term economic growth prospects. Additionally, increased confidence in the strengthening and deleveraging of Cyprus' banking sector—which has reduced the country's vulnerability to banking sector risks—is anticipated to foster robust growth and solid fiscal results.

Moody's anticipates that Cyprus will continue to achieve significant fiscal surpluses, projected at around 2.3-2.4% of GDP for 2024-25, although slightly lower than the government's forecast of 2.8-2.9% of GDP. These surpluses are expected to further reduce the debt burden to under 65% of GDP by 2025. Moody's assesses that the risks to these fiscal and debt projections are skewed towards more favorable outcomes.

The affirmation of Cyprus' Baa2 ratings balances several factors. On one hand, Moody’s notes that "Cyprus benefits from high wealth levels, strong trend GDP growth, robust institutional capacity, and effective policymaking." On the other hand, it adds that "the country faces challenges due to its small economic size, a still relatively high public debt burden, and moderate susceptibility to event risks, including those related to the banking sector and geopolitical issues."

Cyprus' small, service-oriented economy, though diverse within the service sector—including tourism, business services, information and communication technology (ICT), higher education, and shipping—contributes to growth volatility. This volatility, the rating agency notes, impacts economic strength despite high income levels and robust trend GDP growth.

Cyprus' strong institutional capacity and effective policymaking have been demonstrated by its robust management of the coronavirus pandemic and the macroeconomic spillovers from the Russia-Ukraine war. Institutional strength is further supported by recent anti-corruption and judicial reforms.

The affirmation also reflects Cyprus' comparatively high public debt burden, though on a marked downward trend compared to Baa2-rated peers. This is balanced by favorable debt affordability metrics expected to remain solid in 2024-2025, with moderate gross financing requirements and a sizeable cash buffer providing the government with substantial funding flexibility.

Moreover, the affirmation takes into account Cyprus' moderate susceptibility to event risks, driven by banking sector and geopolitical risks.

Moody’s also notes that effective expenditure restraint could enhance these outcomes if Cypriot authorities manage to control growth in the public wage bill, resist changes to cost of living allowances, and contain healthcare spending pressures. Demographic trends suggest healthcare spending may rise more rapidly than expected, posing a challenge for government budgets. Nevertheless, a more rapid debt reduction could improve debt affordability beyond Moody's current expectations, bolstering Cyprus' fiscal strength.

Further confidence in the banking sector's strengthening and deleveraging, which has mitigated Cyprus' susceptibility to banking sector risks, could also exert upward rating pressure. It is added that since Moody's last rating action, the intrinsic strength of Cypriot banks has improved, and deleveraging has continued, reducing the potential risks from the banking system to the sovereign's balance sheet.