Capital Intelligence Ratings announced recently a revision of the Republic of Cyprus’ Long-Term Foreign Currency Rating (LT FCR) outlook to Positive from Stable. Concurrently, the sovereign’s LT FCR and Short-Term FCR (ST FCR) have been affirmed at ‘BBB-’ and ‘A3’, respectively.

This positive shift reflects a faster-than-anticipated decline in general government debt, attributed to consistent primary fiscal surpluses and effective debt management. The agency noted, “The government is skillfully managing its debt maturity profile, thereby reducing refinancing risks, while also building a growing cash buffer to mitigate short-term shocks and external adversities.”

The upgrade also acknowledges progress in resolving non-performing loans in the banking sector. This has led to a significant reduction in government contingent liabilities. Despite a challenging external environment and stringent global financial conditions, other fiscal risks are currently considered manageable.

Cyprus’ ratings benefit from the resilience of its economy and a high GDP per capita. The benefits of being a member of the European Union and the eurozone, including access to financial support from the Recovery and Resilience Facility, also contribute to the ratings.

The ratio of general government debt to GDP decreased to 77.3% in 2023, down from 85.6% in 2022. This decrease was driven by a higher-than-expected primary budget surplus and repayment of bonds and loans amounting to EUR 1.4 billion. CI projects favorable government debt dynamics in the coming years, with the debt-GDP ratio expected to continue declining to a moderate-to-high 66.2% in 2025. The upcoming debt maturities, estimated at EUR 2.4 billion for 2024 and EUR 1.8 billion for 2025, are within the government's capacity for repayment without posing any refinancing challenges.

In 2023, the general government budget performance was robust, posting a higher-than-anticipated overall surplus of 2.9% of GDP, compared to 2.4% in 2022. CI expects the general government budget to maintain a surplus, averaging 3.1% of GDP in 2024-25.

However, risks to the fiscal outlook remain. These include potential declines in fiscal discipline, increased spending on subsidies, social welfare, and public sector wages, as well as the cost of the national health system and potential declines in tax revenues. Currently, the impact of high-risk premiums and tight eurozone monetary policy is considered manageable due to the decline in general government debt and a high proportion of fixed-rate debt.

Short-term refinancing risks have remained stable since CI's last review. This stability is attributed to the government’s sound fiscal management, a favorable debt maturity structure, timely access to capital markets, and the prudent building of cash buffers.

In the banking sector, although its strength has improved considerably, it is still considered moderate. The Central Bank of Cyprus reported that the aggregate NPL ratio declined further to 8.3% in November 2023. Despite these positive developments, asset quality risks persist, especially due to the elevated debt levels in the household and corporate sectors.

The capital adequacy of the banking sector is sound, with an average CET-1 ratio of 21.4% at the end of September 2023. Cypriot banks have made significant progress in deleveraging, with the assets of the banking sector declining to 215.2% of GDP in November 2023.

Despite ongoing external challenges, economic growth remains positive, albeit moderating. Real GDP is estimated to have grown by 2.5% in 2023, reflecting slower growth in key sectors. CI expects real GDP to average an increase of 2.6% in 2024-25, supported by improving domestic demand and continued investment in various economic activities, partly aided by RRF funding and foreign private capital inflows. The high GDP per capita is also a supporting factor for the ratings.

External strength is moderate, affected by large current account deficits and high external debt. The current account deficit likely increased to 10.1% of GDP in 2023, while external debt, excluding Special Purpose Entities, declined.

The ratings could be upgraded further in the next 12-24 months if the government implements comprehensive structural reforms, leading to improved revenue mobilization, increased institutional strength, and quicker resolution of transferred NPLs. A lower-than-expected current account deficit and a faster decline in general government and external debt could also positively impact the ratings.

Conversely, the outlook could revert to Stable in the next 12 months if fiscal performance weakens, public debt dynamics reverse, or if adverse shocks lead to a deterioration in public and/or external finances.