Standard and Poor’s has affirmed Cyprus’ long-term credit rating at BBB- maintaining a positive outlook.
The credit rating agency also noted that despite the crisis in Ukraine and possible spil-overs due to the sanctions against Russia “medium-term economic prospects remain solid.”
It added: “While we expect the crisis in Ukraine to weigh on Cyprus’ economic performances via the sanctions imposed on Russia, an important economic partner, medium-term economic prospects remain solid, with growth expected to average 3.2% per year over 2023-2025.”
As the agency noted, while growth should underperform this year on severe pressure on the Russian economy, we expect solid economic activity, strongly supported by the disbursement of the €1.2 billion EU Resilience and Recovery Facility (RRF) over 2021-2026.
“We expect escalation of the military intervention against Ukraine and the associated sanctions taken by Western countries against Russia will weigh on economic activity in Cyprus in 2022 given the two countries` close economic and financial relations, in addition to pushing up the energy import bill globally,” S&Ps added.
The agency said the closure of Cyprus airspace to Russian aircraft will affect tourist arrivals from Russia, Cyprus’ second largest tourist market, although “a strong rebound in arrivals from EU countries could partially offset that.”
It also pointed out that Russia (including dual-nationality residents) is also a key market for business services, which accounts for 11% of Cypriot GDP and a large share of overall exports. With sanctions affecting key systemic Russian financial institutions, we expect this could also to detract from activity in this sector, at least in 2022, the agency noted.
However, S&Ps noted that “direct exposure to Russia through loans and deposits should be limited for the Cypriot banking system, although some smaller players may display higher concentration.”
“We also expect spillover effects on Russian economic activity could somewhat affect volatility of customer deposits in Cyprus, although the positive funding gap offsets this, with system customer deposits covering customer loans by over 1.8x at end-2021”, the agency said, noting that Cyprus banks have reduced their reliance on foreign deposits, and liquidity in the system is adequate.
It also said that while Cyprus` stock of problematic assets has declined materially recently primarily thanks to market sales, it remains sizable compared with those of European banks (about 14% of gross loans at year-end November 2021 versus 30% at end-2019).
“The high concentration in the real estate sector (13% of the loan book) and tourism (9%), coupled with the high share of loans classified as stage 2 (about 15% of loans) could result in some asset quality deterioration and delay the overall cleanup of banks` tail risks from the 2012 financial crisis”, said the agency.
“However, supportive fiscal and monetary measures, coupled with banks` restructuring efforts for more vulnerable sectors, will partly contain the damage and spread the impact on banks` asset quality across several years”, it said, estimating that credit provisions will remain somewhat above normalized levels (at about 1.1% of gross loans, on average) and NPE ratio will likely hover at 9%-14% over 2022 and 2023.
With regard to public finances, the agency said that following the COVID-19-induced recession in 2020, the Cypriot economy recovered faster than anticipated in 2021, with real GDP growth estimated at 5.5% with GDP growth estimated to accelerate to an average of 3.1% per year from 2022-2025 .
It also pointed out that a much stronger performance in government revenue mobilization led to a sharp decline in the general government deficit to 1.8% of GDP last year, despite still-high expenditure in the context of the pandemic.
Moreover, the agency said that public debt which rose significantly to 115% of GDP due to the Covid-19 pandemic in 2020, adding that pubic debt will continue declining on the back of economic recovery and budgetary consolidation.
“As the budgetary performances improve on a gradual withdrawal of fiscal stimulus and thanks to solid economic performance, government debt started declining in 2021 and we expect this trend to continue, with general government debt reaching about 80% of GDP in 2025” the agency said.