Why Moody’s is wrong to keep Cyprus on junk status

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Cyprus is now into its fifth year of vigorous economic growth, after three years (2012-2015) of steep decline caused by the banking crisis, with little indication the trade-risk vulnerabilities affecting other eurozone markets will become a limiting factor.

GDP has grown consistently, by 0.9% per quarter in real terms from mid-2018 through to the first months of 2019, resulting in a 3.5% annual growth rate for the first quarter.

It is set to slow down, with tourism affected by Brexit, and weaker activity rates spanning Germany and other trade partners, but only to 3.1% this year and 2.7% in 2020, says the European Commission (EC), as strengthening domestic demand compensates for slowing exports growth.

The EC may be wrong, of course, but if it’s right, that’s good news for fiscal correction – maintaining solid tax revenue and alleviating the welfare budget as unemployment continues to fall.

Risk factors such as GDP growth, unemployment and government finances have been continually upgraded in Euromoney’s survey.

In April, the seasonally adjusted harmonized unemployment rate fell below 7% for the first time since the banks collapsed, after reaching an eye-watering 17% at the height of the crisis.

Last year’s general government balance was skewed by one-off support for the Cyprus Cooperative Bank (CCB) sale, causing a temporary deficit of 4.8% of GDP on the EU’s comparable measure.

This year it will return to a surplus of around 3% of GDP, showing improvement on outturns for 2016 and 2017.

This is despite cuts to fuel excise duty, a bigger public sector wages bill, and support for low-income pensioners boosting disposable incomes and consumer spending.

The bottom line is that strong GDP growth and primary budget surpluses should see the debt burden slim down to 90% of GDP in 2020, on a path towards greater stability.

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Investment grade

That raises the question: should Cyprus be regarded junk status?

Fitch and Standard & Poor’s certainly do not agree, after they respectively upgraded the country in September and October, respectively, to investment grade.

And yet Moody’s has held off, retaining its stable Ba2 sovereign issuer rating.

However, as Euromoney’s risk survey demonstrates, the trend has been consistently positive for the past five years:

Cyprus has gained 11 points in the survey, climbing 26 places in the global rankings to 40th out of 186 countries, continuing that rise in the first quarter.

That puts the tourist hotspot towards the top of the third of five tiered categories of risk, nestled between Portugal and Malaysia  in the risk rankings.

Both countries are investment grades, and so are Italy, China, Peru and five other countries all below Cyprus, only stopping at Oman in 50th place.

It’s enough to make Moody’s blush – not least because Euromoney has pressed the point previously, and most independent experts contributing to Euromoney’s survey agree that Cyprus, for all its risks, is an investment-grade issuer.

Experts’ views

One of them is Dimitria Rotsika, senior economist at Piraeus Bank Group.

She is clear that Cyprus is not without its risks, including the fact it continues to face a large amount of non-performing loans (NPLs) in the banking sector.

That view is echoed by the IMF in its latest, post-programme monitoring report, in which it states: “The removal of CCB’s NPLs and securitization of a large NPL portfolio have led to a sharp reduction in NPLs.

“Nevertheless, NPLs are still among the highest in the EU, public and private debt levels remain elevated and efforts to clean up bank balance sheets and build capital buffers are ongoing.”

This is perhaps, crucially, where Moody’s may take some persuading.

And yet as Rotsika asserts: “Cyprus managed to lend via the international debt markets fairly quickly after the loan-agreement conclusion on rather favourable terms that priced in the country’s success in this post-programme era.”

Its capital access score in Euromoney’s survey was lifted as a result.

“The boldest move signalling changes in the domestic economy and the fiscal consolidation is the issue of 30- and 15-year bonds with a return much lower (2.75%) than Greece’s recent issue of a benchmark 10 year at 3.875%,” says Rotsika.

And as the IMF also notes, the political risks are contained. There are no parliamentary elections until 2021, with authorities committed to engaging with the IMF for ongoing advice until 2020.

Plus repayment capacity is manageable, with sizeable primary fiscal surpluses ensuring a decline in the gross public debt-to-GDP ratio to support continued favourable market borrowing terms.

Another survey contributor, Constantin Gurdgiev, a professor at the Middlebury Institute of International Studies, is of the same mindset.

He acknowledges the fact Cyprus is vulnerable to exogenous shocks, especially the European Central Banks (ECB) holdings of Cypriot government bonds, which have one of the shortest maturity profiles of all eurozone bond holdings.

This is a problem when the ECB changes tack and stops replacing maturing assets with new purchases.

Still, Gurdgiev believes the short-term dynamics make Cyprus due an upgrade.

He cites three ongoing factors driving the improved credit risk outlook.

First is the gradual improvement in the investment and trade climate between Cyprus’s traditional extra-EU economic partners, most notably Russia.

“This week’s Council of Europe vote is a more public manifestation of this trend, but beyond the international political arena, the April meeting between presidents Nicos Anastasiades and Vladimir Putin has been a major positive, highlighting growth in trade and a gradual uptick in bilateral capital inflows,” says Gurdgiev.

The second is the ECB’s monetary policy forward guidance:

“Cyprus is enjoying historically low cost of funding for its sizeable government debt,” says Gurdgiev. “Ten-year yields on Cypriot bonds are currently running at around 0.624%, the lowest on record, and substantially below the 2016 H1 highs of 4.1% to 4.15%.

“The ECB is de facto providing support for the government deeply in debt, since Cyprus re-entered the ECB purchasing programme in late 2018.”

Third, is the economy and the fact that, despite gradually cooling off, growth is still there, with unemployment falling, aggregate investment rising and gross national savings above 13% of GDP.

The question is whether all this will strike a chord with Moody’s analysts.

Precedence suggests that eventually they might.

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