S&P’s affirms Cyprus rating, noting strong economy, fiscal propriety and EMU prospect

Standard & Poor’s Ratings Services said yesterday it had affirmed its A long-term and A-1 short-term sovereign credit ratings on the Republic of Cyprus. The outlook is stable. «The ratings on Cyprus are supported by its prosperous and resilient economy, strong political commitment to fiscal consolidation, and the prospect of EMU membership,» said Standard & Poor’s credit analyst Eileen Zhang. «Conversely, its very short track record on fiscal prudence, its high public-sector debt burden, and potential external liquidity pressures constrain the ratings.» The government’s goal of early EMU membership prompted rapid fiscal consolidation in 2005, with the general government deficit falling to 2.6 percent from the 4-6 percent range in the preceding three years. The fiscal deficit is projected to fall to around 2 percent as the country approaches euro adoption, which Standard & Poor’s expects to take place in 2008 or 2009. Gross general government debt is expected to decline to less than 60 percent in 2009 from a peak of 71 percent of GDP in 2004, aided both by primary surpluses and by the use of sinking fund assets. The longstanding peg of the Cypriot pound to the euro has served Cyprus well, underpinning monetary stability and keeping the inflation rate low, at about 2 percent. Cyprus therefore meets the monetary criteria of EMU membership. Adoption of the euro will ultimately shield Cyprus from balance-of-payments pressures. In this regard, current account deficits remain sizable, estimated at 5.7 percent of GDP in 2006. «We expect that the government’s commitment to budget consolidation will continue to produce a lower fiscal deficit and debt burden,» said Zhang. Early adoption of the euro, as well as sustained improvements in the budgetary process (including a medium-term fiscal framework and elimination of expansionary supplementary budgets), more efficient revenue collection, and a lasting decline in transfer payments and defense expenditures could improve the creditworthiness of the Republic. Conversely, any slippage back to the high deficits of the recent past would weaken the government’s credit standing.