Moody’s says Cyprus’s A2 rating reflects flexibility and resilience

In its annual report on Cyprus, Moody’s Investors Service says the A2 rating and positive outlook on the government’s long-term bonds reflect the robust growth of an increasingly flexible and resilient economy. «Cyprus enjoys a high and growing level of GDP per capita and low inflation and unemployment,» said Moody’s Vice President Tristan Cooper, author of the report. «Cyprus has also benefited from its 2004 accession to the EU, including a strengthening of its economic and social institutions.» He explained that the country is likely to benefit further from the adoption of the euro, which the authorities hope to achieve by the beginning of 2008. Assuming that the government remains committed to its program of fiscal consolidation, Moody’s believes its target will likely be achieved. Upward pressure on Cyprus’s rating would likely result from «a sustained commitment to fiscal prudence leading to the fulfillment of the Maastricht criteria and subsequent entry into the eurozone,» said Cooper. The rating agency also identified a number of factors that constrain Cyprus’s rating, including a relatively high level of debt accumulated through fiscal slippage over previous years. «Although significant progress has been made recently toward reducing the fiscal deficit and reversing the upward trend in the public debt burden, it remains to be seen whether such fiscal rectitude can be sustained over the longer term given rising health and pension costs and likely upward wage pressure from public sector unions,» said Cooper. Other negative factors include flagging competitiveness in some sectors, certain deficiencies in the supervision and asset quality of the financial system, and the poor performance of some public enterprises. The economy is relatively small and undiversified, which increases the risk of sector-specific shocks. Tourism, which accounts for around 20 percent of GDP, is vulnerable to regional geopolitical events and increasing competition from cheaper Mediterranean destinations. In addition to regional geopolitical risk, there continues to be uncertainty surrounding the issue of reunification with the Turkish community in northern Cyprus, which would entail significant short-term costs before showing expected benefits in the longer term. «However, the prospects for reunification in the short term appear dim given the likely temptation for a hardening of positions in the runup to elections in Turkey in late 2007 and in Cyprus in early 2008,» said Cooper.