Fitch finds sound reasons for affirming Cyprus ratings

Fitch Ratings has affirmed Cyprus’s long-term foreign currency issuer default rating (IDR) at AA- (AA minus) with a stable outlook and short-term foreign currency rating at F1+. The agency also affirmed the local currency IDR at AA- (AA minus) with a stable outlook and the country ceiling at AAA. «Membership of the euro area – which renders transfer and convertibility risk negligible – and fiscal improvements over the last five years have helped Cyprus achieve its current ratings,» says Chris Pryce, a director in Fitch’s Sovereign team. Cyprus, which joined the union on January 1, 2008, «is a modern, predominantly services-based economy. It has a significant tourist industry, a growing business services sector and a long-established capitalist economy. Its income per head compares reasonably well with its rated peers. Economic growth has been robust, averaging around 3.6 percent over the past decade and inflation has been contained.» «The balance of payments current account deficit is around 6 percent but it is quite well-covered by foreign direct investment. As a member of the EMU, Cyprus’s fiscal performance and economic flexibility to respond to shocks are more important as a driver of sovereign ratings than its external finances. «In 2007, Cyprus recorded its first overall government surplus in several decades and public debt fell to 60 percent of GDP (2006: 65.2 percent) by the end of the year. Surpluses, albeit smaller, are expected this year and next, and the country’s debt ratio is expected to fall sharply to below 50 percent of GDP by end-2008, thanks largely to the use of financial assets (totaling about 6 percent of GDP at end-2007) to pay down debt in 2008.» Uncertainties There are, however, two big uncertainties. «It still has to confront one of the largest threats to long-term fiscal stability from an aging population in Europe as well as the continuing political division of the island,» says Pryce. «The election of a new president, Dimitris Christofias, seems likely to break the logjam in negotiations between the Greek-Cypriot and Turkish-Cypriot communities associated with his hard-line predecessor, Tassos Papadopoulos. Broad-based political support for the resumption of talks now seems to exist and negotiations could begin in months under the auspices of the UN. While any final resolution is a distant prospect, reunification would have sizable economic benefits although there would also be a short-term fiscal cost. While population aging and its impact on public expenditure was not the subject of open debate in the recent election, «Fitch understands that extensive discussions have taken place among the social partners (primarily trade unions, employers and the government) last year and an element of agreement on proposed reforms exists,» Fitch said.

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