London, 04 November 2011 -- Moody's Investors Service has today downgraded Cyprus's government
bond ratings to Baa3 from Baa1 and placed the ratings on review for further
possible downgrade. The rating agency has also downgraded Cyprus's
short-term rating to Prime-3 from Prime-2 and placed
it on review for further possible downgrade.
The key drivers for today's rating announcement are:
1. The high likelihood that the Cypriot banking system will require
state support in 2012 as a result of the large expected write-downs
on its exposures to Greek government bonds. This state support
will have a significantly negative impact on the government's debt
metrics. The full extent of required state support for the Cypriot
banking system could increase further, given the substantial downside
economic and financial risks in Greece.
2. The Cypriot government's loss of international market
access and the resulting likelihood that the government will need to seek
emergency funding from official sources.
3. Cyprus's weaker-than-expected institutional
capacity to approve and implement the budgetary and structural changes
that are needed to correct the government's rising debt trajectory
and improve the longer-term sustainability of its public finances.
Moody's believes that the combined impact, and the links between,
these three factors on the government's balance sheet is,
at best, consistent with the lower end of the Baa rating range.
The structural rigidities in the government budget are not being decisively
addressed, increasing risks to the fiscal consolidation plans.
These vulnerabilities have also substantially reduced the government's
ability to absorb an increase in debt stemming from the crystallisation
of contingent banking liabilities. The potential size of these
liabilities, along with the rapid deterioration of conditions in
Greece, and the government's weak response to these adverse
developments have resulted in a loss of international market access.
The decision to maintain the ratings on review for further downgrade reflects
the need to assess the substantial downside risks to the government's
fiscal performance, the Cypriot banking sector, and the state's
future funding plans. A rising probability that these risks will
crystallise would likely cause the government to lose its investment grade
debt rating.
RATINGS RATIONALE
The first driver of Moody's two-notch downgrade is the very
high likelihood that the Cypriot government will need to contribute to
the recapitalisation effort of the banking system. In accordance
with the revised deal on greater public sector involvement (PSI) in Greece,
announced on 27 October, the losses on Greek government bonds are
now more than double the levels stipulated under the 21 July PSI deal.
This will cause the system to become under-capitalised.
Given the high risk that the banking system will be unable to raise the
necessary capital in the private sector, there is a strong likelihood
that it will require assistance from the Cypriot government. Consequently,
Moody's debt calculations for the sovereign now assume a minimum
of EUR1 billion in government-financed recapitalisation costs;
in total, Moody's base case is that the general government
debt-to-GDP ratio will rise by 5-10 percentage points
as a result of bank recapitalisations.
The second driver of the downgrade is the Cypriot government's loss
of international market access and the resulting risk that the government
will need to seek emergency funding from official sources, such
as the EFSF. As is the case for a number of countries in the euro
area, the difficulties that Cyprus has faced over the past year
are likely to have a long-lasting impact on investors' perceptions
of the riskiness of government debt, and therefore the sovereign's
medium-term funding costs. Moody's also believes that,
within the euro area context, the conditionality that is associated
with official funding places the creditworthiness of supported sovereigns
under pressure because a precedent has now been set with Greek PSI.
(please refer to Moody's Special Comment entitled "Euro Area
Summit -- Summary of Key Credit Implications", 28 October
2011). Moody's notes that the pledged bilateral loan from
Russia should satisfy the bulk of Cyprus's funding needs for 2012
and address any immediate liquidity pressures. Moreover,
the country's domestic market remains open, but at a higher
cost.
The third driver of today's downgrade is the Cypriot government's
weaker-than-expected capacity to implement, in a timely
fashion, the budgetary and structural changes that are urgently
needed to correct the government's rising debt trajectory.
Recent developments have also illustrated the government's inability
to respond decisively and credibly to shocks such as the destruction of
the Vasilikos power plant on 11 July 2011, which was a very disruptive
event from a political, economic and financial standpoint.
In the months since the plant's destruction, the Cypriot government
has faced a number of delays in passing fiscal consolidation measures,
and structural fiscal reform measures appear to be playing a smaller role
than was previously envisaged. Moody's is concerned that
conflicts between the various political parties, as well as the
trade unions, could impede fiscal consolidation and structural reform
at a time of weakening economic conditions both in Cyprus and in its major
trading partners.
FACTORS TO BE CONSIDERED IN THE REVIEW
Moody's review of Cyprus's sovereign rating will focus primarily
on the recapitalisation needs of the Cypriot banking sector. The
situation in Greece remains highly volatile and the magnitude of losses
that the Cypriot banks will experience on their Greek government bond
portfolio and lending book could require further government-financed
capital injections. During the review period, Moody's
expects to receive additional information about the capital requirements
of all Cypriot banks. This should allow the rating agency to refine
its estimates of the likely extent of the government's contribution
to this effort.
The review will also focus on structural changes to key expenditure areas
such as public sector pensions, public sector wages and social transfers.
The second package of fiscal consolidation measures, which was sent
to parliament on 13 October, contains some means-testing
for social transfers, although there is probably more scope to cut
these expenditures further. The government has also committed to
delivering reforms to address the cost-of-living adjustment
for public-sector workers; however, given trade union
pressures, this will be difficult to achieve, but will ultimately
be important for improving the sustainability of the Cyprus's public
finances, which is a particularly urgent concern given the additional
fiscal pressures that will be generated by stressed macroeconomic conditions.
These two factors will determine the extent of the Cypriot government's
need for external support from official sources, such as the EFSF
(or the subsequent European Stability Mechanism (ESM)) for funding and
if so for how long. In Moody's view, a reliance on
the EFSF or ESM for funding increases the risk of burden-sharing
with private sector creditors.
The principal methodology used in this rating was Moody's "Sovereign
Bond Ratings", which was published in September 2008 and is
available on www.moodys.com.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides relevant regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides relevant regulatory disclosures in relation
to the rating action on the support provider and in relation to each particular
rating action for securities that derive their credit ratings from the
support provider's credit rating. For provisional ratings,
this announcement provides relevant regulatory disclosures in relation
to the provisional rating assigned, and in relation to a definitive
rating that may be assigned subsequent to the final issuance of the debt,
in each case where the transaction structure and terms have not changed
prior to the assignment of the definitive rating in a manner that would
have affected the rating. For further information please see the
ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
The rating has been disclosed to the rated entity or its designated agent(s)
and issued with amendment resulting from that disclosure.
Information sources used to prepare the rating are the following :
parties involved in the ratings, parties not involved in the ratings,
and public information.
Moody's considers the quality of information available on the rated
entity, obligation or credit satisfactory for the purposes of issuing
a rating.
Moody's adopts all necessary measures so that the information it
uses in assigning a rating is of sufficient quality and from sources Moody's
considers to be reliable including, when appropriate, independent
third-party sources. However, Moody's is not
an auditor and cannot in every instance independently verify or validate
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Moody's Investors Service may have provided Ancillary or Other Permissible
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for the last rating action and the rating history.
The date on which some ratings were first released goes back to a time
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the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Sarah Carlson
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Bart Oosterveld
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
Releasing Office:
Moody's Investors Service Ltd.
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Moody's downgrades Cyprus's bond ratings to Baa3/P-3, on review for further downgrade
