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Rating Action:

Moody's upgrades Cyprus' government bond rating to B1, outlook stable

13 Nov 2015

London, 13 November 2015 -- Moody's Investors Service, (Moody's) has today upgraded Cyprus' government bond rating by two notches to B1 from B3. The outlook is stable. Cyprus's short-term rating was affirmed at Not-Prime (NP).

The key drivers for the upgrade are:

1) The faster than expected economic recovery and the expectation of a continued more broad-based growth that extends beyond exports. Moreover, the economy has demonstrated resiliency to external risks, emanating from Greece (Caa3, stable) and Russia (Ba1, negative). After three years of contraction, real economic growth is expected to reach 1.2% in 2015 and 1.4% in 2016. Moreover, medium-term growth is expected to be more balanced, supported by a recovery in domestic demand helped by a stabilisation of the financial sector, improved competitiveness and the implementation of structural reforms.

2) Consistent outperformance on fiscal targets have led to a quicker reversal in the public debt ratio. A combination of better than expected growth and also strong budget execution underscore fiscal outperformance. Moody's expects fiscal discipline to continue post programme exit and through parliamentary elections next year. Under Moody's baseline scenario, the government debt burden will now reach below 100% by next year and around 80% of GDP by 2020. Moreover, Moody's expects the country to successfully exit the economic adjustment programme (financed by the European Stability Mechanism (ESM) (Aa1 stable) and the IMF) by mid-2016, further supported by the build-up of significant liquidity buffers.

Concurrently, Moody's has today raised the local-currency and foreign-currency bond ceilings to Baa1 from Baa3. The short-term foreign-currency bond ceiling has been raised to Prime-2 (P-2) from P-3. Additionally, the local-currency and foreign-currency deposit ceilings have been raised to Baa1 from B3 to reflect the full removal of capital controls. The short-term foreign-currency deposit ceiling has been raised to P-2 from NP.

RATINGS RATIONALE

FIRST DRIVER: FASTER THAN EXPECTED ECONOMIC RECOVERY AND THE EXPECTATION OF CONTINUED, MORE BROAD-BASED ECONOMIC GROWTH

The first driver of Moody's decision to upgrade Cyprus' rating to B1 is the faster than expected economic recovery, and the expectation that the export sector will continue to demonstrate resilience and will now be augmented by growth in domestic demand. Moreover, Moody's believes that structural reforms that improve competitiveness along with prospective structural reforms such as the reform of the public administration, privatisation and also the gradual strengthening of the financial sector will improve the sustainability of medium-term growth.

Improvements in cost competitiveness underpin the potential of the export sector as wage growth will likely remain moderate in the coming years. Importantly, the economy, and in particular the tourism and banking sectors, have demonstrated resilience to the economic downturn in Russia and the escalation of the economic crisis in in Greece earlier this year.

The more balanced growth pattern is also driven by the stabilisation in the financial sector, which has resulted in a slight uptick in corporate credit growth this year. While still very weak (with a weighted average Baseline Credit Assessment of caa3), the financial sector reflects stable liquidity trends and increasing prospects for a return to profitability. Importantly, deposits remain stable at a systemic level despite the full lifting of capital controls on 6 April 2015.

Moody's also expects that recent laws implemented in the financial sector, namely the insolvency and foreclosure framework, will support the gradual reduction of non-performing loans (NPLs) in the system, which are currently at a high 47% of total loans. That said, Moody's notes that both the corporate and household sectors continue to have high, albeit reducing debt burdens.

Cyprus' economic growth resumed again in the first half of 2015, increasing 0.4% y-o-y, following a three-year contraction. As a result of the more broad-based recovery, Moody's has revised upward its real GDP growth forecasts for Cyprus to 1.2% in 2015 from 0.5% and Moody's expects growth to reach around 1.4% in 2016.

SECOND DRIVER: CONSISTENT OUTPERFORMANCE OF FISCAL TARGETS LEADING TO A TREND REVERSAL OF THE PUBLIC DEBT RATIO

The second driver for the upgrade is the consistent outperformance of fiscal targets because of strong budget execution and better than expected growth performance. Consequently, Moody's expects that from this year onwards, public debt ratio will start to decline.

Since the onset of the structural adjustment programme, Cyprus's fiscal metrics have consistently exceeded the targets set by the EC and the IMF. Mainly expenditure-related measures (reducing public sector wages and benefits), aimed at permanently reducing the deficit, were included in the 2013 budget, and resulted in significant fiscal consolidation of 7.5% percentage points of GDP over 2013-14, according to IMF data. Strong fiscal discipline and budget execution has persisted since then, supporting the outperformance of fiscal targets. Importantly, the programme does not require additional fiscal measures for next year to meet the primary surplus target of 2.5% of GDP, implying a fiscally neutral policy can be implemented with no impact on growth.

Consequently, Cyprus' government debt trajectory has improved significantly, especially in relation to original programme targets. General government debt peaked last year reaching 108.2% of GDP, one year earlier and lower than what was expected at the time of the last rating action, when Moody's expected debt to GDP ratio to peak in 2015 at 110% of GDP.

Moody's expects fiscal discipline to be sustained through the upcoming parliamentary elections in May 2016 and also continue after the country exits the economic adjustment programme which is also expected by the middle of next year. Based on a primary surplus assumption of 2.5% of GDP and 1.7% growth rate over the next four years, Moody's expects general government debt to GDP to fall below 100% next year and reach round 80% of GDP in 2020, making Cyprus one of the few euro area countries to meet its programme debt-to-GDP target.

Additionally, the rating agency notes that Cyprus regained market access last year and since then accumulated a substantial cash buffer. This buffer, as of today covers most of the country's repayment needs for 2016, preparing the country for a successful exit from the programme in March 2016 when the ESM funded programme finishes and May 2016 when the IMF programme ceases.

RATIONALE FOR STABLE OUTLOOK

The stable outlook on Cyprus's B1 rating reflects evenly balanced upside risks of improving growth and fiscal metrics with the downside risks of a still very large and fragile banking system with high NPLs, with the risk of contingent liabilities crystallising on the governments balance sheet still high.

WHAT COULD CHANGE THE RATING UP/DOWN

Upward pressure on Cyprus's B1 government bond rating could result from continued fiscal discipline after exiting the EC/IMF programme, e.g., if the government's primary surplus were to be sustained at high levels. In addition, evidence that the risks to growth specifically emanating from the banking sector have reduced would imply upward pressure; higher economic growth and/or a more rapid reversal in the upward trend for banks' NPLs would be credit positive.

Downward pressure on Cyprus's B1 government bond rating could emerge if the government's commitment fiscal discipline reduces, especially once the EC/IMF programme concludes. Evidence that the banking sector needs further recapitalisation support from the government would also exert downward pressure on the rating. A re-emergence of elevated financial and debt market stress, which could be triggered in the case of Greece exiting the euro area, would also be credit negative. Earlier this year, uncertainty regarding Greece's euro membership and associated contagion risks constrained positive movement on Cyprus' previous rating of B3.

RATIONALE FOR RAISING OF LOCAL- AND FOREIGN-CURRENCY CEILINGS

Cyprus' local- and foreign-currency ceilings have been raised to Baa1/P-2 from Baa3/P-3. These ceilings reflect a range of un-diversifiable risks to which issuers in any jurisdiction are exposed, including economic, legal and political risks. Cyprus's ceilings also incorporate the currently very low risk of euro area exit and redenomination, consistent with Moody's treatment of other sovereigns in a currency union. The local- and foreign-currency deposit ceilings were also raised to Baa1/P-2 from B3/NP to reflect the complete removal of capital control measures, that were previously instituted in March 2013.

GDP per capita (PPP basis, US$): 30,882 (2014 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -2.5% (2014 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): -1.5% (2014 Actual)

Gen. Gov. Financial Balance/GDP: -8.9% (2014 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -4.6% (2014 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: Moderate level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

On 10 November 2015, a rating committee was called to discuss the rating of the Cyprus, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially increased. The issuer's fiscal or financial strength, including its debt profile, has materially increased.

The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain 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 certain 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 certain 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.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Alpona Banerji
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

Yves Lemay
MD-Banking & Sovereign
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
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

Moody's upgrades Cyprus' government bond rating to B1, outlook stable
No Related Data.
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