Fitch Ratings has affirmed the long-term foreign and local currency ratings of the Republic of Cyprus at A+ and AA respectively and the short-term foreign currency rating at F1. The outlook on the long-term ratings remains stable.
Cyprus faces another difficult year with tourist arrivals possibly falling for a second year in a row due to the war in Iraq. Although tourism had begun to recover from its post September 11 slump, a renewed downturn began in March and is likely to continue at least during April.
Moreover, recovery in the rest of the year may be less rapid than after the 1991 Gulf war, due to continuing global concerns about travel. It is difficult to forecast the outlook with any precision at present but Fitch has based its forecasts on a further five to 10 percent drop in arrivals for the year as a whole, following last year's 10 percent fall. Although drops in tourist arrivals of this magnitude are not unprecedented, the cumulative impact of two years successive decline will be more damaging.
Slumps in tourism tend to have their main impact on GDP growth and public finances rather than the balance of payments and this is likely to be the same this year. After halving to 2.2 percent last year, Fitch expects GDP growth to slow again this year, to well under two percent, while the budget deficit, having risen to 3.5 percent of GDP last year, could exceed four percent of GDP.
The medium-term objective of eliminating the budget deficit has received another set back. However, given that general government debt is likely to be broadly stable and remain below 60 percent of GDP, there is room for a temporary widening of the deficit. Nevertheless, the authorities will need to stem the increase in the deficit and stand ready to reverse its recent widening as soon as conditions permit.
Eliminating the budget deficit and reducing the debt to GDP ratio are essential in the medium term to aid a reduction in the current account deficit and thereby reduce external vulnerability, as well as furthering the aim of participating in EMU at the earliest opportunity. Moreover, given the dependence on tourism, Cyprus's GDP growth is more variable than in other EMU countries and Cyprus will need more headroom than other countries within the Maastricht guidelines to be able to pursue counter-cyclical fiscal policy and live within the constraints of the Stability and Growth Pact.
A persistent current account deficit has been mainly financed by an increase in banks' external debt. This trend will need to be stemmed given that Cyprus's external debt indicators are already high in peer group terms. The expected reduction in the current account deficit this year and the recent slowing in bank lending encourage the view that net external debt may begin to stabilize from now.
In addition, half the increase in net debt since 2001 reflects banks' capital raising, while exchange control liberalisation is giving to rise to one off portfolio adjustments. Banks' external liabilities are mainly non-resident deposits that have been stable during previous periods of uncertainty and are kept very liquid.
Fitch finds it difficult to envisage circumstances in which the banks' external liabilities would directly pressure the sovereign rating. Meanwhile, the structure of public sector debt has improved markedly over the past year.
Although transparency is improving there remain weaknesses in the coverage and timeliness of external data and the supervision of the co-operative banking sector is weak. Both shortcomings are being addressed gradually.
Cyprus's ratings are supported by a relatively high per capita income, 80 percent of the EU average and a third higher than its rating peers, and a dynamic, service-oriented economy with low unemployment and strong institutions. Cyprus is well placed to benefit from its impending accession to the EU. Fitch does not regard the recent failure of UN-sponsored reunification talks as having negative rating implications. — (menareport.com)
© 2003 Mena Report (www.menareport.com)
