London, 13 March 2012 -- Moody's Investors Service has today downgraded
Cyprus's government bond ratings by one notch to Ba1 from Baa3 and has
assigned a negative outlook to the ratings. The rating agency has also
downgraded Cyprus's short-term rating to Not-Prime from Prime-3. Today's
rating action concludes the review for downgrade that Moody's initiated
on 4 November 2011.
The key drivers for today's rating action are:
1.) The increased risk that the Cypriot government would have to provide
renewed financial support to the country's banks because of their
exposure to the Greek government and economy, and the commensurate impact
of such measures on the government's own financial strength.
2.) The likely impact on market confidence in Cyprus stemming from these
banking-sector concerns, as well as broader uncertainties about Europe's
macroeconomic prospects and institutional frameworks. Overall, the
fragile market confidence in Cyprus, which has already led to a loss of
access to international debt markets, is likely to continue, with a high
potential for further shocks to funding conditions for the sovereign and
the domestic banks.
Today's rating action has been limited to one notch in acknowledgement of
the positive developments in Cyprus since Moody's placed the country's
rating on review for downgrade in November 2011. In particular, Moody's
notes that the Cypriot government has now passed a large-scale fiscal
consolidation programme, which contains a greater number of structural
changes to public-sector expenditure than had been anticipated. These
measures are likely to enable the country to achieve a deficit reduction
of around three percentage points of GDP in 2012. Moreover, the recently
confirmed presence of substantial gas reserves in the Cypriot Exclusive
Economic Zone of the Levant Basin is also a positive development.
Although the government is likely to realise some one-off revenue gains
from the sale of licenses to tap these gas reserves, it will probably
take nearly a decade for the sovereign to realise the most significant
and sustained benefits.
Moody's decision to assign a negative outlook is a reflection of the very
significant risks that continue to emanate from the ongoing Greek
sovereign crisis and that will continue to challenge Cyprus over the next
18-24 months.
RATINGS RATIONALE
The main driver of Moody's one-notch downgrade of Cyprus's government
bond rating is the high risk that a government-financed capital injection
into the Cypriot banking system will be needed in view of the banks'
significant exposure to Greece and the ongoing deterioration of the Greek
sovereign debt crisis. On 2 March 2012, Moody's downgraded Greece's
sovereign bond ratings to C, reflecting the rating agency's expectation
that investors will experience losses in excess of 70% on their Greek
government debt holdings. Moody's also believes that the risk of a Greek
sovereign default, even after the debt exchange has been completed,
remains high. Such an event would place an even higher level of stress on
the capital position of the Cypriot banks than was anticipated at the
time of Moody's last rating action in November.
The stress facing Cypriot banks is not only driven by their Greek
sovereign debt holdings, but also by the heightened asset quality
pressure stemming from their significant loan books in Greece as well as
the domestic macroeconomic challenges facing Cypriot banks. Moody's
stress tests on Cypriot banks now imply much higher potential capital
replenishment needs for rated banks compared to Moody's previous
exercises. According to the rating agency's base case, which includes
losses on Greek government bonds under the private sector involvement
(PSI) plan and asset quality deterioration in both Cyprus and Greece,
the banks would need a capital increase equivalent to more than 20% of
GDP in order to return to their current level of Tier-1 capital. Some of
this capital need is included in the current recapitalisation plans of
the banks that are based on the EBA recapitalisation exercise. However,
Moody's believes that there is a very material risk that the private
sector will not be able to provide all the capital needed, which would
probably have to be financed by an increase in government debt. The Ba1
rating therefore incorporates an assumption that the Cypriot government
could need to contribute capital support equivalent to around 5-10% of
GDP.
Looking ahead, Moody's believes that stresses in the Cypriot banking
system, combined with adverse external conditions and fragile confidence
in the private sector, will constrain growth potential in the next few
years, adding to the fiscal consolidation challenges facing the
government. Although the government seems well positioned to achieve
significant progress this year, unfavourable economic conditions present
implementation risks in 2013 and beyond.
The second driver underlying today's rating action is the fragile
financial environment, which increases Cyprus's susceptibility to
financial and macroeconomic shocks given the concerns about the banking
system that have been identified above. To date, the Cypriot government
remains shut out of international markets, though it can still access
domestic markets at a higher cost of funding. Although the government's
financing needs have been largely met for 2012 through a bilateral loan
from the Russian state, there is uncertainty over how the government's
2013 funding needs of more than EUR2 billion will be met. As a euro area
member, Cyprus could potentially access the European Financial Stability
Facility (EFSF)/European Stability Mechanism (ESM). However, the
government's decision to instead meet its 2012 financing needs via a loan
from Russia implies that it may be reluctant to tap EU financing,
possibly due to the conditionality that will accompany it.
WHAT COULD CHANGE THE RATING UP/DOWN
The banking sector will be the most important driver of Cyprus's
sovereign rating and outlook. Moody's says that the sovereign rating
will likely be affected in the event of a material change in the
probability or impact of a further deterioration in Cypriot banks'
positions in Greece. Cyprus's Ba1 rating would likely withstand a modest
capital injection from the government of between 5-10% of GDP into one or
more banks. However, if recapitalisation needs are much larger than this,
then this could warrant further downgrades.
Apart from banking-sector-related issues, upward pressure could gradually
be exerted on the rating if the Cypriot government is able to (i)
implement large-scale structural reforms in its social transfer system
and the public-sector wage bill, and (ii) record significant and lasting
cost savings.
Cyprus's government bond ratings by one notch to Ba1 from Baa3 and has
assigned a negative outlook to the ratings. The rating agency has also
downgraded Cyprus's short-term rating to Not-Prime from Prime-3. Today's
rating action concludes the review for downgrade that Moody's initiated
on 4 November 2011.
The key drivers for today's rating action are:
1.) The increased risk that the Cypriot government would have to provide
renewed financial support to the country's banks because of their
exposure to the Greek government and economy, and the commensurate impact
of such measures on the government's own financial strength.
2.) The likely impact on market confidence in Cyprus stemming from these
banking-sector concerns, as well as broader uncertainties about Europe's
macroeconomic prospects and institutional frameworks. Overall, the
fragile market confidence in Cyprus, which has already led to a loss of
access to international debt markets, is likely to continue, with a high
potential for further shocks to funding conditions for the sovereign and
the domestic banks.
Today's rating action has been limited to one notch in acknowledgement of
the positive developments in Cyprus since Moody's placed the country's
rating on review for downgrade in November 2011. In particular, Moody's
notes that the Cypriot government has now passed a large-scale fiscal
consolidation programme, which contains a greater number of structural
changes to public-sector expenditure than had been anticipated. These
measures are likely to enable the country to achieve a deficit reduction
of around three percentage points of GDP in 2012. Moreover, the recently
confirmed presence of substantial gas reserves in the Cypriot Exclusive
Economic Zone of the Levant Basin is also a positive development.
Although the government is likely to realise some one-off revenue gains
from the sale of licenses to tap these gas reserves, it will probably
take nearly a decade for the sovereign to realise the most significant
and sustained benefits.
Moody's decision to assign a negative outlook is a reflection of the very
significant risks that continue to emanate from the ongoing Greek
sovereign crisis and that will continue to challenge Cyprus over the next
18-24 months.
RATINGS RATIONALE
The main driver of Moody's one-notch downgrade of Cyprus's government
bond rating is the high risk that a government-financed capital injection
into the Cypriot banking system will be needed in view of the banks'
significant exposure to Greece and the ongoing deterioration of the Greek
sovereign debt crisis. On 2 March 2012, Moody's downgraded Greece's
sovereign bond ratings to C, reflecting the rating agency's expectation
that investors will experience losses in excess of 70% on their Greek
government debt holdings. Moody's also believes that the risk of a Greek
sovereign default, even after the debt exchange has been completed,
remains high. Such an event would place an even higher level of stress on
the capital position of the Cypriot banks than was anticipated at the
time of Moody's last rating action in November.
The stress facing Cypriot banks is not only driven by their Greek
sovereign debt holdings, but also by the heightened asset quality
pressure stemming from their significant loan books in Greece as well as
the domestic macroeconomic challenges facing Cypriot banks. Moody's
stress tests on Cypriot banks now imply much higher potential capital
replenishment needs for rated banks compared to Moody's previous
exercises. According to the rating agency's base case, which includes
losses on Greek government bonds under the private sector involvement
(PSI) plan and asset quality deterioration in both Cyprus and Greece,
the banks would need a capital increase equivalent to more than 20% of
GDP in order to return to their current level of Tier-1 capital. Some of
this capital need is included in the current recapitalisation plans of
the banks that are based on the EBA recapitalisation exercise. However,
Moody's believes that there is a very material risk that the private
sector will not be able to provide all the capital needed, which would
probably have to be financed by an increase in government debt. The Ba1
rating therefore incorporates an assumption that the Cypriot government
could need to contribute capital support equivalent to around 5-10% of
GDP.
Looking ahead, Moody's believes that stresses in the Cypriot banking
system, combined with adverse external conditions and fragile confidence
in the private sector, will constrain growth potential in the next few
years, adding to the fiscal consolidation challenges facing the
government. Although the government seems well positioned to achieve
significant progress this year, unfavourable economic conditions present
implementation risks in 2013 and beyond.
The second driver underlying today's rating action is the fragile
financial environment, which increases Cyprus's susceptibility to
financial and macroeconomic shocks given the concerns about the banking
system that have been identified above. To date, the Cypriot government
remains shut out of international markets, though it can still access
domestic markets at a higher cost of funding. Although the government's
financing needs have been largely met for 2012 through a bilateral loan
from the Russian state, there is uncertainty over how the government's
2013 funding needs of more than EUR2 billion will be met. As a euro area
member, Cyprus could potentially access the European Financial Stability
Facility (EFSF)/European Stability Mechanism (ESM). However, the
government's decision to instead meet its 2012 financing needs via a loan
from Russia implies that it may be reluctant to tap EU financing,
possibly due to the conditionality that will accompany it.
WHAT COULD CHANGE THE RATING UP/DOWN
The banking sector will be the most important driver of Cyprus's
sovereign rating and outlook. Moody's says that the sovereign rating
will likely be affected in the event of a material change in the
probability or impact of a further deterioration in Cypriot banks'
positions in Greece. Cyprus's Ba1 rating would likely withstand a modest
capital injection from the government of between 5-10% of GDP into one or
more banks. However, if recapitalisation needs are much larger than this,
then this could warrant further downgrades.
Apart from banking-sector-related issues, upward pressure could gradually
be exerted on the rating if the Cypriot government is able to (i)
implement large-scale structural reforms in its social transfer system
and the public-sector wage bill, and (ii) record significant and lasting
cost savings.
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