(The following statement was released by the rating agency)
Link to Fitch Ratings' Report: Cyprus - Rating Action Report
LONDON, July 05 (Fitch) Fitch Ratings has upgraded Cyprus's Long-term local
currency Issuer Default Rating (IDR) to 'CCC' from 'Restricted Default' (RD).
Individual bonds affected by the exchange completed 1 July have been upgraded to
'CCC' from 'D'; unaffected domestic bonds have been affirmed at 'CCC'. The
Long-term foreign currency IDR has been affirmed at 'B-' with a Negative
Outlook. The Short-term foreign currency IDR has been affirmed at 'B' and the
Country Ceiling affirmed at 'B'.
KEY RATING DRIVERS
The upgrade of Cyprus's local currency IDR reflects the following key rating
drivers and their relative weights:
The announcement of the completion of the government's domestic debt exchange
and issue of the new bonds on 1 July marks the resolution of a default event.
The government's exchange of EUR1bn of domestic laws bonds maturing during the
IMF-EU programme period for new bonds maturing in 2019-23 was considered a
distressed debt exchange (DDE) by Fitch. Although the new bonds have the same
coupon and face value as those exchanged, the transaction represented a material
reduction in terms for bondholders, who were not compensated for the longer
duration against a backdrop of heightened credit risk over the medium term.
The one-notch differential between the local currency IDR (CCC) over the foreign
currency IDR (B-) reflects the agency's assessment of the greater vulnerability
of bonds issued under domestic law relative to foreign law bonds, as
demonstrated by the recent exchange, which reveals a preferential treatment of
foreign law sovereign bonds. Domestic law bonds represent 26% of the stock of
general government debt and foreign law bonds 14%. EUR670m (4% of GDP) domestic
law bonds mature during the programme period, excluding the EUR1,987m
'recapitalisation bond'; EUR1,618bn (9% of GDP) of foreign law MTNs mature
during the same period.
Cyprus's 'B-' foreign currency IDR reflects the following key rating drivers:
- External support under the auspices of the EU-IMF programme improves the
immediate position of the sovereign from both a liquidity and solvency
perspective, albeit with large downside risks.
- There is a high risk of the agreed programme going off track, stemming from
downside risks to economic performance and political commitment to the
- Lack of flexibility to deal with domestic or external shocks, with financing
buffers potentially insufficient to absorb material fiscal and economic
slippage, notwithstanding the recent maturity extensions of domestic debt.
- High public debt, likely to peak above the 126% of GDP by 2015 assumed under
the programme, reflecting Fitch's assumption of a deeper recession in the later
years of the programme and a slower recovery than that assumed.
- Capital controls pose an additional risk: a premature lifting of these
controls triggering material capital flight would have negative economic
The Negative Outlook on the Long-term foreign currency IDR reflects the
following risk factors that may, individually or collectively, result in further
pressure on the ratings:-
- Implementation risk for the programme is high. The deep recession and sharply
rising unemployment will make it more difficult to implement fiscal
consolidation plans. Political will for implementing painful measures may
weaken. Significant slippage from future programme targets, in particular fiscal
deficits, would undermine the rating.
- The recession could be materially deeper and last longer than assumed under
the EU/IMF programme as has been the experience of other programme countries in
the eurozone. This would have adverse consequences for the Cypriot debt
- Intensification of the banking crisis in Cyprus. There is a still high risk of
capital flight from banks if capital controls are lifted prematurely,
exacerbating the domestic credit contraction even assuming liquidity support
from the ECB.
- A further restructuring of Cyprus's marketable liabilities could, depending on
the terms, trigger a second ratings default event.
Fitch's sensitivity analysis does not currently anticipate developments with a
material likelihood of leading to a rating upgrade in the near term. Much
further in the future, the realisation of significant off shore gas and oil
reserves could significantly help the financing of fiscal deficits and place
upwards pressure on the rating.
There is considerable uncertainty over the near- and medium-term evolution of
output, unemployment and the government deficit. The pressure on banks to
de-lever is expected to exert considerable pressure on the economy with knock on
effects to public finances. Fitch expects the recession to be deeper and last
longer than assumed under the EU/IMF programme. Fitch also anticipates slippage
from fiscal targets reflecting the weak macroeconomic outlook and implementation
risks resulting in public debt to GDP ratios materially higher than projected by
Fitch currently assumes that the fiscal costs of bank recapitalisation will not
exceed the EUR2.5bn specified under the EU-IMF programme, which includes a
Should the current banking sector instability result in a prolonged breakdown in
the domestic payments system, this would lead to a surge in corporate bankruptcy
and drive a deeper GDP contraction. However, it is Fitch's expectation that the
residual banking system will be promptly recapitalised and that capital controls
will seek to allow depositors to access funds for consumption and to pay
Fitch has not factored possible hydrocarbon receipts into its projections; these
therefore represent an upside risk beyond the near term. While the authorities
claim government revenues to range between EUR18.5bn (102.9% of GDP) to
EUR29.5bn (164.1% of GDP) in Block 12 alone, the economic viability of
extraction remains uncertain and beyond the horizon of the programme.
Fitch assumes that there is no materialisation of severe tail-risks to eurozone
financial stability that could trigger a sudden and material increase in
investor risk aversion and financial market stress. Fitch also assumes that
Cyprus remains a member of the eurozone.
+44 20 3530 1624
Fitch Ratings Limited
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London E14 5GN
+44 20 3530 1045
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Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:
Additional information is available on www.fitchratings.com
Applicable criteria, 'Sovereign Rating Methodology' and 'Country Ceilings' dated
13 August 2012, and 'Distressed Debt Exchange' dated 8 August 2012 are available
Applicable Criteria and Related Research:
Sovereign Rating Methodology
Distressed Debt Exchange
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