LONDON (Standard & Poor's) April 10, 2013--Standard & Poor's Ratings Services today revised the outlook on the Republic of Cyprus to stable from negative. At the same time, we affirmed our long- and short-term sovereign credit ratings on Cyprus at 'CCC/C'.
The outlook revision reflects our expectation that the Cypriot government will agree to the terms of an up-to €10 billion ESM-IMF financial assistance program and that the program's first loan tranche will be disbursed in time for the government to make a June 4 payment due on a Eurobond. We understand that the ESM-IMF loan will be provided at a low interest rate and at long maturities. Our baseline expectation continues to be that Cyprus will remain a member of the European Economic and Monetary Union (the eurozone). Nevertheless, it seems likely that recently-imposed capital controls will remain, in some form, to protect Cyprus' banks from renewed deposit flight. We expect that the current account deficit will initially widen to more than 10% of GDP as business and financial services exports fall on the expected loss of non-resident transactional deposits. Troika (the EU, IMF, and European Central Bank [ECB]) and Eurosystem lending (the Eurosystem consists of the ECB and eurozone central banks) is likely to fund the greater part of this external financing gap during the life of the program. We understand that once the Memorandum of Understanding formalizing the terms of the program is approved by the Cypriot government, the board of governors of the ESM, and the IMF executive board, the ECB would once again accept Cypriot government securities as collateral in exchange for its credit support to Cyprus' financial institutions. We view this as an important normalization of monetary support for Cyprus' challenged financial sector. In our opinion, Cyprus' economic prospects remain difficult over the near term. We expect economic growth will depend on a significant reorientation of the economic base, likely including the development of offshore gas fields. Expected downsizing in the public sector and financial services sector, as well as the banking system, will likely lead to significant job losses in these areas as well as in real estate and tourism; these sectors account for over 50% of Cyprus' GDP. We project that Cyprus' economy will contract by an estimated 20% between 2013 and 2016. Weak growth and employment prospects may also weigh on public and political support for an ambitious budgetary consolidation program, while raising questions about debt sustainability. The stable outlook balances what we view as the formidable economic adjustment challenges Cyprus faces against the time and resources provided by the Troika and the ECB as a result of the recently-agreed financial adjustment program, which we expect to be approved shortly by all parties. We would likely lower the rating if, contrary to our expectations, the Cypriot government rejects the terms of the revised Memorandum of Understanding. We could also lower the ratings later this year if the government appeared unable to fulfill the program's conditions. We could consider raising the ratings if the economy were to stabilize sooner and at higher levels than we currently project, enabling general government debt to GDP to stabilize earlier. We could also consider an upgrade, in time, if official creditors were to provide even more concessional lending terms to Cyprus over the course of its adjustment program.