S&P's Lowers Cyprus Rating Amid Bailout Talks

Thu, 02/08/2012 - 09:48 — Sarah Fenwick

Standard & Poor's rating agency said today it has lowered its long-term sovereign credit rating on the Republic of Cyprus to 'BB' from 'BB+', citing bailout talks that could result in a rescue package of up to 15 billion euros. The agency confirmed the short-term sovereign credit rating on Cyprus at 'B'.

The government will negotiate a bailout package for the banking system that will also back up any further losses in the banking sector, said S&P's. The rescue package is vital if Cyprus is to avoid defaulting on its loans, said the agency.

"We believe the government will remain in a weak fiscal position due to a banking system that has been unable to cope without government support as a result of its exposure to Greek customers," said the ratings agency.

S&P's estimates that Cyprus needs the equivalent of just over 60% of its GDP to recapitalize its banks, absorb further bank losses, and meet 2012-2014 borrowing requirements. It forecasts an average increase in general government debt of over 10% of GDP in 2012 and 2013, peaking at 108% of GDP in 2013.

Key Points
"In our base-case scenario, we expect Cyprus will negotiate a financial support package of €11 billion, or just over 60% of Cyprus' GDP."
"As a result, we now estimate Cyprus' net general government debt burden will increase by nearly 12% of GDP on average in 2012 and 2013, peaking at over 105% of GDP in 2013."
"Meanwhile, we believe Cyprus' short-term financing pressures are increasing as its negotiations with the European Union, ECB, and IMF (Troika) are unlikely to conclude before September, and significant uncertainty remains over securing bilateral funds."

Excluding recapitalisation funds for the banks, the government deficit is seen at 3.5% of GDP between 2012 and 2014, from 6.3% in 2011, according to the analysts.

The higher government debt burden considerably reduces the government's capacity to respond to any new external shocks like further economic deterioration in Greece in the case that it leaves the eurozone. The analysts estimate that the banks will need €4.5 billion or 25% of GDP to recapitalise effectively.

"We also expect that the government will likely need about €6.6 billion or 36% of GDP to cover maturing debt and underlying deficits during 2012-2014," said S&P's.

Cyprus' real GDP growth will contract by 1.5% this year and will at best stagnate during 2013, said the agency.

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