And The Hits Just Keep On Coming: Fitch Downgrades Cyprus To BBB, Outlook Negative
Do they mean Cyprus... or France?
FITCH DOWNGRADES CYPRUS TO 'BBB'; OUTLOOK NEGATIVE
Fitch Ratings-London-10 August 2011: Fitch Ratings has downgraded the Republic of Cyprus's Long-term foreign and local currency Issuer Default Ratings (IDRs) to 'BBB' from 'A-'. The Outlook on the Long-term IDRs is Negative. Fitch has simultaneously downgraded the Short-term foreign currency IDR to 'F3' from 'F1'.
The Country Ceiling has been affirmed at 'AAA', the ceiling appropriate for euro area members.
"The two-notch downgrade of Cyprus's ratings to 'BBB' reflects the actual and anticipated fiscal slippage, compounded by Fitch's expectation that the sovereign will be unable to access the international debt markets in order to refinance an increasing debt maturity profile in H211 and H112. The 2011 deficit is now expected to be close to 7% of GDP and not all of the increase, from 4%, since the agency's most recent analysis in June can be attributed to the naval base explosion, which took out half of Cyprus's electricity generating capacity," says Chris Pryce, Director in Fitch's Sovereign Group.
The government's calculations indicate its financing requirements in the last five months of the year will be close to EUR1.1bn, of which EUR650m will be existing debt falling due for redemption. Against this, the government has EUR570m of cash balances, representing about half of the total financing requirement. The government anticipates that it will be able to refinance the balance by borrowing from domestic financial institutions, although Fitch considers that this may prove challenging at a time when the banks are facing a decline in asset quality. Even if the sovereign can secure refinancing through H211, it will enter 2012 with minimal cash balances and refinancing needs of EUR1.2bn in the first two months. Under current market conditions (government three-year yields reached 15.4% in August), Fitch believes that the government will be unable to meet this target without recourse to external official assistance, reflecting a lack of options inconsistent with a sovereign issuer in the 'A-' category. At this juncture, Fitch anticipates that such assistance is likely to be forthcoming.
On 11 August, the new government intends to put before parliament an austerity package to be implemented mainly in 2012. Fitch understands that the package is designed to restrain public sector wage costs and employee numbers, cut welfare costs by better targeting of recipients and raise taxes. If agreed by parliament and successfully implemented, it would cut the prospective 2012 general government deficit by about 3.5pp to 2.5%, effectively restoring the expected fiscal position reported in the 2011 Stability Plan. Fitch understands that the package has been endorsed by the leaders of all the main parties and agreed with the Social Partners. While Fitch anticipates that the austerity package will be approved by parliament, the agency remains concerned about the execution risks of implementation, particularly given the inability of previous administrations to address fiscal consolidation and structural reform measures.
Fitch's downgrade of Cyprus's rating by three notches at the end of May reflected the severity of the crisis in neighbouring Greece and the risk this poses for the Cypriot banking system and consequently possible calls for support from Cyprus's public finances. Cypriot banking sector exposure to Greece is significant. Approximately one-quarter of the banking system's assets are now booked as Greek exposure, including almost EUR8bn of Greek sovereign bonds, following the recent repatriation by the Greek parent bank of EUR5.2bn and an estimated EUR5bn (partly secured) of Greek bank bonds. In addition, through their substantial networks in Greece, Cypriot-owned banks have lent significant amounts to Greek companies and households. The worsening fiscal position has led Fitch to revise its previous view that the sovereign would be able to recapitalise the banking system at the assumed level (25% of GDP) without significant external support, given the increased strains on its own funding situation.
The loss of generating capacity from the power station will have a significant impact on growth this year and next. Fitch's forecasts for GDP growth have been revised down by 1.5pp in both 2011 and 2012, although the potential for further slippage cannot be discounted. On the upside, most of the capacity shortfall could be eliminated by the autumn, leading to the possibility of stronger growth in 2012. On the downside, the hike in energy tariffs, the higher cost of the replacement energy supply, the additional austerity and negative confidence effects from the weakening sovereign credit profile could have a further negative impact.
Triggers for further negative rating action would include further fiscal slippage or revisions to key deficit or debt metrics, an inability or unwillingness to implement the austerity package leading to a failure to establish firm fiscal consolidation, a failure to secure sufficient and timely external financial support if needed, weaker macro-economic performance, or a further deterioration in the banking sector outlook, including capital flight via bank deposit outflows
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