By Nick Mann | 22 November 2012
Fitch has slashed Cyprus’s credit rating by two notches and warned of a further downgrade if the bailout of its banking sector costs more than expected.
The downgrade, from BB+ to BB–, is due to the country’s ‘significantly’ deteriorated fiscal position and the lack of a ‘clear and credible’ plan to tackle it, the agency said yesterday.
Cyprus is the second eurozone country to be downgraded this week. France lost its AAA rating from Moody’s on Monday.
Fitch, one of the three main rating agencies, explained that ‘the downgrade of Cyprus's sovereign ratings reflects the materially weaker macroeconomic outlook, a fiscal budget that has significantly underperformed expectations and the continued high level of uncertainty over the costs associated with bank recapitalisation’.
It added: ‘The delay in negotiating official support has contributed to the deteriorating economic conditions and raised uncertainties about public sector reform and the correction of macroeconomic imbalances.’
Cyprus’s three main banks are expected to need at least another €4bn – 22% of gross domestic product – to close a capital shortfall. The government requested bailout support from the European Commission and International Monetary Fund in June to help address this gap. However, a bailout programme has yet to be agreed.
Fitch also warned that the overall cost of recapitalising the banking sector could be substantially higher under ‘more stressed’ scenarios.
Reaffirming its negative outlook on Cyprus’s credit rating, the agency warned that further delays to negotiations over a bailout programme or a significantly bigger-than-expected bank funding shortfall could prompt a further downgrade.
The cost of recapitalising the banks will also increase the country’s debt from 71.1% of GDP to a peak of around 120% by 2014, Fitch said.
Already in 2012 the country’s fiscal deficit for the first nine months of the year was higher than for the same period in 2011. In April, Cyprus set a target of reducing its deficit from last year’s 6.3% of GDP to 2.6% by the end of 2012.
Fitch now expects the deficit for 2012 to be more than 5% of its GDP. ‘This is despite austerity measures, including wage freezes and an increase in VAT by 2 percentage points to 17%,’ Fitch noted. ‘The depressed macroeconomic environment dampened receipts, while any expenditure savings have been offset by an increase in interest and pension expenditure.’
After growing by 0.5% in 2011, the Cypriot economy is now expected to shrink by over 2% this year and remain in recession until 2014.
This weak growth outlook will increase the challenge of reducing the fiscal deficit and debt ratio, Fitch said.
