BANK OF CYPRUS GROUP ECONOMIC RESEARCH DIVISION CYPRUS ECONOMY

Transcription

1 BANK OF CYPRUS GROUP ECONOMIC RESEARCH DIVISION CYPRUS ECONOMY The content of this report is for general information purposes only and does not constitute advice. It has been compiled by the Bank of Cyprus Planning and Research Division using information from sources believed to be reliable; however no assurance or warranty is given regarding the accuracy, timeliness, or applicability of this report s contents. This report might include opinions or views, which, unless expressly stated otherwise, are not necessarily those of the Bank of Cyprus Group. All content and information of this report might be changed or updated without notice. References to books, software, websites, or products within this report do not necessarily constitute or imply an endorsement. July 2012

2 Table of Contents Economy 3-5 Outlook 5-6 Ratings 7-9 Summary

3 Main Economic Indicators G.D.P. (real growth - %) 3,6-1,9 +1,1 0,5-1,1/-1,5 Unemployment (%) 3,6 5,4 6,4 7,9 10,1 Inflation (Consumer Price Index - %) 4,7 0,3 2,4 3,3 3,0 Harmonised Index of Consumer Prices - % 4,4 0,2 2,6 3,5 3,2 Fiscal balance (% GDP) +0,9-5,9-5,3-6,3-3,5/-4,0* Public debt (% GDP)) 48,2 57,8 60,7 71,6 77,0** Current Account Balance (% GDP) -16,8-7,8-7,7-10,4-7,5 * under the assumption that no additional fiscal disciplinary measures will be taken. ** additional amounts regarding the needs for bank recapitalization and the amounts to be provided by the EU, have not been taken into consideration. Sources of statistical data for Cyprus economy: International Monetary Fund, Ministry of Finance, Central Bank of Cyprus & Statistical Service. GDP contracted by 1,6% y-o-y in the first quarter of The secondary sector of the economy (manufacturing, construction, electricity), as well as the trade sector and the transport sector continued to exhibit negative growth rates. Other sectors were on a positive track such as the banking and services sectors (public administration, education, health and other services). Cyprus fell back into recession at the end of 2011 after posting two (and now three with the first quarter of 2012), consecutive quarters of negative growth in the second half of the year. It should be reminded that the economy s slump began after the devastating munitions explosion at Evangelos Florakis Naval Base in July 2011, which caused extensive damage and affected Cyprus s power supply. Further to its profound economic impact, the destructive incident which killed 13 people and injured many more, put the island s presidency under a major test, with growing public discontent against the President, well ahead of the scheduled February 2013 presidential elections. 3

4 The Cyprus government s popularity took a big hit after the incident, which coupled with the rapidly deteriorating economic climate and the banking system under immense pressure, caused growing social discontent and vocal attacks by political opponents against the President and his Progressive Party of Working People (AKEL), which now seems isolated with a minority in parliament. It appears though, that the munitions explosion incident only brought forward a downturn that was inevitable, due to the impact of the deepening euro area sovereign debt crisis. Additionally, the major banks in the country suffered huge losses on their sizeable Greek holdings (following the haircut on Greek government bonds). Meanwhile, the inconclusive election result in Greece in May 2012, cast a heavier shadow over the gloomy euro area short-term economic outlook, with fears intensifying in relation to Greece s possible exit from the eurozone. The June 17 new vote gave the New Democracy Party a marginal lead and the right to form a new coalition government. According to the latest developments in the Cyprus banking sector, Cyprus Popular Bank (Previously Marfin Laiki Bank) was the first one to require a government bailout ( 1,8 billion), even though Bank of Cyprus also followed, the latter for a significantly lower amount. The government has lost market access following the succession of credit rating downgrades to junk status by the three main agencies, with yields at the short end of the sovereign curve surging to 24%. Around EUR4.4bn in principal will need to be refinanced by end-2013 (roughly 20% of GDP) which will prove difficult to roll over when borrowing costs are in the double digits and with little to suggest that the economic outlook will have improved significantly by then. Following these developments, the Cypriot government became the fifth eurozone Member State to formally request a financial bailout from the European Union, to deal with the onslaught of the sovereign debt crisis. Following the decision by ratings agency Fitch to downgrade Cyprus' sovereign debt to junk status (see section 4

5 Ratings below), funding pressures for both the government and the banking sector have intensified. As mentioned above, the most immediate threat comes from the estimated EUR1.8bn recapitalisation of Cyprus Popular Bank, which must be completed by June 30 in order to adhere to the EU rules on bank capital. Given the rapidity with which the EU has responded to Spain's request for a EUR100bn bailout, and considering that the funds required for Cyprus are both miniscule and needed almost immediately, it is likely that a rescue package will be granted quickly and without much objection- even though inevitably under strict conditions for imposing measures to restructure the economy and alleviate concerns about the stability of the public finances and the banking sector. There is also the issue of how money flowing to the banking sector will appear in the public accounts. The EUR100bn sought by the Spanish government is expected to find its way to the banking sector via its bank restructuring vehicle (Fondo de Reestructuracion Ordenada Bancaria; FROB), though this will still be officially recorded up as additional government debt. Should the same accounting measures apply to a Cypriot bank recapitalisation, risk perceptions towards sovereign risk (which have already deteriorated sharply) could shift significantly. One way to avoid this fate would be to seek external support. The government has already approached China and Russia, with the latter having previously doled out a EUR2.5bn loan. This singles Cyprus out as a unique case among the Member States which have required bailouts since the government has effectively gone outside the EU's borders in a seeming contravention of 'keeping it in the family'. This has introduced a geopolitical dynamic, which has not been an issue for the larger Member States in bailout programmes. Outlook GDP is forecast to contract by 1,1%-1,5% in 2012, as the government intensifies its austerity measures (many of which are expected to be imposed by the Troika), and 5

6 uncertainty, particularly over the fate of the Cyprus s stricken banking sector, weighs on domestic demand. It should also be noted that Cyprus large banking sector, with assets of over eight times GDP, is a pillar of the economy, directly generating a high share of jobs and income, and indirectly supporting other business services. The vivid possibility of wage cuts in the public and banking sector, casts a heavy shadow over consumer spending in the near term. Furthermore, trends in the labour market will also weigh on short-term economic activity. Unemployment hit a record of 11,1% in the first quarter of 2012, which showed the increase in joblessness in the last year in Cyprus was beaten only by that of Spain and Greece. This rapid increase, which is likely to continue in the coming months, will have a significant negative impact on confidence in the economy, as well as suppressing wage growth, both of which will weigh on household consumption in the near future. The government s efforts to bring the budget deficit down to 2,5% of GDP in 2012, from 6,3% of GDP in 2011, have not been adequate so far, and therefore, the said target is most likely to be missed. It is expected that the budget deficit will be between 3,5% to 4,0% of GDP by year-end 2012, even though the Finance Minister has warned of measures ahead, some of which, however, do not seem to find their timely way through Parliament. The outlook for 2013 remains highly uncertain. The need for additional austerity measures to reduce the budget deficit and continuing uncertainty are likely to adversely affect consumer and investor confidence further, leading to another year of economic recession. A medium-to-long-term positive prospect for Cyprus, concerns the exploitation of major offshore gas reserves, which, if managed well, could provide an important boost to the country s long-term growth potential, even if the full benefits will most likely take a decade to realize. 6

7 Ratings Fitch Ratings Moody s Ratings Standard & Poor s Last rating action date: 25-Jun-2012 Last rating action date: 13-Jun-2012 Last rating action date: 13-Jan-2012 Last affirmation date: 04-Jul-2012 Last affirmation date: 13-Jun Last affirmation date: 13-Jan-2012 Rating Rating Rating Outlook Negative Outlook Under Review Outlook Negative Country Ceiling AAA Government Ba3 Local Long Bonds Term BB+ Long-term IDR BB+ Commercial NP Foreign Paper Currency BB+ Domestic Long Term Currency Short-term IDR B Foreign Currency B Local Currency Long Term IDR BB+ Short Term Local Currency Short Term B Fitch Ratings downgraded on 25 June 2012 the Republic of Cyprus Long-term foreign and local currency Issuer Default Ratings (IDRs) to BB+ from BBB-. The Short-term IDR has also been downgraded to B from F3. The Outlook on the Long-term IDRs is Negative. Fitch has simultaneously affirmed the eurozone Country Ceiling at AAA. The downgrade of Cyprus s sovereign ratings reflected a material increase in the amount of capital Fitch assumes the Cypriot banks will require compared to its previous estimate at the time of the last formal review of Cyprus s sovereign ratings in January This is principally due to Greek corporate and households exposures of the largest three banks and to a lesser extent the expected deterioration in their domestic asset quality. Fitch assesses that Cypriot banks will require further substantial injections of capital (further to the 1,8 billion 10% of GDP) required by Cyprus Popular Bank, potentially up to 4 billion (23% of GDP). While most of the increase in losses is associated with Cypriot banks Greek exposure, the reported nonperforming loan ratio for domestic Cypriot loans has also risen notably over the past year as the Cypriot economy has contracted and unemployment has risen. 7

8 Even assuming that Greece remains in the eurozone, Cypriot banks will have to bear significant further loan losses as the Greek economy continues to contract over the medium term, as well as, the deterioration in domestic asset quality. Moody s Investor s Service downgraded Cyprus government debt to Ba3 from Ba1 on 13 June The downgrade was prompted by the material increase in the likelihood of a Greek exit from the euro area, and the resulting increase in the likely amount of support that the government may need to extend to Cypriot banks. The two-notch downgrade reflected Moody s assessment that this risk is exacerbated by the fact that the country s finances are already strained and access to the international funding markets is still prohibited. Moody s also reported that Cyprus s programme of fiscal consolidation is proceeding more slowly than was expected. The Minister of Finance had announced back in April that Cyprus will miss its 2012 fiscal targets without the implementation of additional fiscal disciplinary measures. However, no announcement of new measures had been made at the time of the downgrade, and under the current political climate it seemed unclear what of measures would be pursued. Moody s also reported that over the longer term, the presence of substantial gas reserves in the Cypriot Exclusive Zone of the Levant Basin is a credit positive, though it will probably take nearly a decade for the sovereign to realize most significant and sustained benefits. However, in mid-may the government received bids for a second licensing round to tap these gas reserves, which will enable the government to realize some one-off revenue gains from the sale of these licenses in 2012 or Standard & Poor s Ratings Services lowered on 13 January 2012 its long-term and short-term sovereign credit ratings on the Republic of Cyprus by two notches to BB+ from BBB, and B from A-3. The outlook is negative. The downgrade reflects S&P s view of the systemic stresses emanating from the eurozone. S&P believe that the large Cypriot financial sector and Cyprus s 8

9 external asset position, remains susceptible to further write-downs on its high lending exposure to Greece. Cyprus long-term rating could stabilize at the current level if private creditors were to provide any needed capital to domestic banks. If public sector access to market funding improves and government financing is assured, amid stabilizing growth prospects, the ratings could also stabilize. Summary GDP contracted by 1,6% y-o-y in the first quarter of The secondary sector of the economy (manufacturing, construction, electricity), as well as the trade sector and the transport sector continued to exhibit negative growth rates. Other sectors were on a positive track such as the banking and services sector (public administration, education, health and other services). Cyprus fell back into recession at the end of 2011 after posting two (and now three with the first quarter of 2012), consecutive quarters of negative growth in the second half of the year. It should be reminded that the economy s slump began after the devastating munitions explosion at Evangelos Florakis Naval Base in July 2011, which caused extensive damage and affected Cyprus s power supply. The munitions explosion incident only brought forward a downturn that was inevitable, due to the impact of the deepening euro area sovereign debt crisis. Additionally, the major banks in the country suffered huge losses on their sizeable Greek holdings (following the haircut on Greek government bonds). Meanwhile, the inconclusive election result in Greece in May 2012, cast a heavier shadow over the gloomy euro area short-term economic outlook, with fears intensifying in relation to Greece s possible exit from the eurozone. The June 17 new vote gave the New Democracy Party a marginal lead and the right to form a new coalition government. The government has lost market access following the succession of credit rating downgrades to junk status by the three main agencies, with yields at the short end of 9

10 the sovereign curve surging to 24%. Following these developments, the Cypriot government became the fifth eurozone Member State to formally request a financial bailout from the European Union, to deal with the onslaught of the sovereign debt crisis. GDP is forecast to contract by 1,1%-1,5% in 2012, as the government intensifies its austerity measures (many of which are expected to be imposed by the Troika), and uncertainty, particularly over the fate of the Cyprus s stricken banking sector, weighs on domestic demand. It should also be noted that Cyprus large banking sector, with assets of over eight times GDP, is a pillar of the economy, directly generating a high share of jobs and income, and indirectly supporting other business services. The vivid possibility of wage cuts in the public and banking sector, casts a heavy shadow over consumer spending in the near term. The government s efforts to bring the budget deficit down to 2,5% of GDP in 2012, from 6,3% of GDP in 2011, have not been adequate so far, and therefore, the said target is most likely to be missed. It is expected that the budget deficit will be between 3,5% to 4,0% of GDP by year-end 2012, even though the Finance Minister has warned of measures ahead, some of which, however, do not seem to find their timely way through Parliament. Fitch Ratings downgraded on 25 June 2012 the Republic of Cyprus Long-term foreign and local currency Issuer Default Ratings (IDRs) to BB+ from BBB-. The Short-term IDR has also been downgraded to B from F3. The Outlook on the Long-term IDRs is Negative. Fitch has simultaneously affirmed the eurozone Country Ceiling at AAA. The downgrade of Cyprus s sovereign ratings reflected a material increase in the amount of capital Fitch assumes the Cypriot banks will require compared to its previous estimate at the time of the last formal review of Cyprus s sovereign ratings in January

11 Moody s Investor s Service downgraded Cyprus government debt to Ba3 from Ba1 on 13 June The downgrade was prompted by the material increase in the likelihood of a Greek exit from the euro area, and the resulting increase in the likely amount of support that the government may need to extend to Cypriot banks. The two-notch downgrade reflected Moody s assessment that this risk is exacerbated by the fact that the country s finances are already strained and access to the international funding markets is still prohibited. Standard & Poor s Ratings Services lowered on 13 January 2012 its long-term and short-term sovereign credit ratings on the Republic of Cyprus by two notches to BB+ from BBB, and B from A-3. The outlook is negative. The downgrade reflects S&P s view of the systemic stresses emanating from the eurozone. S&P believe that the large Cypriot financial sector and Cyprus s external asset position, remains susceptible to further write-downs on its high lending exposure to Greece. Sources: Cyprus Ministry of Economics and Finance, Cyprus Statistical Service Bureau, Business Monitor International (BMI), International Monetary Fund, European Commission, Eurostat, Fitch Ratings, Moody s Investors Service, Standard & Poor s, Reuters. Prepared by: Elena Triantafyllou, Group Economic Research Division July