S&P's Cuts Cyprus Sovereign Credit One Notch to BBB

Standard & Poor's Rating Services has cut Cyprus' long-term sovereign credit rating by one notch to BBB from BBB+ and the short-term rating to A-3 from A-2.

The main reasons for the downgrade are the island's exposure to Greek debt and the potential for a further devaluation of Greece's sovereign bonds.

"We also believe the effect of a Greek government default could reverberate through Cyprus' economy in the form of private-sector funding costs increasing beyond our previous expectations, thereby reducing investment and overall domestic demand," said a statement from S&P's.

Weaker economic growth could worsen the Cypriot government's debt dynamics and reduce the willingness of its political leaders to press forward with fiscal and labor market reforms, says the rating agency.

"We estimate the exposure of Cypriot banks to Greek debt (sovereign, corporate, and bank combined) at about 165% of Cyprus' GDP," says S&P's.

Any forthcoming Greek sovereign debt exchange could result in bank
recapitalization needs of up to 10% of GDP, according to the agency.

No new austerity measures have been implemented after August 26th, when Parliament took some steps to cut costs and increase government revenue to reduce the deficit. The rating agency says that organised labour and other social partners are blocking the bulk of the measures and GDP is expected to remain flat until 2013.

"We expect this will drag on government revenues as well as delay important structural improvements to Cyprus' public finances, and lead to fiscal deficits of nearly 7% of GDP in 2011 and about 4% in 2012," says S&P's.

On the plus side, a 2.5 billion euro loan from Russia can ease funding pressures and help the government pay back maturing debt in the first quarter of 2012. One-off revenues from licensing natural gas exploration blocks could help reduce the deficit in 2012, says the agency. But, these are temporary revenues which would not structurally improve Cyprus' public finances, says S&P's.

The BBB rating is two notches above junk status.

To post comments and become a full member of your news community, click here.