Fitch Rating Agency downgraded on Tuesday Cyprus` rating by three notches, citing exposure to Greek sovereign debt, while warning that it could downgrade the Cypriot economy even further.
“Fitch Ratings has downgraded the Republic of Cyprus`s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to `A-` from `AA-` and removed them from Rating Watch Negative. The Outlook on the Long-term IDRs is Negative,“ a press release issued Tuesday by Fitch notes.
Chris Pryce, Director in Fitch`s Sovereign Group said “the downgrade reflects the severity of the crisis in neighbouring Greece and the risk this poses for the Cypriot banking system and consequently the public finances of Cyprus.“
According to the release, Cyprus is a small economy with a large banking system equivalent in terms of assets to approximately nine times its GDP.
“Exposure to Greece is a significant source of vulnerability that has intensified with successive downgrades of the Greek sovereign since January 2011, when Fitch put Cyprus on Rating Watch Negative citing fiscal and financial sector risks“, the release adds.
Fitch estimates that this exposure “includes almost EUR14bn of Greek sovereign bonds and an estimated EUR5bn of Greek bank bonds. In addition, Cypriot-owned banks have lent through their substantial networks in Greece significant amounts to Greek companies and households.“
The agency believes that these banks are relatively well placed to absorb the impact of a sovereign debt crisis in Greece that entailed an assumed 50% haircut to face value of Greek government bonds.
It adds that in this scenario the cost of recapitalising the banks to a tier one capital ratio of 10% would be of the order of EUR2bn (11% of GDP), only part of which might have to be met by the state.
“However, in a more severe stress test, where a Greek sovereign default was associated with significant deterioration in asset quality such that non-performing loans rose to 25%, Fitch estimates that the cost of recapitalising the banks could rise to 25% of GDP, necessitating more extensive sovereign support“, the release notes.
Fitch also believes that the Cypriot government would be willing and able to provide effective support to Cypriot banks in a stress test of this magnitude, as at 61% of GDP Cypriot general government debt is not high by euro area standards.
“However, the cost of providing financial sector support could materially alter the government`s debt profile in a manner that would be negative for the sovereign ratings“, the release adds, noting that “Fitch does not rule out additional funding pressures arising for banks, including subsidiaries of Greek banks.“
Furthermore, the agency believes that the European Central Bank would provide liquidity support in such an environment, thereby preserving financial stability in Cyprus.
“Fitch says developments in Greece will continue to have an important bearing on Cyprus`s ratings, underlining the importance of sound public finances and a robust, well- capitalized banking system“, the release concludes.
(source: cna)
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