Moody’s downgrades Cyprus rating two notches

MOODY’S Investors’ Service downgraded Cyprus’ sovereign bond ratings two notches to A2 yesterday, citing concerns at structural problems in the island’s economy and its banks’ exposure to debt-ridden Greece.

The outlook for the Mediterranean island was stable, Moody’s said in a statement. However, it warned that if problems in the Cypriot banking sector from its Greek exposure were to “materially increase” from its current level a further sovereign downgrade could be expected.

Conversely, it said it could consider an upgrade if the government pushed forward with badly needed reforms which could arrest an expected deterioration in public finances.

Moody’s is the second ratings agency to cut Cyprus’s rating in three months. In November Standard and Poor’s cut Cyprus to A, and Fitch placed its AA- rating on review for a downgrade.

All three agencies have cited fiscal slippage. To varying degrees they have all expressed concern over Greek exposure, and the ability of a government wrestling with its own domestic problems to come to the aid of banks, if necessary.

Cyprus has been struggling to keep a lid on growing deficits in recent years and hopes to bring its public deficit below 4.0 percent of GDP in 2011. Moody’s said any improvement in finances was likely to be short-lived because of the rigid structure of government spending, Moody’s said.

“Public-sector wages and social transfers account for two thirds of state spending and, in the absence of structural reforms to these areas, Moody’s estimates that longer-term deficit and debt reduction will be very difficult to achieve,” it said.

While the government can increase revenue, that could be outpaced by a growing salary bill, it said. The government said it was committed to pension reform, and for saving 70 million euros from its public payroll over the next two years.

“The government has presented a comprehensive package to address problems from the global economic crisis, and to address structural problems of the economy,” said Stefanos Stefanou, the Cypriot government spokesman.

Moody’s said that Cypriot bank’s exposure to macroeconomic stress in Greece was substantial. Prolonged exposure increased the probability that those liabilities could manifest on the state’s balance sheet, it said.

Two of Cyprus’s largest banks, Marfin and Bank of Cyprus have a substantial presence in Greece. The island’s three largest domestic banks have over 40 percent of their total lending in Greece, Moody’s said.

Bank assets total around 650 percent of Cyprus’ GDP. If foreign banks and their subsidiaries are included the figure reaches 925 percent, Moody’s said.