S&P cuts Cyprus sovereign debt rating on bank fears

(NICOSIA) - Standard & Poor's lowered its long-term sovereign debt rating for Cyprus on Tuesday from A+ to A, with a negative outlook, expressing concerns about the government's potential exposure to credit risks in the disproportionately large banking sector.

Regarding the banks, it noted their large exposure to struggling Greece and the island's own relatively very high levels of domestic credit.

"The downgrade reflects our opinion of increased vulnerabilities from embedded credit risk of the Cypriot financial system's external assets and domestic loan book, and the impact these could ultimately have on public finances," said Standard & Poor's credit analyst Benjamin Young.

The banking index on the Cyprus Stock Exchange fell 4.48 percent, according to the Cyprus News Agency, while the main market index closed down 4.41 percent.

Standard and Poor's said after a decade of rapid expansion, the banks' balance sheets now exceeded 700 percent of GDP, including both domestic and foreign institutions.

It said the total exposure to Greek customers, and securities of the Greek government and corporations, had grown to more than 250 percent of GDP.

It said that at 280 percent of GDP, the relative size of domestic credit in Cyprus was also among the highest in Europe. Much of it is collateralised with property assets, which, overall, suffered a decline in value over the past two years.

"Although the system reports high capital levels, the sheer size of Cyprus's financial centre poses funding risks in our view," S&P said.

"The negative outlook reflects our opinion of the risks that the large financial sector contingent liabilities could migrate to the government's balance sheet," said Young.

The agency noted that the government had already incurred direct exposure through a three billion euro note issue, equivalent to 17 percent of GDP.

"This financial system support has added to the fiscal pressure the government already incurred from the global recession, in our view," S&P said.

It noted new revenue-raising measures in the pipeline, including excise duties on petroleum and tobacco and the planned introduction of a five percent VAT rate on foodstuffs and pharmaceuticals, but said it expected the island's 2010 deficit to remain largely unchanged at six percent of GDP.

"Although we believe that the passing of the 2011 budget... will be sufficient to achieve the government's target of a 4.5 percent of GDP deficit, we forecast that the government's debt-to-GDP ratio will peak at 79 percent in 2011, compared with 48 percent at year-end 2008," it said.

Cyprus President Demetris Christofias blamed the S&P downgrade on quibbling by trade unions and political parties over the government's deficit reduction plans.

He called for a swift consensus on the plans to prevent more draconian measures being imposed by the European Union or other international organisations.

"If all the social partners had shown the required responsibility to take simple measures, this development wouldn't have happened," Christofias said at a business conference in the capital Nicosia.

"If people weren't playing ping-pong with the measures, saying: 'We can't do this,' or: 'If this doesn't happen, we can't accept it,' then we wouldn't be in danger of the EU or foreign organisations imposing harsher measures that don't bear thinking about."

Christofias's government has been trying to secure agreement on a raft of measures to reduce the deficit, including a cut in the state payroll and tax increases, such as a new higher rate on bank profits as well as the introduction of VAT on food and pharmaceuticals.