Cyprus Peace Talks Face Growing Obstacles But Success Would Improve Credit Standing

Cyprus is steadily recovering from its recent financial difficulties. Despite being downgraded to junk during the 2012/13 financial crisis, it has managed to exit the EU-led rescue package, and re-started bond issuance in 2014. Earlier this month, the Bank of Cyprus (the largest commercial bank) announced that it had fully repaid its EUR 11.4bn emergency loan.

The Cyprus peace talks currently underway in Geneva face a number of hurdles, including debates about borders, land swaps and restitution, the future of Turkish forces, and the detail of a proposed new Federal structure. Russia has considerable interests in the island but was not invited to the talks, a decision which may jeopardise the outcome.

But there are considerable rewards in unification which could transform the economy of the entire island. If, as expected, Turkey agrees to write-off most of the North Cyprus debt burden, then Sapienta Economics estimate that a united Cyprus would have a combined debt of €20.42bn, almost identical to the estimated combined GDP, giving a debt/GDP ratio of 100%. This would immediately put the unified state on a stronger financial footing and would probably lead to further rating agency upgrades, lower funding costs, and the possible return of flight capital. In addition, recent gas discoveries in Cyprus waters to the south of the island offer scope for joint exploitation and economic diversification.

Like the rating agencies, banks are increasingly optimistic on the Cyprus government; and their assessment of credit risk was improving throughout most of 2015, and continued into 2016. The CBC* for Cyprus improved by a notch in October 2016.

Failure in the struggling peace talks would probably be slightly negative for credit; but success would put Cyprus on course for a brighter economic future and further improvements in credit standing.

*CBC = Credit Benchmark Consensus; a 21-category scale which is explicitly linked to probability of default estimates sourced from major banks. A CBC of bbb+ is broadly comparable with BBB+ from S&P and Fitch or Baa1 from Moody’s.

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