Cyprus’s 2021 budget targets a wider deficit than we had previously expected, but fiscal performance should still be strong relative to regional and ratings peers, Fitch Ratings says. The delay in passing the budget highlights pandemic-related spending pressures, although it was primarily caused by political demands for a formal investigation into the country’s citizenship for investment scheme.
The Cypriot Parliament adopted the 2021 budget by 29 votes to 26 on 21 January 2021. The budget envisages EUR6.48 billion of revenues and expenditure of EUR7.16 billion, resulting in a deficit of EUR680 million or 3.2% of GDP. Spending growth was constrained in the first three weeks of 2021 while a temporary budget, in which expenditure allocations were rolled over from a year earlier, was in place.
Cyprus’s record of significant fiscal consolidation since its 2012-2013 financial crisis is an important strength for its ‘BBB-‘/Stable sovereign rating. However, the fiscal easing measures, including additional social spending, in the new budget mean that the 2021 fiscal deficit will be wider than the 2% of GDP that Fitch forecast when we affirmed the rating last October.
This partly reflects the severity of the second wave of Covid-19 infections, which saw the seven-day rolling average of new cases peak above 600 in early January before falling to 130 by the end of the month (daily new cases in the first wave never exceeded 50). The government estimates that the additional fiscal support in 2021 will be equal to 1.5% of GDP compared with the initial draft budget prepared in the autumn.
High public debt is a legacy of the 2012-2013 crisis, but Cyprus’s persistent underlying budget surpluses pre-pandemic, which peaked at 3% of GDP in 2019, and robust GDP growth averaging 4.4% in 2015-2019 increased its capacity to absorb the pandemic shock.
A fiscal deficit of 3.2% this year, in line with the 2021 budget, would be narrower than any other non-‘AAA’ rated western European sovereign and below the forecast ‘BBB’ category median of 5.3%. The government’s latest estimate of the 2020 is about 4.5% of GDP on a cash basis, well below the aggregate eurozone deficit of 8.8% of GDP in the European Commission’s Autumn 2020 economic forecasts.
The delay in passing the 2021 budget after it was rejected in December originally stemmed from the (unsuccessful) efforts of the opposition DIKO party, which supported previous budgets, to make its backing conditional on the government allowing Cyprus’s auditor-general to investigate the controversial ‘citizenship for investment’ scheme.
But as the budget debate continued, political pressure for higher expenditure grew, especially demands for more social spending in response to the recession triggered by the pandemic (the 2020 contraction is estimated at 5.5%-6.0%, although GDP was still 20% higher in 3Q20 than in 2015).
The possibility of continuing economic disruption (notably to the tourism sector, which depends on western European countries hit hard by the second wave of the pandemic) that necessitates further spending or results in lower tax revenues remains a moderate fiscal risk.
The large banking sector remains a weakness relative to ‘BBB’ category peers due primarily to weak asset quality, notably very high non-performing exposure ratios that still weigh on capital and profitability.
Cyprus has the highest use of loan moratoria in Europe according to the European Banking Authority (about 55% of private-sector loans at end-September 2020), but this reflects the lack of barriers to granting moratoria and the absence of a state-guaranteed loans scheme, as well as borrower exposure to the sectors most affected by the pandemic.
