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Nicosia - Moody’s cut Cyprus’ credit rating by two notches
on Wednesday and warned another downgrade was possible, highlighting an energy
crisis and exposure to Greece that threaten to tip the island into fiscal
meltdown.
Markets have trained their sights on the east Mediterranean
nation as a possible fourth recipient of a eurozone bailout since a huge
explosion destroyed its largest power plant, and political wrangling now risks
derailing much-needed economic reforms.
If the reforms were significantly delayed or watered down,
the country’s debt would be marked down again from its new grade of Baa1 to no
more than two steps above junk status, the rating agency said.
The yield on Cyprus’ benchmark 10-year bond issued in
February 2010 spiked to 9.5% on Wednesday following the Moody’s statement, up
from 8.9% a week ago and from around 6.20% in early May.
“The Baa1 rating does incorporate an assumption that
something resembling those (fiscal) reforms does eventually get legislated and
implemented,” Moody’s senior analyst Sarah Carlson told Reuters.
Cyprus, one of the eurozone’s smallest members, has seen its
external borrowing costs spiral in the past 12 months as ratings agencies
issued downgrades in response to its banks’ exposure to Greece and the lagging
reforms.
The July 11 blast at the Vassilikos plant, which wiped out
53% of the island’s energy production,
significantly worsened the situation.
Cyprus is not a regular on international bond markets, but
at current yields it has been effectively shut out of that financing option.
Until now it met its borrowing needs from domestic markets.
Last week, central bank governor Athanasios Orphanides
warned it could be forced to seek a bailout unless tougher austerity measures
were taken immediately.
Growth forecast cut
Moody’s also cut its growth outlook for Cyprus to zero this
year and 1% in 2012, due in part to reduced power production after the
Vassilikos explosion.
Downward ratings pressure could also be exerted if problems
in the Cypriot banking sector - holding between €4.5bn and €5bn of Greek debt -
were to require a substantial injection of government money, Moody’s said.
It last downgraded Cyprus in February, when it cited the
same structural and Greece-related concerns. Rival agencies Fitch and Standard and
Poor’s, which have also downgraded Cyprus this year, both rate the country at
A-.
Moody’s said it would consider a rating upgrade if Cyprus
introduced sweeping structural reforms in its social transfers system and
public sector wage bill, and recorded significant and lasting cost savings.
Blast impact
Vassilikos was destroyed when a cargo of confiscated Iranian
munitions stored in a military base several hundred metres away from the plant
exploded.
Since then, Cyprus’ state-owned electricity authority,
which has an effective monopoly on power generation, has introduced rolling
power cuts. Economists have estimated the cost of the blast and its
consequences at at least €1bn, a significant slice of Cyprus’s €17.4bn economy.
Cyprus launched a plan on July 1 to cut spending in the
civil service and scrap a number of state-owned organisations. But that
programme and anticipated further measures to deal with the fallout from the
blast face significant political hurdles.
On Tuesday, a number of parties accused the government of
backtracking on reforms because they feared an angry backlash from Cyprus’
powerful labour unions.
The two parties in Cyprus’s centre-left government do not
have an absolute majority in parliament to push reforms through, so any measures
have to be adopted by consensus.
Moody’s said that if any of the plans were watered down or
delayed significantly, it could prompt a further downgrade. An increasingly
fractious political climate added to implementation risks, it said.
“There are so far no short-term measures to compensate for
the plant’s destruction,” Carlson said. “We think this will mute the
government’s planned range of structural measures that have been designed to
improve fiscal sustainability over the medium term.”
