A «fiscal win» for Cyprus

While slow at first to admit it had a crisis, Cyprus was fast to react under the new government, in power for 18 months this June. After a rather dramatic bail-in, which involved taking depositors’ money to rescue troubled banks, Cyprus lingered in a slow but painful recession that saw unemployment approach 20% -higher than any time in its history.

But just over a year since then, Cyprus is returning to markets with a yield that few would have expected just a few months ago. The 500 million euro bond is likely to be priced with a rate below 5.5%, according to sources close to the deal. Compare that to yields on its medium term note of more than 15% a few months ago.

Georgiades423_21What gives? To be sure, there is a lot of favorable circumstance helping Cyprus return to the market. On a European level, the European Central Bank’s easy money policy is leading to a market that is starved for yield, forcing investors to seek attractive options for their increased liquidity, at a time when both emerging markets and other crisis hit Eurozone countries are recording fast declining yields.

Closer to home, Greece’s return to the markets earlier this year is also making many investors more bullish on Cyprus, which is seen as an annex to the Greek economy. And, on Cyprus itself, foreign investors have been snapping up local assets—hotels, property, equities, distressed debt—at attractive prices as they are sold off by heavily indebted Cypriot firms. Even the island’s troubled banks, Bank of Cyprus and Hellenic, are attracting investor interest. The former is recording strong stock sales despite the fact that its share is suspended from the stock exchange; while Hellenic has attracted two anchor investors, U.S. hedge fund Third Point and Wargaming, a Russian gaming software developer now based in Cyprus, both teeming with liquidity.

Supporting the issue, however, is Cyprus’ own favorable circumstance. For one thing, Cyprus’s economy-despite the downturn—has defied expectations of a double-digit contraction—and is looking at a recession of around 5%. Unlike Greece, Cyprus’s government moved quickly and deliberately towards a fiscal correction in 2013, recording below budget government spending–before cutting another 10% in the 2014 budget. And, unlike Greece, Cyprus concentrated on fat-cutting rather than across-the-board cuts that would make an ineffective state more ineffective still. Even VAT collections have increased since last year, despite the recession.

At the same time, Cyprus’s politics have been notably less messy than in neighboring Greece. Despite still having to face some big reforms ahead, including overhauls to the national health system, the civil service, education and taxes, the government has shown that it enjoys broad support from the Parliament –despite only commanding a minority in the legislature. There have been some hiccups: Parliament voted against the recapitalization of Cyprus’s cooperative banks and against an umbrella privatizations bill. But those hiccups were resolved after cosmetic changes. And although lawmakers are insisting on protecting bank borrowers, even for the better off, at the expense of the banks, they are still expected to pass a foreclosures and insolvency bill this summer.

And, importantly, Cyprus’s troika of creditors—from the ECB, the European Commission, and the International Monetary Fund—seem to think the government is doing well too. Despite some delays, each troika review so far has come back with the same evaluation: “Cyprus is on track with better-than-expected performance.” That will likely continue.

The biggest threat still facing Cyprus is the bad loans held by the Cypriot banks, which threatens to hamstring any economic recovery due to a credit crunch by the banks. But here too, the bond issue may add to the virtuous cycle. As the biggest bank faces an upcoming ECB stress test later this year, it should get an unforeseen capital boost from Cyprus’s surprise return to the capital markets. Why, the new bond will likely refinance the recapitalization bond held by Bank of Cyprus and that is valued at a discount by regulators: that means BoC will be trading in a junky old bond with a shiny new one at face value. That will help the bank’s capital and liquidity position.

Now Cyprus is looking like it could be rewarded by investors for its willingness to move forth with reform. And that is an important lesson from the crisis.

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