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By Stelios Orphanides
As Cyprus prepares for a clean exit from its adjustment programme next month, the yields on its government bonds in the secondary market have started to rise, reversing a downward trend which began mid-2013, months after the island’s bailout, a comparison of data shows.
The €1bn 10-year government bond issued in October at an average yield of 4.25 per cent, which saw its secondary market yield drop to 3.70 per cent by the end of December, has come under pressure in recent weeks and its secondary market yield rose by the end of January to 3.82 per cent, data compiled by Bank of Cyprus shows. The bond issue marked Cyprus’s return to the markets and prompted the government to announce a clean exit strategy, with which it ruled out any bridging loan or credit line from international creditors.
In a similar fashion, the seven-year bond issue by Cyprus in April at an average yield of 4 per cent, saw its secondary market yields drop to 3.14 by December 31 before they rose to 3.24 per cent by January 29, according to the Bank of Cyprus data.
At the same time, secondary market yields of German and Italian bonds went in the other direction. The yields of German 10-year bonds dropped from 0.63 per cent end-December to 0.40 per cent a month later, while those of Italian bonds dropped by 0.08 basis points to 1.51 per cent on January 29 compared to a month before, according to Bank of Cyprus data.
A market analyst interviewed by the Cyprus Business Mail said that the pressure on Cypriot bonds resulted from turbulence caused by the slowdown of China’s economy, which affected stock markets worldwide.
“As Cypriot bonds remain rated at non-investment grade and are considered high-yield securities there is a positive correlation with the course of share markets,” said the analyst who was commenting on condition of anonymity citing the lack of authorisation to talk to the press on the matter.
A positive correlation will drive yields of Cypriot bonds up and those of other euro-area countries rated as investment grade up when share markets are bearish as investors then seek “safe havens”, the analyst added.
The difference in secondary market yields of Cypriot 10-year bonds compared with respective German securities rose from 3.07 per cent on December 31 to 3.42 per cent on January 29.
Investors, the analyst continued, have not yet factored-in the increased likelihood of Cyprus completing its adjustment programme without implementing some of the reforms it agreed with international creditors, including the privatisation of the telecom Cyprus Telecommunications Authority (CyTA).
All opposition parties, including DIKO, which helped the government, as it lacks a majority in the parliament to pass reforms, said they will reject a bill to establish CyTA Ltd, which is the last remaining requirement for Cyprus to successfully complete its cash for reforms programme in March.
Moody’s Investors Service, Fitch Ratings and Standard & Poor’s assign Cyprus a B1, BB- and B+ rating respectively, while respective Italian ratings are Baa2, BBB+ and BBB-. Germany is rated with a triple-A by all rating companies.
“CyTa remains neutral at this point,” the analyst said adding that “investors have not started looking at country specifics”.
This means that “reforms have to go ahead” as additional pressure on Cyprus debt will result when investors begin to factor in the prospects of the economy, the analyst added.
Demetris Georgiades, the head of the fiscal council, an independent watchdog tasked with monitoring fiscal developments in order to prevent a fiscal derailment, said that the development was a cause of concern.
“It is clear that there is resistance to reforms, including privatisations, which analysts take into account and this is a cause of concern,” Georgiades said.
Georgiades comments came as doctors at public hospitals staged a strike on Monday to protest a bill that would extend their retirement age to 68 and to set a cap on the number of patients they examine in response to the government’s intention to go ahead with a gradual implementation of the national healthcare scheme.
Stavros Zenios who teaches finance and risk management science at the University of Cyprus and the Norwegian School of Economics, said that while the Cypriot programme made “huge progress”, complacency caused by public rhetoric referring to the its success is also a cause for concern, as Cyprus’s debt seen at €19.4bn in November, up from €18.8bn or 108 per cent of gross domestic product in December 2014, remains “fragile”.
The drop in Cyprus’s borrowing costs following the 2013 bailout “was a result of much higher, or even negative, interest rates on European markets,” Zenios said. “When (public) debt is around 100 per cent of GDP and inflation in Europe is well below 1 per cent, it takes extraordinary growth rates of around 3.5 per cent to stabilise public debt”.
Zenios said that the financial turmoil in China and the drop in oil prices which affects producer countries including Russia, a major market for Cyprus which expects its economy to grow 2 per cent this year, are causing uncertainty on global markets and as a result, “fragile countries like ours are affected more directly and more negatively compared with European core countries”.
Alexander Michaelides, also an economist who teaches finance at the London-based Imperial College, said that Cyprus’s economic recovery is facing additional external risks from the unresolved Greek crisis as well as from uncertainty with respect to the “Brexit” debate in the UK, Cyprus’ largest source of incoming tourism, which is expected vote in a referendum at an unspecified time on whether it will remain a European Union member.
“In the face of this challenging environment, it becomes important for Cyprus to exit the memorandum in a clean way to make faster the return of Cyprus government bonds in the non-junk category,” as the investment grade rating is also known, as it could help Cyprus kill two birds with one stone, Michaelides said.
An investment grade sovereign rating could help reduce interest rates on loans to the private sector, and so boost growth, and help deal with the large stock of non-performing loans which threatens financial stability, he said.
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