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Fitch downgrades Cyprus economy, central bank disagrees

06-01-2011 08:03 BJT

NICOSIA, May 31 (Xinhua) -- The Cyprus Central Bank said on Tuesday it disagreed with an analysis by Fitch Rating Agency that had led to a new downgrading of Cyprus by three notches.

Fitch Ratings Agency, in a report released on Tuesday, several days after it had been leaked to the press, said it has downgraded the Republic of Cyprus' Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to A- from AA-, with a negative outlook.

Fitch cited Cyprus' exposure to Greek sovereign debt and warned that it could downgrade the Cypriot economy even further.

"The downgrade reflects the severity of the crisis in neighboring Greece and the risk this poses for the Cypriot banking system and consequently the public finances of Cyprus," it said.

According to the release, Cyprus is a small economy with a large banking system equivalent in terms of assets to approximately nine times its GDP.

"Exposure to Greece is a significant source of vulnerability that has intensified with successive downgrades of the Greek sovereign since January 2011, when Fitch put Cyprus on Rating Watch Negative citing fiscal and financial sector risks," the release added.

The Cyprus Central Bank, expressing disagreement with the Fitch analysis, said it is taking measures for further strengthening the banking sector and called on state financial authorities to anticipate developments.

"Our banks continued to be profitable and during the last year they have increased their capital base, resulting in over covering the increased Basil III requirements, which will not be fully compulsory until 2019," the Cyprus Central Bank statement said.

Fitch Ratings Agency also acknowledged that Cypriot banks, despite their extensive exposure to the Greek debt, are relatively well placed to absorb the impact of a sovereign debt crisis in Greece that entailed an assumed 50 percent haircut to face value of Greek government bonds.

It estimated that in this scenario the cost of recapitalizing the banks to a tier one capital ratio of 10 percent would be of the order of 2 billion euros (11 percent of GDP), only part of which might have to be met by the state.

"However, in a more severe stress test, where a Greek sovereign default was associated with significant deterioration in asset quality such that non-performing loans rose to 25 percent, Fitch estimates that the cost of recapitalizing the banks could rise to 25 percent of GDP, necessitating more extensive sovereign support," the Fitch release stated.

Editor:Yang Jie |Source: Xinhua

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