DBRS Upgrades Cyprus’ Credit Rating to ‘A’ Amid Sharp Debt Reduction and Strong Fiscal Outlook

DBRS Morningstar has upgraded the long-term foreign and local currency ratings of the Republic of Cyprus from A (low) to “A,” while revising the outlook from positive to stable. At the same time, the agency affirmed Cyprus’ short-term foreign and local currency ratings at R-1 (low), with the outlook on all short-term ratings remaining stable.

According to the agency, the decision reflects the sharp reduction in public debt in recent years and expectations of further significant improvements in the coming years. General government debt fell to 64.3% of GDP in March 2025, down from 96.5% in December 2021, supported by large fiscal surpluses and robust nominal GDP growth, which was driven by strong domestic demand and increased exports in the services sector.

Looking forward, DBRS projects that public debt will continue on a steady downward path as the state budget maintains substantial surpluses alongside a favorable economic outlook. Fiscal outcomes are further reinforced by structural revenue improvements, including higher corporate income tax revenues resulting from the relocation of several companies to Cyprus.

The government’s Annual Progress Report of April 2025 forecasts an annual budget surplus of 3.5% of GDP for 2025 and 3.7% for the years 2026 to 2028. Based on these fiscal surpluses, general government debt is projected to drop to 57.4% of GDP in 2025 and reach 43.3% by 2028. The anticipated reduction in outstanding debt helps counterbalance the impact of higher interest rates on the government’s interest burden.

The European Commission expects general government interest expenditure to remain steady at 1.2% of GDP between 2024 and 2026. The government continues to benefit from favorable terms on the ESM loan secured in 2013, which accounted for 28.8% of gross government debt as of March 2025.

Morningstar DBRS also highlights the significant volume of outstanding intra-governmental debt, which is excluded from general debt calculations. By the end of 2024, central government debt to domestic social security funds amounted to 35.5% of GDP, reflecting the use of social security surpluses to finance past budget deficits. While this provides a cheap and stable funding source, it poses potential risks if the social security system were to run prolonged deficits that required fiscal transfers. Nonetheless, such risks appear unlikely in the near future given steady employment growth and higher contribution rates, which are expected to sustain surpluses in the system.

The government’s short-term financing risks are mitigated by a large cash reserve, amounting to 9.6% of GDP in July 2025. Still, the main threats to fiscal stability stem from potential economic shocks or contingent liabilities within the sizable domestic banking sector, whose assets totaled 205% of GDP in June 2025 and remain highly concentrated. These risks are partly cushioned by the sector’s strong financial position.

The agency points out that fiscal balances have consistently recorded substantial surpluses in recent years. Between 2022 and 2024, the general government budget surplus averaged 2.9% of GDP, largely thanks to buoyant revenue growth. Government revenue as a share of GDP increased from 41.1% in 2021 to 44.3% in 2024, benefiting not only from favorable growth and employment trends but also from structural improvements such as the relocation of foreign companies to Cyprus under government headquartering policies.

Further support came from the rise in social security contributions since January 2024, which strengthened the system’s financial standing. Revenue growth has been strong enough to offset rising expenditures, particularly in public wages and social benefits. In the first seven months of 2025, income tax revenues increased 8.8% year-on-year and social security contributions grew 9.2%, though VAT revenues saw a modest 1.9% rise, partly due to a temporary cut in the VAT rate on electricity beginning April 2025. Meanwhile, expenditures on wages and transfers increased by 6.9% and 6.7% respectively.

Thanks to stronger-than-expected revenue growth, the government revised its fiscal forecasts upward in April 2025. The Annual Progress Report projects surpluses of 3.5% of GDP in 2025 and 3.7% for 2026–2028, compared with the October 2024 medium-term plan, which had anticipated an average surplus of 2.4%. According to DBRS, these projected surpluses will equip the government to handle spending pressures from schemes such as “Rent for Installment,” rising defense needs, and risks from large energy projects including the LNG terminal and the Great Sea Interconnector pipeline. Additional long-term challenges are expected from climate change adaptation and mitigation costs.

DBRS flags a further fiscal risk tied to potential reforms in international corporate taxation, as Cyprus relies heavily on this revenue stream. Corporate income tax revenue represented 6.3% of GDP in 2023, compared to the EU average of 3.3%.

On the economic front, Cyprus continues to outperform much of the eurozone. After expanding 3.4% in 2024, real GDP grew by 3.3% in the first half of 2025, outpacing the euro area’s 1.5% growth. The economy has been buoyed by exports in tourism, ICT, and intellectual property services, as well as strong private consumption supported by rising employment. Tourist arrivals jumped 10.4% year-on-year in the first seven months of 2025.

The Central Bank of Cyprus projects real GDP growth of 3.1% in 2025 and 3.0% in 2026, sustained by strong domestic demand, moderate real wage growth, and ongoing job creation. Investment is also set to benefit from large projects in tourism and real estate alongside inflows from the EU’s Next Generation fund. Risks remain, particularly from geopolitical tensions and global trade shocks, though Cyprus’ service-driven economy is less exposed to U.S. tariffs on EU goods.

Despite its strengths, Cyprus’ ratings remain constrained by the small size and external vulnerability of its service-based economy. Tourism and foreign capital inflows continue to drive growth but expose the country to external shocks. The ICT sector has grown significantly, with its share of gross value added rising from 4.8% in 2015 to 11.4% in 2024, though job creation has lagged. Labor productivity has improved but remains below the EU average, with GDP per employed person at 89.2% of the EU27 average in 2023.

In banking, stability is supported by strong capital buffers, with the CET1 ratio reaching 25.9% in March 2025 compared with 17.8% in December 2022, boosted by higher net interest income. Liquidity positions are also solid. However, asset quality remains a weakness. While the NPL ratio has fallen sharply from 46.4% in 2016 to 6.1% in March 2025, it is still far above the EU average of 2.1%. Higher interest rates have increased debt servicing burdens for households and firms, though early indicators show no fresh uptick in problem loans.

Externally, Cyprus continues to face a large current account deficit, excluding special purpose entities (SPEs). The deficit widened to 8.5% of GDP between Q2 2024 and Q1 2025, compared to just 1.4% in 2017, fueled by strong domestic demand. While services exports rose, they were outweighed by higher profit outflows to foreign shareholders. Still, the deficit has been financed mainly by non-debt foreign direct investment, such as property purchases and capital injections. Gross external debt, excluding SPEs, has fallen significantly, to 174% of GDP in March 2025 from 315% in 2017.

The agency emphasized that the stable outlook reflects balanced risks. “Cyprus’ ratings are supported by a stable political environment, the strong financial condition of the domestic banking sector, the government’s sound fiscal and economic policies in recent years, and a moderate interest burden,” DBRS stated. While governance indicators have weakened in recent years, EU membership continues to underpin institutional quality.

At the same time, the country’s ratings remain limited by the small scale of its service-based economy, relatively low labor productivity, and the large current account deficit.

Looking ahead, DBRS said that credit ratings could be upgraded if sustainable growth and strong fiscal performance drive further debt reduction, alongside signs of greater resilience and productivity gains. Conversely, ratings could face downward pressure if public debt deteriorates significantly due to prolonged weak growth, higher fiscal pressures, or the realization of large contingent liabilities, particularly from the banking sector.

By fLEXI tEAM