Chart of the Week: Cyprus 5-Year CDS

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Cyprus is the first EU country to apply for ESM pandemic crisis support in order to face the surge in healthcare spending. The economic fallout is driven by tourism exposure (with total contribution of travel and tourism representing about 22% of GDP) and also weak external position that was already an issue before the outbreak (high deficit in its trade in goods). March tourism felt 73.5% YoY, thus reinforcing fears the summer tourism season might be ruined by the pandemic threat. If tourism revenues remain low in July and August, 2020 GDP could fall by more than 13%, making Cyprus the European country most affected by the economic crisis resulting from the virus. Unlike other countries, such as Italy, the use of the ESM credit facility has not been the subject of intense debate among the Cypriot political class. The ESM mechanism has been made very attractive for EU countries in need, with little to no conditionality (no enhanced surveillance and no macro conditionality) and low spread charged to cover ESM costs (at 0.1%). The initial market reaction is rather positive with Cyprus 10 year bond spread to Germany tightening almost 60bps from May 15^th, and the country’s 5-year CDS decreasing by 20bps over the same period. The feared stigma attached to the use of the ESM seems to have been quite exaggerated. If market reaction remains this way and the Merkel-Macron proposal takes too long to become reality, it could encourage other EU countries that cannot borrow at negative rates on all the curve, especially on maturities up to 10 years which is the average maturity of ESM loans, to turn to the ESM.