Credit rating agency Standard & Poor's Ratings Services last night raised its outlook on Bermuda's creditworthiness to stable from negative.

The action lifts the immediate threat of a credit downgrade, which would have resulted in Government having to pay higher rates of interest to borrow money.

In its statement, S&P said its decision reflected "receding economic, fiscal, and banking-sector risks compared with our expectations in mid-2009".

S&P affirmed the Island's AA long-term credit rating and A-1+ short-term rating, and noted that Government had "low, although increasing, indebtedness".

The agency said it estimated the Gvernment's deficit deteriorated to six percent of gross domestic product from 3.7 percent in 2008. But it expects the deficit to improve to 3.3 percent of GDP by 2013.

S&P said the downturn in the Bermuda economy was less sharp than it expected, thanks principally to the Island's insurance and reinsurance sector holding up well during the financial market turmoil, and it noted that GDP per capita is around $97,000. However S&P warned that "the ratings could come under downward pressure if the general Government deficit was to continue at current levels due to weaker-than-expected economic growth or flagging political will to consolidate fiscally".

Finance Minister Paula Cox welcomed the news and said it reflected the resilience of the Bermuda economy.

But Shadow Finance Minister said he disagreed with S&P's assessment and said there was no evidence to suggest Government had a plan to cut its debts.

"We estimate that GDP fell only 2.5 percent in real terms in 2009, noticeably better than the four percent decline we had previously forecast," states the report compiled by S&P primary credit analyst Nikola Swann. "In our view, the economy depends largely on the strength of demand from the US; we therefore expect only a gradual recovery in Bermuda, with GDP increasing 0.5 percent in 2010."

On Government debt, the report states: "We believe there is broad-based and increasing political support for fiscal consolidation, via reducing public expenditure as a share of the economy.

"We expect this to begin gradually in 2010, and the deficit to retreat to 3.3 percent by 2013, with additional support from the slow return of economic growth and tax and fee hikes announced in the 2010-2011 Budget Statement.

"We expect Bermuda's net general Government debt will rise as shrinking fiscal deficits continue, but will not exceed four percent of GDP by 2013. The island will thus remain one of the least-indebted sovereigns we rate."

Banking sector risk is one of the areas most closely examined by S&P. The agency noted that Butterfield Bank had managed to raise $550 million in extra capital this year following its $200 million Government-guaranteed preference share issuance last year. S&P said it did not expect any further support of the Island's banking system to be necessary, but warned that Butterfield's credit quality could still weaken in the medium term.

The report goes on to state: "The Bermudian banking system is a considerable net external creditor, by our measures. Still, with external assets at 239 percent of GDP at year-end 2009 and external debt of 144 percent, we view the system as large relative to the Bermudian economy.

"We believe this size gives it the potential to cause balance-of-payments difficulties and pose a significant fiscal contingent liability to the Government in the event of financial sector distress."

For S&P to consider raising the Island's credit rating, it would need to see "stronger and much more diversified economic growth alongside a sustained reduction in the general Government deficit".

Minister Cox said: "Government is pleased with the more positive view taken by S&P on Bermuda's economic prospects in the near term.

"The ratings' update confirms the underlying substance of Bermuda's economy and its resilience. We have challenges yet, but our economic and fiscal policy response has assisted in limiting the deeper deterioration that was widely expected. The ratings update is good news."

Mr. Richards said the rating agencies had got it wrong with their AAA ratings of many of the mortgage-backed securities whose collapse in value was at the centre of the global financial crisis. And he believed that S&P had got it wrong again with Bermuda.

"What we have learned with credit rating agencies is that even though they use the word 'outlook', their reports are backward-looking, rather than forward-looking," Mr. Richards said last night.

He said there was no evidence of political will to cut public expenditure. "The Finance Minister may have told S&P that, but I have not heard her tell the people of Bermuda that," he added.

"We in the United Bermuda Party have suggested a freeze on the size of Government, but they're still hiring people.

"They've increased payroll tax, but I don't think they'll get the yield they're looking for, because unemployment has increased, particularly in the construction industry, and unemployed people pay no payroll tax."