Moody's Investors Service cut Cyprus's sovereign ratings to junk today, saying there was a heightened risk the government would have to support its banks, heavily exposed to Greek debt.
Moody's cut the island-state one notch to Ba1 from Baa3. The outlook was negative, it said.
It is the second ratings agency to cut Cyprus to junk, after Standard and Poor's, which has Cyprus at BB+.
Fitch rates Cyprus BBB-, one notch above junk.
The increased risk that the Cypriot government would have to provide renewed financial support to the island's banks because of their exposure to Greece was a key driver in the rating action, Moody's said.
It estimated that under the banks' participation in Greece's private sector debt-swap scheme, and factoring in a deterioration in asset quality in Cyprus and Greece, the banks would need a capital increase equivalent to more than 20 per cent of GDP to return to its present level of Tier-1 capital.
Although some of this capital is included in present bank recapitalisation plans, Moody's said there was a "very material risk" that the private sector would not be able to provide all the capital needed.
Cypriot fiscal slippage has shut the island out of international debt markets for almost a year. It acquired a €2.5 billion bilateral loan from Russia to meet its financing requirements this year.
"Overall, the fragile market confidence in Cyprus, which has already led to a loss of access to international debt markets, is likely to continue, with a high potential for further shocks to funding conditions for the sovereign and the domestic banks," Moody's said.
Its decision to assign a negative outlook was a reflection of "very significant risks" that continue to emanate from the Greek sovereign crisis, and which will continue to challenge Cyprus over the next 18 to 24 months, it said.
It said its downgrade was limited to one notch, acknowledging a government fiscal consolidation programme and the discovery of substantial gas reserves off the island's shores.
Cyprus announced a discovery of between 5 and 8 trillion cubic feet of gas in a field offshore in December. It has now declared a licensing round for another 12 blocks.
Although authorities are likely to realise some one-off gains from the sale of licenses to tap reserves, it will probably take nearly a decade for the island to realise the most significant and sustained benefits, Moody's said.
Reuters
