LONDON - U.S. ratings agency Fitch has downgraded Cyrpus to "junk" status, prompted by the amount of rescue money that would be needed to bail out its banks, which are heavily exposed to the Greek economy.
It lowered the rating for the country — one of the smallest members of the 17-country group that uses the euro — by one notch to BB+ from BBB- on Monday and warned further downgrades were possible in coming months due to a possible worsening of the situation in Greece.
With this downgrade, Fitch joins the other major ratings agencies — Moody's and Standard & Poor's — in pushing Cyprus' credit rating into junk territory.
Cyprus is scrambling to find about €1.8 billion ($2.26 billion) — or about 10 per cent of its gross domestic product — by a June 30 deadline to recapitalize its second largest lender, Cyprus Popular Bank. The lender is the most heavily exposed of the country's banks to Greek government debt. Cypriot officials have said that they would seek foreign aid from fellow eurozone nations or from Russia, or a combination of the two.
Fitch estimates Cyprus will need another €4 billion ($5 billion) to recapitalize its banking sector due to their Greek exposure and because of a rise in bad loans over the last year as the Cypriot economy has shrunk and unemployment has risen to record levels. Cypriot banks will also suffer more losses on loans to Greek businesses and households as the Greek economy continues to contract.
"Fitch acknowledges that its estimates of the losses and capital needs of Cypriot banks are subject to considerable uncertainty and are conservative," the agency said. "Nonetheless, in Fitch's opinion, Cypriot banks will require substantial injections of capital in order to secure confidence in their financial stability."
The agency said it expects Cyprus to clinch a bilateral loan — likely from Russia — to cover its refinancing needs of some €2.25 billion ($2.82 billion) for next year, but also expects the country to apply for an EU bailout to help with the banks' recapitalization.
The Cypriot finance ministry said in a written statement Monday that it remains steadfast to its deficit-cutting commitments and that it's working together with the Cyprus Central Bank to secure the needed money.
"The Finance Ministry has no doubt that with careful and timely handling, the challenges which have surfaced at this time as a result of the eurozone crisis will be dealt with effectively and overcome soon," the ministry said.
"The Cyprus Republic, both on a national and European Union level, has at its disposal all the necessary tools to absolutely ensure the banking system's health and to further counter today's economic challenges."
Unable to borrow from international markets due to its junk credit rating, Cyprus has had to rely on a €2.5 billion ($3.13 billion) loan from Russia to cover its needs for the year. The Cypriot government is wary of tapping the EU bailout fund for the full amount it would need to recapitalize its banks and to pay its bills for next year because of the tough conditions that may come attached. Cyprus is keen to protect its 10 per cent corporate tax which attracts a lot of foreign business.
Fitch predicts Cyprus' government debt will shoot above 100 per cent of GDP, more than 12 points more than its previous estimate. The agency said that a government target to bring the budget deficit below 3 per cent of GDP through another round of spending cuts and tax increases will be missed by as much as a percentage point.
It also sees the Cypriot economy stagnating this year, though it expects a return to growth over the medium-term as long as the government manages to keep the deficit below 3 per cent of GDP next year.