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Moody's downgrades Cyprus by 2 notches

Moody's downgrades Cyprus by 2 notches

July 27th, 2011 by MENELAOS HADJICOSTIS, Associated Press in News

NICOSIA, Cyprus (AP) - Moody's downgraded Cyprus' credit rating by two notches over concerns about the economic toll of a deadly blast that took out the island nation's main power station.

As well as cutting its rating on Cyprus from A2 to Baa1, the credit rating agency also slapped a negative outlook on the country Wednesday, meaning that another downgrade may be in the offing.

Moody's said the destruction of the Vasilikos power plant as a result of a July 11 blast at a nearby naval base has amplified concerns about the fiscal situation in Cyprus, which began using the euro currency in 2008.

As well as killing 13 people, the blast has led to rolling, two-hour power cuts to cope with demand.

"This incident has caused material disruption to the Cypriot medium-term economic and fiscal position," Moody's said, adding that it has reduced its growth forecasts for Cyprus to zero percent and one percent in 2011 and 2012 respectively.

Before the blast, the European Commission projected Cyprus' economy to grow by 1.5 percent this year and 2.4 percent in 2012.

Moody's also said that an "increasingly fractious political climate" in the wake of the blast raises the risk that planned economic reforms may be watered down or delayed.

Public anger at the government over the blast of dozens of seized containers filled with Iranian munitions has yet to subside. Thousands continue to protest outside the presidential palace, accusing the government of negligence and calling on President Dimitris Christofias to quit.

Some 98 containers, most of them filled with gunpowder, were left stacked in an open field since being seized from a Cypriot-flagged ship in 2009 that the U.N. said breached a ban on Iranian arms exports.

The Cyprus government and opposition leaders agreed last week to cuts cost to buoy the economy in the wake of the blast.

But there is still disagreement on how deep cost cuts should go, especially to the public payroll that takes up about a third of the island's (euro) 8 billion ($11.58 billion) budget.

Cyprus' top banker last week warned that the blast may force Cyprus to seek a bailout if deep spending cuts aren't swiftly made.

Cyprus has pledged to the EU to cut its fiscal deficit which now stands at 5.3 percent to 3 percent of GDP by next year.

Moody's also said there is a material risk that the Cypriot government may need to prop up some of the island's banks over the next few years because of their heavy exposure to bailed-out Greece.

"Therefore, a period of prolonged macroeconomic stress would increase the likelihood that these contingent liabilities will crystalize on the Cypriot government's balance sheet," said Moody's.

Moody's also pointed to the Cypriot banking sector's large size relative to the economy, as domestic bank assets total 600 percent of the island's (euro) 17.4 billion ($25.18 billion) gross domestic product. Around 40 percent of the total loans of the island's three largest domestic banks are to customers based in Greece.

However, Cypriot banks should remain well capitalized over the short term after strengthening their capital reserves over last year.

The agency said it would consider upgrading Cyprus' credit rating if the government moves ahead with large scale structural reforms. But it warned of additional downgrades if those reforms are watered down or significantly delayed.

Credit rating agencies Fitch and Standard and Poor's have also downgraded Cyprus in recent months, mainly because of the island's Greek exposure.