NICOSIA, Cyprus — The Cyprus government has vowed to do what is needed to finalize a bailout agreement with international lenders after ratings agency Standard & Poor's downgraded Cyprus further into junk status amid concerns that the country could default on its debts.
The U.S. agency said Friday that the two-notch downgrade to CCC+ was due to a "considerable and rising" risk that the country, one of the 17 European Union countries that use the euro, may default. It also maintained its negative outlook on the country, meaning that further downgrades are possible.
S&P said it went ahead with the downgrade because the Cypriot government is running out of money while uncertainty remains over the terms of a bailout that the country is trying to negotiate with international lenders and its euro partners. The rescue loans will be used to salvage the country's banks, which are heavily exposed to Greece.
"With the government's financing options increasingly limited – coupled with what we view as the hesitant attitude of Cyprus' eurozone partners toward sharing the cost of a severe banking crisis – we view the risk of a sovereign debt default as considerable and rising," S&P said.
Unable to borrow from international markets for more than a year, the Cypriot government this week had to tap the pension funds of the country's top three state-owned companies to cover salaries and benefits up until March when it's hoped the first batch of bailout cash will arrive.
Germany's Foreign Minister Guido Westerwelle said Friday that there are "appropriate aid mechanisms" for Cyprus, but that the country must first make "serious reforms" and achieve "real budget savings."
Cyprus government spokesman Stefanos Stefanou played down the S&P downgrade, saying the country is "making every effort" to clinch a bailout accord and attributed any difficulties with doing so to squabbles among its euro partners.
Cyprus' Finance Minister Vassos Shiarly said one such difficulty is the International Monetary Fund's insistence on money being pumped directly into troubled banks from the European Union's bailout fund instead of lending it to governments first and pushing up public debt. The EU is balking at that because its single banking supervisor isn't in place yet.
S&P said some progress has been made putting together the bailout with the "troika" of international creditors – the European Commission, the European Central Bank and the IMF. It also acknowledged the country's efforts to shore up public finances with this week's approval of the 2013 budget that incorporates troika-mandated spending cuts totaling almost 6 percent of the country's (EURO)17.5 billion ($23.2 billion) gross domestic product. Cyprus is the third-smallest economy in the eurozone, ahead of Estonia and Malta.
Shiarly said the fact that the country has done "all and more" that the troika has asked it to do even before a bailout accord has been signed – from slashing government workers' salaries and benefits to raising a host of taxes – will stand it in good stead when its eurozone partners decide on the bailout on Jan. 21.
But S&P said it doubts whether state-owned companies have much more money to help the government pay its bills if a bailout deal isn't finalized by March, while presidential elections set for February could complicate matters.
The agency said it's still unclear how Cypriot banks – whose assets total more than five times the country's economy – will get the money they need to replenish their depleted capital buffers.
A draft version of the bailout foresees Cypriot banks needing up to (EURO)10 billion ($13.25 billion) to recapitalize, raising questions whether Cyprus can pay off any such loan when its economy is projected to contract by 3.5 percent of its GDP next year.
S&P said if the government were to take on the cost of the bank's recapitalization, the Cyprus' debt would rise "well above" 100 percent of GDP.
Shiarly said that it's premature to talk about whether the country's debt would be sustainable since an exact figure on the banks' actual needs won't be known before sometime next month when an assessment by investment firm PIMCO and auditors Deloitte will have wrapped up.
Cyprus' left-wing President Dimitris Christofias – who won't run for re-election in the February poll – said Friday that he would never accept a writedown of Cyprus' debt in order to make it sustainable, but Germany didn't rule it out.
Shiarly said any such haircut would do more harm than good because a large amount of Cypriot government bonds are held by Cypriot banks and the losses they would sustain would push their recapitalization needs even higher.
Associated Press writer Frank Jordans in Berlin contributed.