Moody's Investors Service cut its credit ratings on Cyprus' sovereign debt by two notches o n Wednesday, citing rising risks of a Greek exit from the euro currency and an already strained fiscal position.
The speculative grade credit for the European Union member, which is third-smallest economy in the euro zone, is also on review for further downgrade, Moody's said in a statement.
Cyprus, most of whose population is Greek Cypriot, has close cultural, business and political links with Greece. But that relationship has not been without difficulties as Greece's economy has crumbled.
The weak credit position is exacerbated by limited access to international markets, Moody's said.
Moody's rating cut, to Ba3 from Ba1, takes into account a new assumption that Cyprus will need to contribute capital support to its banking system in excess of a prior estimate of 5 to 10 percent of gross domestic product.
On Tuesday, Moody's cut the credit ratings on two Cypriot banks and put them on review for possible further downgrade because of the rising risks of a Greek exit from the euro zone. A third bank's rating was held but also put on review for downgrade.
Greece goes to the polls on Sunday, June 17 to vote in parliamentary elections after an inconclusive outcome in May. That previous election raised the possibility that a new government could backtrack from an agreement with European partners for a 130 billion euro bailout package.
A bigger risk of a euro exit by Greece could lead to faster withdrawals of deposits from Cypriot banks' Greek branches, thereby straining liquidity. If there were to be an exit, a redenominated Greek currency would likely trigger a default in Greece that "would materially weaken" the solvency of Cyprus' banks, Moody's has said.
Cyprus is rated BB-plus with a negative outlook by Standard & Poor's, two notches above Moody's new rating. Fitch has Cyprus at investment grade, albeit one notch away from junk status at BBB-minus, also with a negative outlook.