International credit rating agency Moody's drove Cyprus deeper into junk on Thursday with a three notch downgrade from B3 to Caa3 over concerns that the country may ultimately default on its burgeoning debt level.
Moody's says more downgrades are possible for the country that is trying to finalize a bailout with international lenders to rescue its banks, which sustained massive losses on bad Greek debt and loans.
The agency said that an anticipated increase in the amount of money that Cypriot banks will need to recapitalize will push the country's debt to a point where it won't be able to pay it down.
The agency said that it believes that there is a "significantly increased likelihood" that Cyprus may default outright or seek for its debt to be written down, but doesn't foresee that happening this year.
Moody's said it estimates Cypriot banks will need around €10 billion ($13.11 billion) to replenish their capital buffers, equal to a provisional estimate contained in a draft bailout agreement that Cyprus has reached with the European Commission, the European Central Bank and the International Monetary Fund. But this would lift Cyprus' debt this year to a whopping 150 percent of its €17.5 billion ($22.95 billion) gross domestic product, Moody's said.
Cyprus' debt level could rise to more than 154 percent of GDP by 2015 because of continued uncertainty over how much banks will ultimately need in combination with the country's weakening economy.
The Cyprus Finance Ministry projects the economy to shrink this year by 3.5 percent and unemployment to reach almost 14 percent.
U.S. investment firm PIMCO and auditors Deloitte have been tasked with figuring out exactly how much Cypriot banks will need. That figure is expected later this month.
Cyprus Finance Minister Vassos Shiarly insisted Thursday that the country could handle its debt, even if it reaches such a high level.
"Our analysis indicates that the debt, despite being at such high levels, is manageable and under the conditions which we describe can be viable," he told reporters.
Moody's said that although there's strong political will among Cyprus' partners in the 17-member group that uses the euro not to repeat the kind of writedown that was allowed for Greece to get its own spiraling debt under control, the sheer size of Cyprus' debt burden will compel the country's authorities to consider such a move.
Cypriot authorities have so far ruled out any such a debt writedown or "haircut," arguing it would do more harm than good because most of Cyprus' debt is held by the country's own banks. A writedown would therefore raise the banks' recapitalization needs — and by extension the country's debt — even higher.
Euro area countries will deal with Cyprus' bailout during a Jan. 21 meeting.
Last month, ratings agency Standard & Poor's also slapped Cyprus with a two-notch downgrade to CCC+ over similar fears that the country could default on its debts.