UPDATE 2-Fitch cuts Cyprus credit rating over weakened economy

Wed Nov 21, 2012 1:51pm EST

* Ratings agency downgrades Cyprus two notches to BB-minus

* Fitch says credit outlook negative

* Banks in Cyprus battered by Greek debt crisis

By Daniel Bases

NEW YORK, Nov 21 (Reuters) - Fitch Ratings downgraded Cyprus by two notches on Wednesday and pushed it further into junk territory, assigning a BB-minus credit rating because of its weaker macroeconomic outlook.

The credit outlook remains negative, Fitch said in a statement.

"The downgrade of Cyprus's sovereign ratings reflects the materially weaker macroeconomic outlook, a fiscal budget that has significantly underperformed expectations and the continued high level of uncertainty over the costs associated with bank recapitalization," Fitch said.

Cyprus is trying to negotiate with the European Commission, European Central Bank and the International Monetary Fund on a bailout package, with sticking points over how much is needed to recapitalize Cypriot banks, privatizations and pension cuts.

Cypriot banks were battered by their exposure to the debt-crippled Greek economy. The delay in negotiating a deal, with resistance to reforms, Fitch said, only serves to increase the risk to Cyprus's medium-term fiscal and economic health.

"The delay in negotiating official support has contributed to the deteriorating economic conditions and raised uncertainties about public sector reform and the correction of macroeconomic imbalances," Fitch said of the European Union member state.

Standard & Poor's has Cyprus on watch for a downgrade and holds the rating two notches below Fitch at B. Moody's Investors Service has Cyprus also on review for a downgrade with a rating of B3, which is three notches below Fitch.

In its analysis, Fitch highlights a deterioration in Cyprus's fiscal deficits, with an expectation it will be more than 5 percent in 2012 versus an April assessment from the government of 2.6 percent of gross domestic product.

"This is despite austerity measures, including wage freezes and an increase in VAT (Value Added Tax) by 2 percentage points to 17 percent," Fitch said.

Fitch believes, as a baseline scenario, the general government debt to GDP will peak at roughly 120 percent in 2014, up from 71.1 percent last year. The bulk of that increase is likely due to recapitalizing the banking system.

"The three main Cypriot banks will need at least around a further 4 billion euros (22 percent of GDP) in addition to the 1.8 billion euros already injected into Cyprus Popular Bank in 2012," Fitch said.

Fitch said its rating is predicated on the expectation that the Cypriot authorities will reach agreement with the European Commission, European Central Bank and the International Monetary Fund on an official financing program.

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