Cyprus sets hopes on uncertain bailout after rating cut

LIMASSOL, Cyprus/BERLIN Fri Jan 11, 2013 7:35am EST

Ireland's Prime Minister Enda Kenny (L) talks to journalists with Cyprus' presidential race's forerunner and president of the right-wing Democratic Rally party Nicos Anastasiades upon his arrival at a European People's Party (EPP) summit in the Cypriot town of Limassol January 11, 2013. REUTERS/Jamal Saidi

Ireland's Prime Minister Enda Kenny (L) talks to journalists with Cyprus' presidential race's forerunner and president of the right-wing Democratic Rally party Nicos Anastasiades upon his arrival at a European People's Party (EPP) summit in the Cypriot town of Limassol January 11, 2013.

Credit: Reuters/Jamal Saidi

LIMASSOL, Cyprus/BERLIN (Reuters) - Cash-starved Cyprus set its hopes on securing a bailout that looked uncertain on Friday after a savage ratings downgrade from credit agency Moody's dumped further economic misery on the island.

Moody's cut Cyprus by three notches overnight, forecasting its debt pile was set to rise and with an increasing likelihood of default because of the capital needs of its banks, burnt by their exposure to indebted Greece.

Greek Prime Minister Antonis Samaras, on the island for a meeting of centre-right European parties, said Cyprus would, along with Greece, "manage to pull through".

The meeting, due to be attended by several other EU leaders including German Chancellor Angela Merkel, was hosted by Nicos Anastasiades, the frontrunner for presidential elections on February 17.

He told Reuters on Thursday he was committed to meeting the terms of any international aid package.

Cyprus applied for a financial rescue last June after its banks suffered huge losses on the EU-approved writedown on Greece's debt.

But hurdles to clinching a deal are stacking up.

A potential rescue bill of 17 billion euros - roughly equivalent to its entire economic output - has deepened concerns among its European partners about the island's indebtedness, and some doubt it would be able to repay the aid without further concessions from lenders.

Germany, the EU's paymaster, has expressed unease about channelling taxpayers' money into a country seen by some as a hub of money laundering. Cyprus is a popular tax haven for wealthy Russians but says it fully complies with international rules against money laundering.

Meanwhile, debt restructuring has been ruled out as an option both by Nicosia and Brussels, with European Economic and Monetary Affairs Commissioner Olli Rehn quoted as saying on Friday that a 'haircut' was not under consideration.

FOCUSED ON THE POSITIVE

Reacting on Friday to the Moody's downgrade, Cypriot Finance Minister Vassos Shiarly said he wanted to focus on the positive, saying he looked forward to the conclusion of a bailout deal.

"A conclusion on a memorandum of understanding does improve the prospects," he told state radio. Asked about the rating action, he said: "We are not at all happy about it."

Cyprus's outgoing leftist government has faced criticism at home it was slow to adopt financial reforms, and to negotiate effectively with lenders.

Out of pocket, it has been relying on short-term, high-yield borrowing from domestic banks and public corporations for the past several months.

Cyprus is expecting the results of an asset review of its banking sector on January 18. Preliminary reports suggest banks will need anything between a baseline scenario of 7.3 billion and a worst-case of 10 billion euros.

Authorities are desperately trying to avoid adoption of the worst-case assessment by lenders. With fiscal needs, the total bailout bill will rise to 17 billion, and catapult Cyprus's eventual debt burden to 140 percent of GDP.

Economists say a debt restructuring would be futile in Cyprus's case since the majority of its debt is held by domestic banks - the same institutions the bailout is intending to save.

"It might satisfy someone's sense of justice, but it wont solve the problem," said economist Fiona Mullen. "There aren't any easy answers out there, apart from giving them a thousand years to pay it back."

(Editing by John Stonestreet)

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