* Agency cuts island's rating by 2 notches to Baa1
* Says new rating factors in fiscal reforms
* Says further cut possible; also cites Greek debt holdings
* Cuts Cyprus growth view to zero this year, 1 pct in 2012
* 10-yr bond yield spikes to 9.5 percent
(Recasts, adds detail)
By Michele Kambas
NICOSIA, July 27 Moody's cut Cyprus's credit
rating by two notches on Wednesday and warned another downgrade
was possible, highlighting an energy crisis and exposure to
Greece that threaten to tip the island into fiscal meltdown.
Markets have trained their sights on the east Mediterranean
nation as a possible fourth recipient of a euro zone bailout
since a huge explosion destroyed its largest power plant, and
political wrangling now risks derailing much-needed economic
If the reforms were significantly delayed or watered down,
the country's debt would be marked down again from its new grade
of Baa1 to no more than two steps above junk status, the rating
The yield on Cyprus' benchmark 10-year bond issued in
February 2010 spiked to 9.5 percent on
Wednesday following the Moody's statement, up from 8.9 percent a
week ago and from around 6.20 percent in early May.
"The Baa1 rating does incorporate an assumption that
something resembling those (fiscal) reforms does eventually get
legislated and implemented," Moody's senior analyst Sarah
Carlson told Reuters.
Cyprus, one of the euro zone's smallest members, has seen
its external borrowing costs spiral in the past twelve months as
ratings agencies issued downgrades in response to its banks'
exposure to Greece and the lagging reforms.
The July 11 blast at the Vassilikos plant, which wiped out
53 percent of the island's energy production, significantly
worsened the situation.
Cyprus is not a regular on international bond markets, but
at current yields it has been effectively shut out of that
financing option. Until now it met its borrowing needs from
Last week, central bank governor Athanasios Orphanides
warned it could be forced to seek a bailout unless tougher
austerity measures were taken immediately .
GROWTH FORECAST CUT
Moody's also cut its growth outlook for Cyprus, to zero this
year and to 1 percent in 2012, due in part to reduced power
production after the Vassilikos explosion.
Downward ratings pressure could also be exerted if problems
in the Cypriot banking sector - holding between 4.5 and 5
billion euros of Greek debt - were to require a substantial
injection of government money, Moody's said.
It last downgraded Cyprus in February, when it cited the
same structural and Greece-related concerns. Rival agencies
Fitch and Standard and Poor's, which have also downgraded Cyprus
this year, both rate the country at A-.
Moody's said it would consider a rating upgrade if Cyprus
introduced sweeping structural reforms in its social transfers
system and public sector wage bill, and recorded significant and
lasting cost savings.
Vassilikos was destroyed when a cargo of confiscated Iranian
munitions stored in a military base several hundred metres away
from the plant exploded.
Since then, Cyprus's state-owned electricity authority,
which has an effective monopoly on power generation, has
introduced rolling power cuts. Economists have estimated the
cost of the blast and its consequences at at least 1 billion
euros, a significant slice of Cyprus's 17.4 billion euro
Cyprus launched a plan on July 1 to cut spending in the
civil service and scrap a number of state-owned organisations.
But that programme and anticipated further measures to deal with
the fallout from the blast face significant political hurdles.
On Tuesday, a number of parties accused the government of
backtracking on reforms because they feared an angry backlash
from Cyprus's powerful labour unions.
The two parties in Cyprus's centre-left government do not
have an absolute majority in parliament to push reforms through
so any measures have to be adopted by consensus.
Moody's said that if any of the plans were watered down or
delayed significantly that could prompt a further downgrade. An
increasingly fractious political climate added to implementation
risks, it said.
"There are so far no short-term measures to compensate for
the plant's destruction," Carlson said. "We think this will mute
the government's planned range of structural measures that have
been designed to improve fiscal sustainability over the medium
(Editing by John Stonestreet)