Cyprus sets sail through eye of financial storm

A minority Cypriot government must persuade a hostile opposition to approve unpopular tax hikes to close a widening budget deficit, and even then may still face the ignominy of going cap in hand to Brussels for a bailout.

As global markets panic over debt-ridden European and US economies, credit rating agencies have shown no mercy to a country that is struggling to overcome the political and financial turmoil caused by a deadly munitions blast on July 11 that wrecked economic growth prospects.

Standard & Poor's and Moody's had already downgraded Cyprus, when Fitch stepped in on Wednesday and did the same.

Fitch said Cyprus will probably be unable to meet financing requirements for the rest of this year and in early 2012, forcing it to seek a bailout.

The government argues that the austerity measures it has agreed upon will see it through this roughest of patches by reaching the EU's own fiscal deficit target next year, but doubters say the cuts aren't deep enough.

Averof Neophytou, the deputy leader of largest right-wing party, Disy, issued a statement following the Fitch blow blaming President Demetris Christofias for the country's woes.

"He has consciously chosen through the economic bankruptcy of Cyprus to obligingly lead us toward the support mechanism, destroying the economic fabric of Cyprus, which for decades has been built with the sweat and hard work of small businesses and workers."

Although Christofias has one of the toughest fights of his political career looming there are some economists who believe the fundamentals are strong.

"If you put all the indicators together Cyprus is one of the strongest performing economies in Europe; it's among the top 10. The credit agencies are using a simplistic argument with no relevance to the present situation," economist Costas Apostolides told AFP.

He said credit agencies like Fitch are driving interest rates up when they need to come down to stimulate growth.

"The Fitch narrative is wrong; there is no appreciation that the banks are strong and they did not need government assistance. This can be solved with a recovery but a recovery needs lower interest rates."

Fitch and the other ratings agencies have expressed serious concerns about the ability of Cypriot banks to withstand the pressures on their balance sheets of their heavy exposure to Greek bank debt.

Apostolides agreed the government measures were a step in the right direction but said there was nothing in the package about stimulating growth.

"It's a first step which should be encouraged even though it came late after a lot of incompetence and indecision."

The government has a minority in the 56-seat parliament, and must somehow achieve consensus, or the eurozone member is in for a very difficult ride.

Finance Minister Kikis Kazamias said Fitch's sombre outlook was "excessive" because it failed to take on board the efforts the government was taking to ensure the deficit was reduced to 2.5 percent of GDP in 2012.

The communist-led cabinet agreed to raise VAT, taxes on savings and income tax for top earners.

VAT would rise by two points to 17 percent, the tax on interest earned from bank deposits from 10 percent to 15 percent, for Cypriot residents only, and income tax from 30 percent to 35 percent for those earning more than 60,000 euros.

Instead of pay cuts, public sector unions have agreed to make a contribution from their salaries of three percent of gross income for the next three years, or more if needed.

This was presumably offered to avoid pension reform. Public sector workers contribute less and receive bigger pensions than people in the private sector.

Bit powerful trade unions warned on Wednesday that if politicians were hell-bent on attacking their rights they would strike.

The government has seemingly opted against taking the unions head on in favour of squeezing more concessions through a softly-softly approach.

It is committed to axing 5,000 jobs over the next five years, freezing new recruits and cutting overtime by 20 percent in efforts to trim the state payroll.

The minister said that without taking these proposed measures the deficit would reach closer to seven percent in 2011.

With only communist AKEL backing the government after the coalition collapsed last week, the package needs support from the opposition parties when it goes to a parliamentary vote on August 25 following a three-day debate.

And former coalition party centre-right Diko said the government had "surrendered" to powerful unions by not reforming the pension system that was draining finite public finances.

Christofias swore-in a new cabinet on Friday after a munitions blast killed 13 people and knocked out the island's biggest power plant on July 11, leading to rolling daily power cuts, economic disruption and public uproar.

Cyprus, which was already struggling to get its finances in order, was left reeling after the explosion, which all but crushed any hopes of economic growth this year.