Fitch downgrades Cyprus on Greece exposure fears

Fitch Ratings downgraded Cyprus's sovereign ratings today and put them on negative outlook, citing the exposure of the eurozone island's banks to toxic Greek debt.

Fitch Ratings said it lowered Cyprus' long-term foreign and local currency issuer default rating to BB+ from BBB-, mirroring a similar downgrade by Moody's Investors Service on June 13.

Fitch said the downgrade was "principally due to Greek corporate and households exposures of the largest three banks -- Bank of Cyprus, Cyprus Popular Bank and Hellenic Bank -- and to a lesser degree the expected deterioration in their domestic asset quality."

The downgrade also "reflects a material increase in the amount of capital Fitch assumes the Cypriot banks will require compared to its previous estimate" made in January, it said.

"The negative outlook primarily reflects the risks associated with a further worsening of the eurozone crisis, notably further contagion from Greece," it added.

Fitch said the Cypriot banks will require capital injections of potentially up to four billion euros -- 24 percent of the island's gross domestic product -- in addition to the 1.8 billion euros already earmarked for Cyprus Popular Bank.

"Even assuming that Greece remains in the eurozone, Cypriot banks will have to bear significant further loan losses as the Greek economy continues to contract over the medium term as well as the deterioration in domestic asset quality," it said.

Fitch said the scope for raising further capital from the private sector was limited, meaning the government would have to provide the lion's share.

Cyprus will have to undertake "significant fiscal reform... to absorb the economic and financial cost of an aging population and as part of a broader structural reform effort necessary to enhance productivity and international competitiveness," it said.

Cyprus' medium-term economic outlook is weak, it said, adding the economy was expected to "stagnate this year and next."

It was expected to recover only slowly as "macroeconomic imbalances unwind and the headwinds from the ongoing eurozone and Greek crises persist."

"However, as these imbalances are resolved, Fitch expects the underlying fundamentals of the economy to support a resumption of economic growth over the medium term."

Cyprus said the assessment by Fitch was of "critical importance," saying it was the first time the country had been given a non-investment grade by all rating agencies.

"With this in mind, the finance ministry acknowledges the challenges Cyprus is called upon to face and remains focused on achieving its fiscal promises and securing the necessary funds to cover the state's funding requirements," the ministry said.

"There is no doubt that with careful and timely handling the challenges arising at this stage from the euro crisis will be effectively dealt with and soon overcome."