International credit rating agency Moody's has announced that it downgraded Cyprus's government bond rating by three notches to middle-range junk bond status, citing the anticipated increase in the government's debt burden.
The downgrade on Thursday from B3 to Caa3 was driven by the further increase in the amount of government support that Cypriot banks are likely to require.
"Given that the resulting increase in the debt burden is likely to be unsustainable, Moody's believes there is a significantly increased likelihood that the Cypriot government may eventually default outright or press for a distressed exchange," Moody's said.
Moody's says more downgrades are possible for the country that is trying to finalise a bailout with international lenders to rescue its banks, which sustained massive losses on bad Greek debt and loans.
The agency said that it believes that there is a "significantly increased likelihood" that Cyprus may default outright or seek for its debt to be written down, but doesn't foresee that happening this year.
It added however that its base case "does not assume a default or distressed exchange in 2013".
Moody's now estimates that the bank recapitalisations will be about 10 billion euros ($13.11 billion), which equates to more than 50 percent of GDP. That could take Cyprus' ratio of debt to GDP to 150 percent in 2013, which "would be one of the highest levels in Moody's rating universe," Moody's said.
Moody's also placed Cyprus's debt on "negative" outlook citing liquidity concerns, the bank recapitalisation needs and the delay in negotiations with the "troika" of the European Commission, the European Central Bank and the International Monetary Fund on a package of aid to resolve the country's liquidity crunch.
In total, Moody's has downgraded Cyprus's rating nine notches in the last 10 months, as the European sovereign debt crisis has persisted.
Earlier this week, Panicos Demetriades, Cyprus Central Bank governor, met eurozone ambassadors to explain reform and restructuring plans for the troubled banking sector.
Eurogroup finance ministers could decide as soon as January 21 on a draft agreement with international lenders for a bailout reportedly totalling 17.5 billion euros ($23.1bn).
Cyprus has already pushed through tough austerity measures to meet the demands of eurozone creditors for more than one billion euros in cuts and savings.