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S&P's Downgrades Cyprus Credit, Outlook Negative

Standard & Poor's Ratings Services said that it has lowered its long-term sovereign credit rating on the Republic of Cyprus to 'A-' from 'A', citing significant exposure to Greece's financial sector which could lead to the government being forced to bail out the banking system.

At the same time, the short-term sovereign credit rating was cut to 'A-2' from 'A-1'. The outlook on the ratings remains negative.

"In our view, the increasing likelihood that the Greek government will restructure its debt heightens the risk that a significant portion of the Cypriot government's large financial-sector contingent liabilities will become explicit liabilities migrating to the Cypriot government's balance sheet," Standard & Poor's credit analyst Benjamin Young said.

The ratings on Cyprus could be lowered further if S&P's perceive "an increase in the embedded credit risks in the Cypriot financial system, as evidenced by further deterioration either in credit conditions in Greece or in Cyprus' own funding base."

Alternatively, "should the Cypriot banking sector exhibit strong resilience and further strengthen its capital levels sufficient to support its Greek exposure without resorting to government resources, the ratings on Cyprus could stabilize at current levels," said S&P's.

It is the fourth downgrade of Cyprus' sovereign credit by ratings agencies Moody's, Fitch and Standard & Poor's since the beginning of the year.

Politicians react

There were some colourful reactions from politicians, with opposition MP Averoff Neophytou (DISY) saying that the government's 'contact with reality needs testing'.

Finance Minister Charilaos Stavrakis denied this, pointing out that he has repeatedly said that the economy faces difficulties. Decisions by the ratings agencies are 'out of the government's hands,' he said. And ruling party AKEL Secretary Andros Kyprianou called Neophytou a 'champion of attack' and said he should avoid further verbal attacks on the government.

On S&P's downgrade of Greece's sovereign credit

There were also cries of foul play from Greece; Finance Minister George Papaconstantinou said that the rating agencies do not take into consideration the strict assessments that Greece receives from the EU, the IMF and the European Central Bank at regular intervals.

In related news, according to an IMF working paper, the European debt crisis "has been the theater of sovereign credit rating downgrades, widening of sovereign bond and credit default swap spreads, and pressures on stock markets."

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