NICOSIA, Cyprus (AP) -- International ratings agency Moody's downgraded euro member Cyprus into junk status Tuesday on heightened concerns over the exposure of its large banking sector to Greece.
The agency reduced its rating on Cyprus by one notch to Ba1 and assigned a negative outlook, meaning that further downgrades are possible.
Moody's is the second agency to push the island nation's credit rating to junk after Standard & Poor's in January, mainly because of the banking system's Greek exposure. Fitch rates Cyprus a notch above junk.
The downgrades have effectively shut Cyprus out of the international markets, prompting it to seek a euro2.5 billion ($3.3 billion) low-interest loan from Russia to meet its financing needs for this year.
Moody's said apart from their significant Greek government bold holdings, Cypriot banks' woes are compounded by their large Greek loan portfolios. It said those stresses on the banking system combined with weak private sector confidence and adverse external conditions will constrain the island's growth potential in the next few years and add to the fiscal challenges facing the government.
"Although he government seems well positioned to achieve significant progress this year, unfavorable economic conditions present implementation risks in 2013 and beyond," Moody's said.
The agency said that although Cypriot banks are looking to bolster their capital buffers through private sector investment, there is a "very material risk" that the government will have to step in to cover a likely shortfall that could amount to 5-10 percent of the island's gross domestic product. That could, in turn, deepen the eurozone member's debt load.
The Cyprus Finance Ministry said in a statement that the agency's downgrade isn't justified because its reasoning doesn't substantially vary from the one it used for its previous ratings cut last November.
It said the Cyprus government is aware of the challenges that the economy faces in light of Europe's debt crisis and the unfolding situation in Greece.
"The government remains committed to meeting its fiscal targets, implementing growth-oriented measures and policies and to securing the necessary funding to cover the state's financial needs," the ministry said.
It added that in conjunction with the central bank, it's looking at all options to effectively handle the problems that banks face.
Moody's said the scale of the downgrade was limited in light of the government's move to curb public spending and the discovery of substantial natural gas deposits off the island's shores.
The hope in the government is that the austerity being pursued will shrink the deficit to around 3 percent of Cyprus' gross domestic product. Longer-term, the gas discovery should support the country's finances too, though Moody's noted that Cyprus won't enjoy the full benefits for at least a decade.
Moody's said although the Russian loan helps Cyprus get by this year, there's uncertainty over how the government will secure some euro2 billion to meet its financing needs for 2013.
It said that it may turn to Europe's bailout fund for support, but the fact that the government turned to Russia for a loan suggests that it's reluctant to tap EU financing due to the strings attached to such a move. The three countries that have been bailed out — Greece, Ireland and Portugal — have had to enact harsh austerity measures in return for rescue loans.