Moody's has downgraded Cyprus's government bond rating by three notches from B3 to Caa3, citing the anticipated increase in the government's debt burden.
The downgrade to middle-range junk bond status was driven by the further increase in the amount of government support that Cypriot banks are likely to require, AFP reported.
"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.
It added, however, that its base case "does not assume a default or distressed exchange in 2013".
Moody's now estimates that the bank recapitalizations will be about €10bn, which equates to more than 50pc of GDP.
That could take Cyprus' ratio of debt to GDP to 150pc 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 recapitalization 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.