Fitch downgrades Cyprus, ‘may need bailout’ as finance minister raises taxes

The move puts the ratings at triple-B, a notch closer to junk level than downgrades last month by rival credit-ratings companies Moody's Investors Services and Standard & Poor's.

It also follows a three-notch downgrade by Fitch at the end of May on the Cyprus banking system's exposure to Greece's debt crisis.

Fitch said circumstances that could trigger further negative ratings actions include a worsening of the government's budget woes, an inability or unwillingness to implement a planned austerity package or a weakening of the economy.

The downgrade and negative outlook also reflects its expectations that Cyprus won't be able to tap international debt markets to refinance debt coming due in the second half of this year and the first half of next year, Fitch said. The country's deficit is expected to widen to nearly 7% of gross domestic product this year, from earlier estimates of 4%.

Moody's last month cut Cyprus's ratings to within three notches of junk on concerns the island nation may be the next euro zone country to need a bailout.

S&P had cut Cyprus to three notches above junk on concerns that it will struggle to meet government deficit targets this year and next.

Cypriot Finance Minister Kikis Kazamias is preparing to raise taxes to plug a budget gap that will be wider than estimated this year after a power plant blast knocked out more than half the island’s electricity.

“With the present situation, if nothing changes the fiscal deficit will be 6.5 percent of gross domestic product in 2011,” Kazamias said in Parliament in Nicosia today. The previous target had been for a shortfall of 4.5 percent, he said. Cyprus, struggling to avoid becoming the latest victim of Europe’s debt crisis.

The move by Fitch, which cited the nation’s economy and concerns the country will have difficulty raising funds in international debt markets, followed downgrades last month by Moody’s Investors Service and Standard’s & Poor’s.

President Demetris Christofias, seeking to restore investor confidence, reshuffled his Cabinet last week after a July 11 explosion knocked out the 767-megawatt Vasilikos power plant.

Kazamias said that his proposed austerity measures, which will amount to 600 million euros ($852 million), or 3.5 percent of GDP next year, will help keep the deficit at 2.5 percent in 2012. He asked lawmakers to help design a second fiscal package to be part of the 2012 budget.

Kazamias said he wants to raise tax rates on bank-deposit interest to 15 percent from 10 percent and to 17 percent from 15 percent on dividends. Raising the interest tax rate  will bring in €20 million in 2011 and €30 million in 2012, while a further €15 million will come from the dividend rate hike, he said.

The minister also said he plans to increase the tax rate for incomes over €60,000 a year by 5 percentage points to 35 percent. He didn’t estimate that move’s impact on revenue.

The ministry is also drawing up a bill to raise the value- added tax rate for non-food and non-medicine items to 17 percent from 15 percent, which will bring in €20 million in 2011 and €130 million in 2012, he said.

“Its inflationary impact will be excluded from wage indexation in the public sector,” Kazamias said.