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Standard & Poor's Ratings Services lowered its rating on Cyprus for the second time this year, saying the island nation will struggle to meet its general government deficit targets for this year and 2012.

If the government were to miss the deficit targets of less than 4% of gross domestic product, or GDP, in 2011 and 2% in 2012, S&P said the debt burden would likely increase. That would reduce the government's ability to back-stop its domestic banking sector, which is vulnerable to the potential restructuring of government debt in Greece.

Two days earlier, S&P downgraded Greece further into deep junk territory after it concluded the proposed restructuring of the nation's government debt would amount to a selective default.

On Friday, the ratings company issued a one-notch downgrade on Cyprus to BBB+, placing the rating three levels above junk territory. The outlook remains negative, meaning future downgrades are possible.

S&P said the Cypriot banking system's loans to Greek customers and holdings of Greek sovereign and bank debt are alone equivalent to more than 160% of the nation's GDP, while Cypriot banks' domestic claims are nearly 280% of GDP.

Although the banking system is considered well capitalized, S&P said it anticipates potential losses that may reduce those levels. And while the baseline expectation is that the Cypriot government won't need to recapitalize the banks in the near future, S&P said ongoing uncertainty outside of Cyprus increases the risk of support.

The negative outlook concerns S&P's view of the likelihood of a downgrade if substantial expenditure cuts fail to materialize, or if the government is required to recapitalize the banks.

-By John Kell, Dow Jones Newswires; 212-416-2480; [email protected]

http://online.wsj.com/article/BT-CO-201 ... 15693.html