Cyprus needs to raise taxes

Moody's downgraded Cyprus's credit rating by two notches to Baa3, one level above junk, on Friday, forecasting the government would have to bail out its banks next year due to their exposure to Greek debt. As the government has lost access to international capital markets, it would probably need to seek emergency funding from official sources, the ratings agency said.

The downgrade was the latest blow to the Mediterranean island, which has been hammered by ratings agencies and financial markets in the past year because of its banks' exposure to Greek debt and fiscal slippage, which has seen runaway deficits nudging 6.5 to 7.0 percent of gross domestic product.

Orphanides, who is also a member of the European Central Bank's Governing Council, said the authorities were slow to address signs of stress.

An austerity package cutting salaries in the civil service and plans to trim spending were a step in the right direction but more was needed, he said.

"In the position we are in right now, we cannot rule out that an increase in tax may be warranted," Orphanides told a conference at the University of Cyprus.

"We need to convince the world that we are reliable enough to overturn this situation."

Cyprus, the third smallest member of the euro zone, recently secured a loan from Russia for 2.5 billion euros to help finance debt maturing in 2012.

Copyright Reuters, 2011