Moody's Investors Service downgraded Cyprus's government bond ratings on Wednesday by two notches to Ba3 from Ba1 and has assigned a negative outlook to the ratings.

The rating agency said in a statement it also downgraded Cyprus's short-term rating to Not-Prime from Prime-3.

Moody's cited as the main reason for its action the increased possibility that the Cypriot government would have to provide renewed financial support to the country's banks because of their exposure to the Greek economy, and the commensurate impact of such measures on the government's own financial strength.

The Cypriot government is urgently seeking 1.8 billion euros (2.3 billion U.S. dollars) to recapitalize the second largest bank of the island and a government minister said it may have to borrow up to 4 billion euros to refinance its debt.

Moody's statement also said there would likely be a negative impact on market confidence in Cyprus, stemming from the banking-sector concerns, as well as broader uncertainties about Europe's macroeconomic prospects and institutional frameworks.

"Overall, the fragile market confidence in Cyprus, which has already led to a loss of access to international debt markets, is likely to continue," Moody's said.

Moody's mentioned a large-scale fiscal consolidation program which the government had introduced several months ago and which contained a greater number of structural changes to public-sector expenditure than had been anticipated.

These measures are likely to enable the country to achieve a deficit reduction of around 3 percentage points of GDP in 2012 from 6.5 percent at the end of last year, Moody's said. (1 euro = 1.26 U.S. dollars)