Ireland's short-term and long-term credit ratings have been downgraded by the ratings agency Standard & Poor's in response to the greater than expected cost of recapitalising the banks.
In a statement issued this morning, the agency cut Ireland's long-term sovereign rating to A from AA- while the short-term grade was lowered to A-1 from A-1+.
Standard & Poor’s said Ireland's rating may be lowered again if negotiations over the International Monetary Fund (IMF)-European Union program or the December budget fail to ease a funding crunch.
The agency said it has also viewing short- and long-term ratings negatively, meaning a further downgrade is possible.
The downgrade to A and the CreditWatch action applies to other ratings that depend on Ireland's sovereign credit rating, including the issuer credit rating on the National Asset Management Agency (Nama), and the senior unsecured debt ratings on government-guaranteed securities of Irish banks.
"The lower ratings reflect our view that the Irish government will have to shoulder additional costs associated with further capital injections into Ireland's troubled banking system," said Standard & Poor's credit analyst Frank Gill.
"We expect the government to be given access to a joint loan programme extended by the EU and the International Monetary Fund (IMF)."
The agency warned that the prospects of a recovery in the medium term would be influenced by Ireland's stock of domestic credit, which is among the highest in the euro zone.
"We think it reasonable to expect that the EU-IMF program currently being negotiated should help Ireland manage its downsizing of the commercial banks' balance sheets," Mr Gill added.
However, accelerated asset disposal could hasten the need for additional capital requirements as some assets could be liquidated at prices below carrying values, the agency said, adding public debt could rise still further.
Standard & Poor’s said an external support program may instill greater market confidence in the ability of Irish banks to rollover external debt but added it will not reduce levels of private and public debt.
The agency said it considers domestic demand to be "unlikely" to recover until 2012. "The outlook for future costs to the government from financial retrenchment remains uncertain," Mr Gill said. "In our view, Ireland's banking system will take several years to downsize."
Until then, the agency warned the banking system was "unlikely" to be in a position to support the country's economic growth.
Standard & Poor's now expects close to zero nominal GDP growth for 2011 and 2012 and does not envisage GDP exceeding 2 per cent a year in real terms before 2013.
This is as a consequence of the high overhang of private debt, fiscal austerity, and the uneven outlook for external demand in Europe,
The agency said its "baseline expectation" is that Ireland's budgetary position improves by €15 billion (just under 10 per cent of GDP) over 2011-2014 exclusive of any additional capital needs of the banking system.
It warned, however, "reform fatigue" could set in should the global economic environment weigh on the pace of the recovery.