Bermuda's Government bond ratings for local and foreign currency have been downgraded by Moody's Investors Service, with the Island's small size and lack of diversity in the face of "external shocks" cited as the main factors behind the move.

The debt ratings agency Moody's lowered both ratings to Aa2 — the foreign currency rating from Aa1 and the local currency rating from Aaa, with a stable outlook. But Finance Minister Paula Cox said the fact that Bermuda was not insulated from the global economic crisis had been reflected in Moody's downgrade and admitted the ratings agency had earlier indicated that such a move could be on the cards.

Only last month, both Ms Cox said she was not surprised that Moody's might want to rethink the Island's ratings in the tough economic climate and the ratings agency itself warned of the possible ratings cut. "The current global credit crisis and recession are affecting the outlook for Bermuda's most important industry, insurance and reinsurance," Moody's vice-president Steven Hess said in a statement. "Government finance is also being affected, although it remains strong in comparison to most other countries in the Aa rating category."

Moody's report said that Bermuda could see an "adverse impact" from changes to US and other countries' tax laws on its international business sector, particularly insurance.

"While we do not see a major threat to the viability of the industry, the dynamism experienced over the past decade in this industry could be considerably lessened," said Mr. Hess.

"So, we see slower economic growth in the next several years."

Mr. Hess concluded that Government's decision to guarantee Butterfield Bank's $200 million issuance of preferred stock or to buy stock if it was not sold on the market, while not large enough to materially affect Government finances, was a liability that arose at a time when the budget deficit was already increasing from very low levels in recent years.

But Ms Cox pointed to the ratings agency's affirmation that Government's finances remained strong in relation to other countries in the Aa rating category as a reason to be positive.

"Ministry of Finance stated that Bermuda's economy would likely contract in the range of one — 1.5 percent in 2009, with the expectation of a slow recovery in 2010 should global economic and financial conditions improve," she said.

"The Ministry of Finance is pleased that the adjusted rating remains in the top tier of the ratings matrix.

"At Aa2, our sovereign bond rating is only two notches below the highest rating of Aaa. We are pleased also that Moody's has attached a stable outlook to the Aa2 rating.

"Moody's continues to endorse the Island's institutional strength and Government's long record of prudent fiscal management. Government remains optimistic about future prospects for growth and will manage the economy accordingly."