The cost of insuring Greek government bonds rose on Thursday after ratings agency Moody's said there was now a 50% chance of the country defaulting on its debts.
The warning came as Moody's cut Greece's credit rating to Caa1, almost the lowest rating assigned to any country. The move intensified the pressure on European leaders as negotiations over a second rescue package for Greece continued in Vienna.
This "troika review", involving the European Union, the International Monetary Fund and the European Central Bank, is also considering what additional measures Greece must take in return for the next instalment of its original bailout plan.
Greece is understood to have agreed to €6.4bn (£3.9bn) of fresh austerity measures, including tax increases and accelerated privatisations. The next tranche of Greece's original aid deal, worth €12bn, is seen as vital by Greek officials to pay public sector wages and pensions.
Moody's justified the downgrade by arguing that Greece will fail to meet the deficit reduction targets that were set as part of its existing bailout deal. The Athens government, though, said Moody's had failed to appreciate the efforts it is taking to bring its debts under control.
"Over five-year investment horizons, around 50% of Caa1-rated sovereigns, non-financial corporate and financial institutions have consistently met their debt-service requirements," Moody's said. "Around 50% have defaulted."
It now costs €1.455m to insure €10m of Greek debt until 2016, after traders pushed the five-year Greek credit default swap (CDS) contract up by 25 basis points to 1455, according to data from Markit. In contrast, the Spanish CDS was trading at 252bp.
"The downgrade … adds to negative sentiment ahead of the troika review results, which are expected before the weekend," said Gavan Nolan, director of credit research at Markit. "A bailout is expected to follow by the end of the month. ECB and EC officials still appear to be at odds over the issue of rescheduling debt, though there are signs that the ECB is becoming more flexible."
Bloomberg reported that Greece has "entered the debt rating hall of shame", with only Ecuador sporting a worse rating.
Nolan added that the prices of Greek debt already imply that the country's credit rating is even lower, at CCC.
Prime minister George Papandreou is expected to present details of his new "mid-term fiscal plan" to Jean-Claude Juncker, the chairman of the group of eurozone finance ministers, on Friday.
Negotiations over the shape of a second bailout package will continue in the coming weeks, before being definitely decided on at the next EU summit meeting in June.