BERLIN (Reuters) - The euro zone is not considering a debt restructuring for Cyprus, the EU's top economic official was quoted on Friday as saying, as the heavily indebted island struggles to negotiate an international aid deal.
Cyprus applied for a financial rescue last June after its banks suffered huge losses on the EU-approved writedown on Greece's debt.
But it has so far failed to persuade its European partners to sign off on the package, given concerns the level of the island's indebtedness means it would be unable to repay the aid without further concessions from international lenders.
But "a haircut is not an option for us," Olli Rehn, the European Economic and Monetary Affairs Commissioner, told the German business daily Handelsblatt in an interview.
Ratings agency Moody's slashed Cyprus's credit rating by three notches late on Thursday on an expected rise in its liabilities, adding that it saw a 50 percent probability the Mediterranean island would "default outright or press for a distressed exchange" on its debt.
In Nicosia, Cypriot Finance Minister Vassos Shiarly said he was "not at all happy" about the Moody's downgrade but wanted to focus on the positive outlook for Cyprus offered by the anticipated conclusion of a bailout deal.
The rescue package could reach 17 billion euros, virtually equivalent to Cyprus' entire economic output.
But hurdles to a deal are stacking up.
Germany, the EU's paymaster, has expressed unease about channeling taxpayers' money into a country seen by some as a hub of money laundering. Cyprus is a popular tax haven for wealthy Russians but says it fully complies with international rules against money laundering.
Rehn said he shared those concerns.
"The government in Nicosia has already changed its legislation (on money laundering). But we must now ensure that the new laws are also applied. The problems are known to me," he said.
Germany's main opposition Social Democrats (SPD) have said they would not back a request in the lower house of parliament for financial help for Cyprus due to their concerns over "dirty money" in the country's banks.
Members of Chancellor Angela Merkel's own coalition think likewise.
Merkel, who has so far had the centre left's support for euro zone bailout votes, has said she expects the talks on aid for Cyprus to take time and has called implicitly for privatizations the island's leftist government has ruled out.
Cyprus holds presidential elections next month.
Rehn played down worries of an SPD veto of aid for Cyprus.
"The SPD is a deeply pro-European political force. So I believe that they can eventually support an aid package for Cyprus if we have found a convincing solution on Cyprus which is acceptable for taxpayers and which helps finally to clear up the problem of money laundering," Rehn said.
Rehn said international creditors wanted to follow the Spanish model in restructuring Cyprus's banking sector, adding he could not go into details as negotiations are still ongoing.
(Reporting by Gareth Jones and Michele Kambas in Nicosia; Editing by John Stonestreet)