Greece became the lowest-rated country in the world in the rankings of Standard & Poor's on Monday, putting it below Ecuador, Jamaica, Pakistan and Grenada.

The rating agency cut Greece three notches and warned it would view a likely debt restructuring as a default.

This was the latest blow for the country's Socialist government, which is scrambling to push a new austerity package through parliament to clinch continued funding under a year-old bailout plan despite rising public discontent.

Barely a year after Athens was granted a first 110-billion-euro aid package, the European Union, the IMF and the European Central Bank are working on a second funding deal.

Meanwhile, European banks holding Greek debt appear to be moving toward agreement on buying new bonds to replace those they hold that reach maturity.

S&P said European policymakers looked increasingly likely to impose a restructuring of Greece's debt -- either via a bond swap or by extending bond maturities -- as a means of having the private holders of Greek bonds share the burden.

In our view, any such transactions would likely be on terms less favorable than the debt being refinanced, which we, in turn, would view as a de facto default according to Standard & Poor's published criteria, the agency said.

In such a case, S&P added, Greece's credit rating would be lowered to selective default, or SD, while the ratings on the country's debt instruments would be cut to D.

It cut Greece's long-term sovereign credit rating to CCC, four steps away from default, from B. The short-term rating was affirmed at C and all ratings were removed from credit watch.

The move takes S&P's rating of Greece one notch below Moody's Caa1, while Fitch ranks Greece at B+. This makes Greece the lowest country in S&P's rankings.

S&P said the outlook on the long-term rating remained negative, a sign that another downgrade is likely in the next 12 to 18 months.

GREECE'S WILL TO STAY IN EURO

Reacting to the downgrade, Greece said the move by Standard & Poor's overlooked the government's commitment to carry on with tough fiscal efforts to repair public finances and remain a member of the 17-member euro currency club.

The decision also overlooks the government's moves to avoid any problems relating to Greece's contractual obligations, as well as the will of all Greeks to plan our future inside the euro zone, the Finance Ministry said in a statement.

Several banks have come out publicly in favor of rolling over their holdings of Greek debt, including France's Credit Agricole, which owns Greek bank Emporiki.

Germany's banking association said on Saturday it backed the idea of private creditors participating in the rescue.

The banks' participation would be part of a second bailout for Greece worth around 120 billion euros aimed at giving Athens more time to tackle its 340-billion-euro debt load, under the assumption that it will not be able to borrow on international markets this year or next.

Concerns that a second rescue may trigger a credit event drove the cost of insuring Greek government debt against default to a record high of 1,600 basis points on Monday.

Five-year credit default swaps (CDS) on Greek government debt rose 58 bps on the day to 1,600 bps, according to data monitor Markit, meaning it costs 1.6 million euros to protect 10 million euros of exposure to Greek bonds.

The U.S. stock market briefly turned negative and the euro pared gains against the dollar after the downgrade. Brent crude also fell after the move increased investors' nervousness over the economy and oil demand.

There are differences between the leaders of European Union states and the ECB, which remains opposed to private sector involvement in any Greek debt restructuring, saying it may set off a chain reaction in financial markets that would undermine the credit-worthiness of other stressed euro zone sovereigns.

EU leaders will discuss a new deal at a June 23-24 summit.

Ben May, an economist at London-based Capital Economics, said he did not see the S&P downgrade as having a material impact on the timing of a new funding package.

We believe some form of a second bailout package will be in place to avoid a disorderly default, he said.

After failing to meet fiscal targets under the first bailout deal the government, which is trailing the conservative opposition in opinion polls, has decided to raise taxes and slash spending more than planned this year to avoid default.

The prospect of more austerity and rising unemployment has fueled 20 days of protests in central Athens with a big general strike planned for Wednesday, challenging the government as its new package is headed for parliament for a vote.

(Editing by James Dalgleish)

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