Lisbon/New York -
Moody's became the first rating agency to cut Portugal's credit standing
to junk, warning that the country may need a second round of rescue funds before it
can return to capital markets.
The downgrade on Tuesday was not entirely unexpected and
served as a reminder that Europe's debt troubles extend beyond Greece, which has
dominated news headlines over its second financial bailout.
Some economists think Ireland may also need additional
support, and investors worry Spain and Italy could be next in line for aid.
"It goes to show that this whole crisis isn't over just
yet," said Jay Bryson, global economist for Wells Fargo Securities in Cape
Hatteras, North Carolina. "Even if they cough up some more money for
Greece, and that looks like it's a done deal, it's not over."
The protracted sovereign debt struggle has darkened the
global economic outlook, cooling demand for Asia's exports and leaving
financial markets on edge.
Mohamed El-Erian, co-chief investment officer for bond fund
PIMCO, said it was unlikely that Europe's troubles would constitute a
"Lehman moment" that paralyses the US economy, but it was a drag on
an already disappointing recovery.
The debt troubles add another wrinkle to the European
Central Bank's (ECB's) interest rate decision on Thursday. Economists widely expect the
ECB to raise its benchmark rate, which would be the second hike this year, to
try to cool inflation.
But the move could raise already high borrowing costs for
Portugal and other so-called peripheral European countries. Yields
on long-term Portuguese government bonds are well above 10%, more than
three times higher than those of Germany.
Moody's Investors Service slashed Portugal's credit rating
by four levels to Ba2, causing the debt-laden Iberian country to follow Greece
into junk territory below investment grade. Greece is rated much lower, at
Portugal in April became the third eurozone country to
request a bailout, after Greece and Ireland.
Moody's cited heightened concerns that Portugal will not be
able to fully meet deficit reduction and debt stabilisation targets set out in
its loan agreement with the European Union and International Monetary Fund (IMF).
Portugal is receiving funds from a three-year, €78bn EU/IMF
bailout programme and does not need to issue long-term debt in the market until
But Moody's said there is an increasing probability Portugal
will not be able to borrow at sustainable rates in capital markets in the
second half of 2013 and for some time thereafter.
There was a "growing risk that Portugal will require a
second round of official financing before it can return to the private market,
and the increasing possibility that private sector creditor participation will
be required as a pre-condition", Moody's said.
Of the three major rating agencies, Standard & Poor's
and Fitch Ratings both have Portugal at BBB-minus, the bottom of the investment
The first repercussions of the downgrade could come as early
as Wednesday, when Portugal is due to place up to €1bn in a three-month Treasury
bills auction. It may have to pay a higher premium to entice buyers.
Portugal's new centre-right government said in a statement
that Moody's did not take into account strong political backing for austerity
after a June 5 election, and an extraordinary tax announced last week.
Unlike the previous minority Socialist government, the new
ruling coalition has a comfortable majority in parliament to pass austerity
measures and reforms. It did acknowledge, though, that the rating cut
"shows the vulnerability of the country's economy amid a debt
It also reaffirmed commitment to deepening and speeding up
austerity measures that the country vowed to implement under its bailout pact,
saying a strong macroeconomic adjustment was "the only way to reverse the
course and restore confidence".
The country has to slash its budget deficit to 5.9%
of gross domestic product this year after overshooting its target last year,
when the gap was 9.2%, and then reduce it to 3% by the end of 2013.
Anthony Thomas, Moody's analyst for Portugal, told Reuters
"evidence that Portugal is meeting or indeed exceeding its deficit
reduction targets" could be a positive that may lead the agency to change
its outlook on the country's credit rating to stable from negative.
But he also said the outlook depends a great deal on whether
eurozone officials will require private sector participation when extending new
financing to the region's troubled countries. Right now, such participation is
planned to be only voluntary so as not to cause ratings agencies declaring it a
Filipe Garcia, head of Informacao de Mercados Financeiros
consultants in Porto, said Moody's move was "a bit extreme" and likely to exacerbate concerns over Portugal's debt.
"The capacity to return to the markets after a while depends
on a more global, structural solution by Europe rather than on what each
troubled country does. I think it's too early to think of a second bailout for
Portugal right now, not this year at least," he said.
Garcia said the rating agencies were not taking into
account the European Union's political determination to avoid a eurozone
member's default, despite the union's strong support for Greece, which is in far worse shape than Portugal.
"Either they don't believe in the power of the
political will by the European Union to avoid default, or they are
underestimating this political union," he said.