* ESM could help in long term but increases short-term risk
* Fitch says likely to cut Portugal rating if no bailout
(adds analysts, Fitch director, details on Greece, Spain)
By Ingrid Melander
ATHENS, March 30 (Reuters) - Plans for the euro zone’s new bailout fund increase the risk in the short term that weaker economies will default, Fitch Ratings said on Wednesday after Standard & Poor’s downgraded Greece and Portugal due to similar concerns.
Fitch said last week’s decision to give the future European Stability Mechanism preferred creditor status could deter private investors from buying the bonds of the weakest euro zone states.
This would drive up these countries’ borrowing costs, making governments more likely to resort to defaulting on their debts, even before the ESM is created in 2013.
“In the short term, it potentially increases the risk of sovereign default arising from the current crisis by making it more, rather than less difficult for sovereigns currently under stress to secure affordable medium and long-term financing from the market,” Fitch said in a statement, which did not include any announcements of rating cuts. [ID:nLDE72S1LY]
Standard and Poor’s cut Greece and Portugal’s ratings on Tuesday over risks that the ESM would increase the likelihood of debt restructurings.
The European Commission challenged S&P over the Greek downgrade on Wednesday, saying it did not share the agency’s view and had concerns about how credit rating agencies functioned. [ID:nLDE72T18V]
S&P also cut Cyprus’s long-term sovereign rating to A- from A on Wednesday, its second cut in five months, citing worries about Cypriot banks’ exposure to Greek debt. [ID:nLDE72T1MQ]
Many investors see a significant chance that Greece, possibly Ireland and even Portugal will eventually have to restructure their debts, saying the obligations they have amassed are too big to be whittled away by austerity programmes.
Analysts said the concerns Fitch and S&P were expressing about the ESM showed how difficult it was for the European Union to decide to what extent private bondholders should be involved in finding a solution to the bloc’s debt crisis.
“The EU is between a rock and a hard place. They have to find the balance between protecting taxpayers’ interests and not making it more difficult for highly indebted economies to access markets,” said Diego Iscaro, at IHS Global Insight.
Others said the EU must tread carefully to avoid alienating investors.
“If their intention is that all debt could be restructured, if they came out and said that, that might unsettle markets even more,” said Ben May at Capital Economics.
Fitch said that the outcome of last week’s EU summit was not the main determinant for its euro zone ratings and that it was still focused on public finances and macro-economic indicators.
The main short-term risks to Ireland’s sovereign rating remained the recession and possible additional bank support costs, it said, while it will keep judging Spain mostly on its budget consolidation efforts and cost of restructuring banks.
Portugal’s A- rating, which is on credit watch negative, is most at risk of a downgrade, said Paul Rawkins, Fitch’s senior director for western Europe.
The agency, which cut Lisbon’s rating last week when the Prime Minister resigned, warned on Wednesday it was likely to cut it further soon if Portugal did not seek a bailout.
In the longer term, Fitch said, the ESM should help resolve future debt crises and could help strengthen the credit profile of highly indebted countries such as Belgium and Italy.
“Nevertheless, in the short term their ratings could still come under downward pressure if current deficit reduction targets are missed,” Fitch said.
The EU’s new bailout fund puts increased pressure on Greece’s junk rating.
“For Greece, the programme relies on them regaining (market) access in 2012 and that looks increasingly unlikely now,” Rawkins told Reuters. “The implementation risk (to the current EU/IMF bailout plan) is high and will get higher because the measures they are required to take will become more difficult.”
Europe’s politicians have been openly critical of the credit rating agencies and last year summoned executives including Moody’s chief Michel Madelain and S&P’s President Deven Sharma for a grilling before finance ministers.
The EU’s executive has told the agencies to watch their step when judging a country’s financial health, saying it will probe their work and could even set up a rival rating agency. But so far, little has come of these threats. (Editing by Ruth Pitchford)