July 5, 2011 / 6:14 PM / 9 years ago

Moody's cuts Portugal to junk, warns on 2nd bailout

LISBON/NEW YORK (Reuters) - Moody’s on Tuesday cut Portugal’s credit standing to junk in the first such move by a ratings agency and warned the country may well need a second round of rescue funds before it can return to capital markets.

Portuguese flags are seen on the meeting room in Lisbon June 16, 2011. REUTERS/Jose Manuel Ribeiro

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 Caa1.

Portugal in April became the third euro zone country to request a bailout, after Greece and Ireland.

Moody’s cited heightened concerns that Portugal will not be able to fully achieve the deficit reduction and debt stabilization targets set out in its loan agreement with the European Union and International Monetary Fund.

Portugal is receiving funds from a three-year, 78-billion-euro ($112 billion) EU/IMF bailout program and does not need to issue long-term debt in the market until 2013.

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, Moody’s said, and the increasing possibility that private sector creditor participation will be required as a pre-condition.”

It also said Portugal faced formidable challenges in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.

Of the three major ratings agencies, Standard & Poor’s and Fitch Ratings both have Portugal at BBB-minus, the bottom of the investment grade range.

Portugal’s new center-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 crisis.”

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 percent of gross domestic product this year after overshooting its target last year, when the gap was 9.2 percent, and then reduce it to 3 percent 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 euro zone 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 “credit event.”

Filipe Garcia, head of Informacao de Mercados Financeiros consultants in Porto, said Moody’s move was “a bit extreme” and was 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 ratings agencies were not taking into account the European Union’s political determination to avoid a euro zone member’s default, despite the union’s strong support for Greece, which is in a 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.

Robert Tipp, chief investment strategist at Prudential Fixed Income in New Jersey, said the downgrade showed the European debt crisis was unlikely to stop at Greece, which looks set to receive a second bailout.

“Once Greece gets wrapped up, you move on to the next country, and in all likelihood that will be the shape of things to come over the next year or two in the euro zone until the long-term financing trajectory for these countries gets stabilized,” he said.

In practical terms, Portugal may have to pay a higher premium to place up to 1 billion euros in 3-month Treasury bills in an auction on Wednesday due to the downgrade.

“It’ll probably make the yield a bit worse, but I don’t expect anything major, because when you go to the market now you have to have the issue booked in advance,” Garcia said. Portugal has opted to stay in the T-bill market after the bailout.

Additional reporting by Daniel Bases in New York and Sergio Goncalves in Lisbon; Editing by Dan Grebler

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