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Moody's debt downgrade adds to Portugal's woes

Barry Hatton

Moody's downgraded Portugal's credit rating on Tuesday, saying the debt-stressed country is struggling to generate growth and faces a tough battle.

Moody’s downgraded Portugal’s credit rating on Tuesday, saying the debt-stressed country is struggling to generate growth and faces a tough battle to restore the fiscal health needed to calm jittery financial markets.

The move is a setback for efforts by the 17 nations using the euro currency, including Portugal, to stem the bloc’s sovereign debt crisis which has forced Greece and Ireland to accept bailouts and could still spread to other debt-heavy, and far bigger, members such as Spain.

European leaders last weekend agreed on a broad set of measures they hoped would finally contain the continent’s financial difficulties that over the past year have threatened the existence of the single currency.

By increasing the size of the bloc’s bailout reserve and allowing it to purchase government debt, leaders hoped to offset market fears about the euro countries’ fiscal soundness.

But Moody’s Investors Services said Portugal’s prospects, despite the introduction of long-awaited reforms, remained gloomy as it battled to erase debt and persuade investors to lend it money amid global economic uncertainty.

“The cost of market funding is likely to remain high until the deficit has been reduced to a sustainable level and the prospects for economic growth have improved,” Moody’s said in a statement.

More bad news
It cut Portugal’s long-term government bond ratings to A3 from A1 and assigned West Europe’s poorest country a negative outlook.

The Moody’s announcement came on the eve of a government debt agency sale of 12-month Treasury bills worth up to €1-billion.

The development is likely to push Portugal’s already punitive borrowing costs even higher and will weaken the government’s argument that it does not need a bailout as it faces a long struggle out of its financial plight.

The government has acknowledged that its debt yields—for weeks at more than 7% on Portuguese 10-year bonds—are unsustainable in the long term.

Expected higher interest rates and oil prices are further bad news for Portugal’s chances of recovery, Moody’s said.

“Since the external adjustment is likely to take several years to complete, concerns about the growth outlook are likely to persist for some time,” Moody’s said.

Reform will take years to bear fruit
The ratings agency also expressed concern about funding for Portuguese banks, noting they had been shut out of markets for more than a year and relied on the European Central Bank for loans. Financial help for them would add to the government’s burden, Moody’s said.

Moody’s praised the government’s austerity measures aimed at lowering a level of national debt that has alarmed markets and prompted investors to charge high rates for lending money to a country viewed as risky.

But the minority government is under fierce political pressure to compromise with opposition parties, which if they voted together could bring down the administration, and with trade unions that have organised a series of strikes over the past year.

Also, commendable plans for labour and legal reform will take years to bear fruit, Moody’s said.

Portugal’s budget deficit hit a record 9,3% of gross domestic product in 2009—the fourth-highest in the eurozone and way above the 3% allowed for the countries using the common euro currency. The government says it reduced the deficit to below 7,3% last year and is aiming for 4,6% this year. European leaders have backed the government’s strategy.

Some analysts fear the austerity measures could backfire as they bite further into Portugal’s weak economic recovery after a contraction in 2009. The Bank of Portugal expects a double-dip recession this year, while the jobless rate has risen to a record 11,2%.—Sapa-AP

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