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Moody’s downgrades Portugal rating by a notch

Moody’s Investors Service on Tuesday downgraded Portugal’s ratings by a notch from A3 to Baa1 and warned that it expected the country to have to seek outside help to resolve its debt problems.

Moody’s said its decision was “driven primarily by increased political, budgetary and economic uncertainty, which increase the risk that the government will be unable to achieve (its) ambitious deficit reduction targets” in the period 2011-2014.

The downgrade follows others by Moody’s itself and the other top ratings agencies after parliament rejected the government’s latest austerity package last month, forcing its resignation.

The markets increasingly believe that Lisbon will be forced to seek outside help, like fellow eurozone strugglers Greece and Ireland last year, and are demanding ever higher rates of return to provide fresh funds to cover its debt.

On Monday, the rate of return on Portugal’s benchmark 10-year bonds rose for a 10th straight session to record highs near 8.5 percent, an unsustainable level to have to pay for long-term funding.

Moody’s said the political outlook — with elections to be held June 5 — was uncertain following the resignation of the government and noted figures last week showing that Portugal missed its key deficit reduction targets.

The government had aimed for a public deficit of 7.3 percent of Gross Domestic Product in 2010 but this was revised up to 8.6 percent, even further away from the EU limit of 3.0 percent. The target for this year is 4.6 percent.

Moody’s warned that the terms of the recently agreed European Stability Mechanism (ESM) “contemplates debt restructuring as a distinct possibility,” meaning that investors could lose money by investing in Portuguese bonds.

The ESM is to replace in 2013 the European Financial Stability Facility (EFSF) set up last year after the EU and International Monetary Fund bailed out Greece in May to prevent a debt default.

Moody’s said it believes that the “new government will likely approach the facility as a matter of urgency” to secure help as Portugal will not easily be able to raise fresh funds from the money markets for some time.

It was unclear how Lisbon was going to cover its debt refinancing needs over the next few months but Moody’s said its eurozone partners would likely provide help on a short-term basis before it tapped the EFSF.

A ratings downgrade, which increases the risk profile of the affected country, usually results in it having to pay higher interest rates to raise fresh funds, adding to the pressure.