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Portugal reels after Moody’s junk rating

Published on 06/07/2011

Bailed-out Portugal paid an immediate price Wednesday for a drastic Moody's rating downgrade to junk status, having to offer investors a much higher rate of return to raise fresh funding.

Dropped four notches to Ba2, Lisbon found itself on the defensive in the markets as rattled investors demanded more for their money, with the new government’s tough austerity programme forgotten quickly in the crossfire.

Portugal did manage to raise 848 million euros ($1.22 billion) for three months at a yield, or rate of return, of 4.926 percent, but this was up from the 4.863 paid at a similar sale on June 15.

Worse still, the yield on its benchmark 10-year bond soared above 12 percent for the first time ever, and compared with 10.755 percent late Tuesday as the downgrade sparked fresh nerves about the whole eurozone debt crisis.

"The sale was clearly affected by this decision and investors ended up demanding higher interest when, in the last ten days, short-term rates had fallen," Filipe Silva, fixed-income strategist at Carregosa bank said.

Moody’s said its downgrade reflected "the growing risk that Portugal will require a second round of official financing before it can return to the private market (to raise funds)."

In other words, it did not believe that a first bailout of 78 billion euros agreed with the European Union and International Monetary Fund earlier this year would stabilise Portugal’s public finances.

It said it was increasingly concerned that Lisbon would not meet the deficit reduction and debt stabilisation targets agreed with the EU and IMF.

In addition, it seemed likely that in a second bailout private sector creditor banks would have to take some of the pain, as is now being mooted for Greece which was bailed out in May 2010 and now needs another deal to keep it afloat.

Analysts at French brokers Aurel BGC said Moody’s now appeared to be taking a much harder line "regarding countries requesting help from Europe (and that) … a downgrading of the sovereign rating would become automatic."

At Credit Mutuel-CIC, strategists said the decision by Moody’s "threatens to re-ignite worries about the strength of the eurozone just as a resolution of the Greek case seemed to be offering a period of respite."

Local analysts said the downgrade would make life much harder for Portugal.

"The banks and companies are going to have a much more difficult time in raising finance," said Cristina Casalinho of BPI bank, noting that growth is going to come under even more pressure.

The reaction elsewhere was sharp, with EU officials rounding on Moody’s and the ratings agencies in a scathing attack on their credibility.

"We must break the oligopoly of the ratings agencies," said German Finance Minister Wolfgang Schaeuble, adding that he wanted to "break" their power and "limit" their influence.

European Union officials and ministers reacted furiously, having already been alarmed by a Standard and Poor’s statement on Monday that proposals for a debt rollover in a second Greek rescue would be tantamount to default, raising the risk of a damaging contagion effect.

"I deeply regret the decision of one rating agency to downgrade the Portuguese sovereign debt and I regret it most in terms of its timing and magnitude," said European Commission president Jose Manuel Barroso.

The agency’s remarks "do not provide for more clarity, they rather add another speculative element to the situation," he said.

At Credit Mutuel-CIC, strategists said in a note: "The face-off between the rating agencies and the European authorities is going to get tougher."

Amadeu Altafaj, the commission’s spokesman for economic affairs, said Moody’s timing was "questionable" and based on "hypothetical scenarios" which contradicted the European Union’s own assessments.

"This is an unfortunate episode and raises once more the issue of the appropriateness of behaviour of credit agencies and of their so-called clairvoyance," he told a news briefing.