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SP downgrades, Portugal, Greece on debt worries

Standard & Poor’s downgraded its credit ratings on struggling Greece and Portugal on Tuesday, saying that investors in their bonds could lose out under the terms of a new eurozone bailout system.

S&P cut Portugal by one notch to BBB-, having slashed its rating only last week on fears Lisbon would have to seek a bailout after the government fell when parliament rejected austerity plans aimed to balance the public books.

Greece was cut by two notches to ‘BB-,’ with both countries now hit by a series of downgrades in the past few months as the money markets bet that they will have to restructure their debt at the expense of investors.

S&P, one of the top three ratings agencies, said Tuesday’s downgrades reflected its concerns that a new eurozone debt rescue system agreed at an EU summit last week would be to the detriment of creditors.

The EU summit confirmed “expectations that (i) sovereign debt restructuring is a possible pre-condition to borrowing from the European Stability Mechanism (ESM), and (ii) senior unsecured government debt will be subordinated to ESM loans,” S&P credit analyst Marko Mrsnik said in a statement.

“Both features are, in our view, detrimental to the commercial creditors of EU sovereign ESM borrowers,” Mrsnik said.

The ESM bottom line means that investors could see their investments restructured, either in terms of the amount they get repaid or the time they have to wait for repayment.

In either event, their investment would be worth less and they would need to get higher rates of return if Athens or Lisbon tried to raise fresh money.

S&P said it saw “two key differences between the ESM,” operational in 2013, and the European Financial Stability Facility, set up after Greece had to be bailed out in May last year by the EU and International Monetary Fund.

These differences, combined with “Greece’s hefty government debt and high borrowing needs, undermine Greece’s plans to resume commercial borrowing by mid-2013 … and increase the likelihood of debt restructuring,” it added.

Portugal, seen as the next eurozone country most likely to call for help, was in the same position, it said, with Lisbon needing to access the EFSF and then the ESM to put its affairs in order.

S&P also warned that weaker-than-expected growth or political problems could undermine Lisbon’s efforts to stabilise its public finances, which justified its decision to put the Portugal ratings on negative outlook.

Shortly before the S&P announcement, the Bank of Portugal said it expected the economy to shrink 1.4 percent this year, even worse than its previous estimate of 1.3 percent, as austerity measures dent growth prospects.

The economy, it added, should grow 0.3 percent next year, instead of the 0.6 percent if forecast previously.

For Greece, whose near default in May threatened to sink the whole eurozone project, S&P said the government was struggling badly to meet the targets set under its 110 billion euros ($150 billion) EU-IMF bailout accord, most crucially on the budget deficit.

S&P said data suggested last year’s deficit would exceed the target of 9.6 percent of Gross Domestic Product and the 2011 goal of 7.5 percent — still way above the EU limit of 3.0 percent.

“We believe that additional measures to meet the targets could create further political and social pressures which, in turn, could undermine the government’s resolve to fully comply with the EU-IMF program,” it warned.

In the money markets, the ratings downgrades had an immediate impact, pushing up the yield or rate of return for investors on Greek benchmark 10-year bonds to 12.568 percent from 12.499 percent on Monday.

Portuguese rates rose too, to 7.881 percent from 7.818 percent, having hit a record high of 7.97 percent shortly after the announcement.

Rates on 10-year bonds above 6.0 percent are considered exorbitant, and unsustainable above 7.0 percent, meaning both countries face huge problems if they have to raise fresh cash to cover maturing debt.