Portugal Pays Up in First Test of 2011 Debt Demand: Euro Credit

Portugal's Finance Minister Fernando Teixeira dos Santos
Portugal's Finance Minister Fernando Teixeira dos Santos said on Dec. 15 the government is taking the necessary measures so that it doesn’t have to request aid. Photographer: Jerome Favre/Bloomberg

Portugal sold six-month bills today, the first of Europe’s high-deficit nations to test investor demand in 2011 after the threat of default forced Greece and Ireland to seek bailouts last year.

The government debt agency, known as IGCP, auctioned 500 million euros ($665 million) of bills repayable in July. The yield jumped to 3.686 percent from 2.045 percent at a sale of similar maturity securities in September, with investors bidding for 2.6 times the amount offered. A year ago, the country paid just 0.592 percent to borrow for six months.

“We have a long year ahead, and one auction is not going to answer any questions,” said Padhraic Garvey, a strategist at ING Groep NV in Amsterdam. “Getting paper into the market doesn’t mean the crisis is over. It just means job well done this time, and next month it’s got to be done again.”

Portugal, which intends to sell as much as 20 billion euros in bonds to finance its budget and redemptions this year, is raising taxes and cutting wages as it tries to convince investors it can narrow its budget gap after the Greek debt crisis led to a surge in borrowing costs for indebted euro nations last year. Ireland in November became the second euro country to seek a bailout and the first to request aid from the European Financial Stability Facility.

Yield Premium

European nations that have already sold bills this year include France, Belgium, the Netherlands and Malta, with Germany also holding an auction today. Austria’s debt agency canceled a scheduled Jan. 11 bond auction, opting instead to sell debt via a syndicate of banks later this month.

The difference in yield between Portuguese 10-year bonds and German bunds, Europe’s benchmark, reached a euro-era record of 484 basis points on Nov. 11. The spread is currently about 376 basis points, up from 362 a week ago. The Greek yield premium to bunds widened to a record 974 today.

Today’s auction shows investors are charging Portugal seven times more than they demand from Germany for six-month money.

“Yields are tremendously high for a six-month bill, still showing that Portugal has no place to hide on the curve,” said David Schnautz, a strategist at Commerzbank AG in London. “The first real test will be the bond auction, which can happen as soon as next week.”

Portugal doesn’t face any bond redemptions until April, with repayments that month and in June worth about 9.5 billion euros. The nation’s debt agency estimates this year’s gross financing needs will be 3 billion euros lower than in 2010, and plans to sell a new bond through banks in the first quarter.

Spain will sell 93.8 billion euros of bonds this year, compared with 93.5 billion euros in 2010, while Italy’s borrowing needs will decline to 225 billion euros from 249 billion euros, according to figures compiled by Barclays Capital.

Facing Facts

“Portugal really needs to sell a new bond in the first quarter,” said Olaf Penninga, who helps oversee 140 billion euros at Robeco Group in Rotterdam. “It needs to raise money to finance the budget and face the bond redemption in April.”

The government is taking the necessary measures so that it doesn’t have to request aid, Finance Minister Fernando Teixeira dos Santos said on Dec. 15. The 2011 budget includes the deepest spending cuts in more than three decades. In September, the government said it would trim the wage bill by 5 percent for public-sector workers earning more than 1,500 euros a month, freeze hiring and raise value-added sales tax by 2 percentage points to 23 percent to help narrow a deficit that amounted to 9.3 percent of gross domestic product in 2009.

Portugal’s debt rating was cut one level by Fitch Ratings on Dec. 23, which said the economy faces a “deteriorating” outlook. The grade was lowered to A+, the fifth-highest level, from AA-. Fitch said the outlook for that assessment is negative, meaning it is more likely to worsen than improve.

Next Victim?

Moody’s Investors Service on Dec. 21 said Portugal’s bond rating may be downgraded one or two levels because budget cuts may worsen the country’s “sluggish” economic growth. Moody’s cut Portugal’s credit rating two steps to A1 on July 13. Standard & Poor’s said on Nov. 30 it may lower the country’s rating, having already cut it to A- from A+ in April.

“The big question in the market for Portugal is, is it next in terms of a bailout?” said Phyllis Reed, head of bond research at Kleinwort Benson Private Bank in London. “It may be that, sooner or later, that is what is going to happen.”

The credit rating companies are also reviewing other countries. Moody’s said on Dec. 15 it may cut Spain’s Aa1 credit rating and on Dec. 16 said it placed Greece’s Ba1 bond ratings on review for a possible downgrade. Ireland’s credit rating was cut by five levels by Moody’s on Dec. 17.

Portugal is counting on exports such as paper and wood products to support economic expansion as it cuts spending. The budget forecasts gross domestic product growth of 0.2 percent in 2011, slower than last year’s estimated 1.3 percent pace. Portugal’s economic growth has averaged less than 1 percent a year in the past decade, one of Europe’s weakest growth rates.

The country posted the biggest shortfall in the 16-nation euro region in 2009 after Ireland, Greece and Spain. It set a target for a budget deficit of 7.3 percent of GDP last year and 4.6 percent in 2011, and aims to reach the European Union limit of 3 percent in 2012.

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