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Portugal, Greece Downgraded by S&P on Restructuring Concerns

Portuguese Prime Minister Jose Socrates
Even as Portuguese Prime Minister Jose Socrates repeatedly denies his country needs help, investors are increasing bets that it will be forced to follow Greece and Ireland into seeking aid from the European Financial Stability Facility. Photographer: Jock Fistick/Bloomberg

Portugal and Greece were downgraded by Standard & Poor’s, which said the European Union’s new bailout rules may mean that both nations eventually renege on their debt obligations.

S&P cut Portugal for the second time in a week to the lowest investment-grade rating of BBB-, three steps below Ireland. Greece’s rating fell two grades to BB-, three levels below investment grade. S&P cited concerns that both countries may be forced to restructure debt after seeking European aid and that governments will be paid back before other creditors.

The moves increase pressure on European policy makers trying to stem the sovereign-debt crisis almost a year after Greece became the first euro member to seek a bailout. Even as Portuguese Prime Minister Jose Socrates repeatedly denies his country needs help, investors are increasing bets that it will be forced to follow Greece and Ireland into seeking aid.

“The downgrades intensify the pressures facing peripheral economies, Portugal in particular,” said Neil Mackinnon, a London-based economist at VTB Capital Plc and a former U.K. Treasury official. “It increases the likelihood of bailout.”

New rules on bailout loans, which take effect in 2013, mean sovereign-debt restructuring is a “potential pre-condition to borrowing” from the future European Stability Mechanism and that senior unsecured government debt will be subordinated to ESM loans, S&P said. Both aspects, announced after a meeting of European leaders in Brussels on March 25, are “detrimental to commercial creditors,” the rating company said.

Emergency Loans

While Portugal “may be able” to obtain emergency loans without restructuring, the priority given to ESM loans “reduces the prospect of timely payment to government bondholders and likely also results in lower recovery values,” it said.

S&P had warned when it cut Portugal’s rating last week that it may do so again once the details of the ESM were announced.

The temporary European Financial Stability Facility forms the lion’s share of the 750 billion-euro ($1.1 trillion) bailout pool agreed by European leaders nearly a year ago. It will be replaced by the permanent ESM in 2013.

“Financial markets are generally disappointed with the outcome of EU summits this month,” VTB’s Mackinnon said. “They don’t feel there is a proper acknowledgement that debt restructuring and bank recapitalization is required.”

The gap between Portuguese and German borrowing costs surged to 467 basis points today, the highest intraday level since Nov. 11. The Greek spread widened to 938 basis points from 934 basis points yesterday.

‘Inevitable’ Move

“It only accelerates the inevitable move to calling the EFSF for Portugal,” said Glenn Marci, a strategist at DZ Bank AG in Frankfurt.

Portugal, which has about 9 billion euros ($12.8 billion) of bond redemptions coming due in April and June, faces weeks of political uncertainty after Socrates resigned on March 23 in the wake of a parliamentary defeat on his austerity measures. Elections are expected in May or June.

Portugal’s debt levels aren’t as onerous as those of Greece or Ireland, said Marchel Alexandrovich, an economist at Jefferies International in London.

“Markets have come around to the view that sooner or later Greece and Ireland have debt that is unsustainable,” he said. “Portugal and Spain are in a different boat. Portugal is on the cusp, it has debt levels much, much lower than Greece and Ireland.”

Rescue Aid

S&P said that Portugal is still likely to need aid.

“Given Portugal’s weakened capital market access and its likely considerable external financing needs in the next few years, it is our view that Portugal will likely access” Europe’s current and future rescue funds, S&P said.

A bailout may total as much as 70 billion euros, said two European officials with direct knowledge of the matter. Analyst Laurent Fransolet at Barclays Capital estimated in a note on March 25 that Portugal’s current cash position was likely to be about 4.5 billion euros to 5 billion euros, enough to cover the April redemption, though not the one in June.

S&P said it retained a negative outlook on Greece’s sovereign debt rating because the country may be falling behind its budget targets. “There are growing risks to the sovereign’s budgetary position, the possibility of slippage,” S&P analyst Marko Mrsnik said on a conference call. “The debt figure of 2010 could be higher than 9.6 percent” of gross domestic product.”

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