Portugal Downgraded as Fitch Says Recession May Loom

Portugal’s debt rating was downgraded one level by Fitch Ratings, which said the economy faces a “deteriorating” outlook as the government struggles to curb the euro region’s fourth-largest budget deficit.

The long-term foreign and local currency issuer default rating was lowered to A+, the fifth-highest level, from AA-, Fitch said in a statement yesterday. The outlook is negative. Fitch on March 24 cut the rating by one step to AA-. The company said in a separate report that there is a risk the European Union will need to rescue other euro member states after bailouts of Ireland and Greece.

“The downgrade reflects an even slower reduction in the current account deficit and a much more difficult financing environment for the Portuguese government and banks than incorporated into Fitch’s previous rating and the negative outlook assigned on 24 March 2010, as well as a deteriorating near-term economic outlook,” the rating company said.

The Portuguese government plans to cut state workers’ wages and raise taxes to convince investors it can narrow the budget gap, after the Greek debt crisis led to a surge in borrowing costs for high-deficit nations. Ireland became the second euro country to seek a bailout and the first to request aid from the European Financial Stability Facility last month.

Yield Spread

The difference in yield between Portuguese 10-year bonds and German bunds, Europe’s benchmark, reached a euro-era record of 483 basis points on Nov. 11. The spread was at 364 basis points yesterday.

The rating downgrade announced by Fitch is “difficult to understand” at the present time as Portugal’s 2011 budget has been approved and its banking system is “solid and resilient,” the Finance Ministry said yesterday in a comment sent by e-mail.

“The structural budget adjustment targeted for 2011 -- equivalent to almost four percent of GDP -- will be extremely challenging especially if, as Fitch expects, the economy falls into recession next year,” the rating company said in yesterday’s statement.

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. Portugal doesn’t face any bond redemptions until April and has completed this year’s sales of debt. Borrowing costs rose at a Dec. 15 sale of 500 million euros ($655 million) of three-month bills.

Market Funding

“The government has demonstrated that it can retain access to market funding, albeit at a high cost, during crises,” Fitch said. “The current ratings are premised on the Portuguese government retaining market access and do not assume that it seeks external financial support under an EU-IMF program.”

Moody’s Investors Service on Dec. 21 said Portugal’s bond rating may be downgraded one or two levels because of concerns that budget cuts will 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. S&P yesterday affirmed France’s AAA rating.

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.

‘Systemic’ Crisis

Fitch said in a separate report yesterday that the crisis is “systemic” and shows concerns on the viability of the single currency as a whole.

“While the euro zone’s underlying credit fundamentals are stronger than current levels of risk pricing indicate, Fitch believes that the crisis is systemic in as much as it reflects concerns about the viability of the euro as well as country-specific vulnerabilities,” the ratings company said in London.

Portugal is counting on exports such as paper and wood products to support economic expansion as it cuts spending. The budget forecasts GDP growth of 0.2 percent in 2011, slower than this 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.

“Evidence that the economy was on a sustainable recovery path, supported by adherence to the government’s fiscal consolidation targets, could result in a revision in the rating outlook to stable,” Fitch said yesterday.

Portugal’s 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.

The country posted the biggest shortfall in the 16-nation euro region last year after Ireland, Greece and Spain. It aims to cut its budget deficit to 7.3 percent of GDP this year, 4.6 percent in 2011, and to reach the EU limit of 3 percent in 2012.

(Updates with Finance Ministry’s comment in sixth paragraph.)
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