August 16, 2022

Portugal’s Debt Rating Cut to Junk by Moody’s

Moody’s cut its rating on Portugal’s long-term government bonds to Ba2 from Baa1 and said the outlook was negative, suggesting more downgrades might be in store.

Even though Portugal negotiated a $116 billion rescue package in May, the ratings agency cited the risk that the country would need a second bailout before it could raise funds in the bond markets again and that private sector lenders would have to share the pain.

It also warned that Portugal might fall short of the financial goals it had worked out with the European Union and the International Monetary Fund under the terms of its bailout because of the “formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.”

The downgrade came a month after a general election in Portugal in which voters unseated the Socialist government of José Sócrates. Since then, the new center-right coalition government, led by the Social Democrats and Prime Minister Pedro Passos Coelho, have pushed ahead with austerity measures and other reforms pledged by Portugal in return for its bailout.

Among such austerity measures, Mr. Passos Coelho’s government said last week that it would need to raise taxes to meet its budget deficit target. Under the plan, the government hopes to collect 800 million euros ($1.2 billion) in additional tax receipts this year by introducing a special tax that will amount to a 50 percent cut on the traditional Christmas bonus given to Portuguese workers, equivalent to one month of salary.

Responding to Moody’s decision on Tuesday, the finance ministry said in a statement that Moody’s had “ignored the effects” of the tax plan outlined last week in Parliament. The tax increase, the ministry added, “constitutes a proof of the government’s determination to guarantee the deficit targets for this year.”

The finance ministry said Moody’s downgrade vindicated the government’s recent policy initiatives since “a robust program of macroeconomic adjustment constitutes the only possible approach to reverse the tide and recover credibility.” The new government has also shelved several infrastructure projects, including a new high-speed train link between Lisbon and Madrid, as well as pledged to speed up the privatization of state-controlled companies.

Still, proposals like raising taxes will most likely yield more pain for citizens of a country whose economy is forecast to contract 2 percent this year and next.

As a practical matter, the downgrade “means that a smaller universe of investors can hold Portuguese debt on their books,” said Carl B. Weinberg, chief economist at High Frequency Economics in New York, referring to rules banning many investment vehicles from holding debt rated below investment grade. Portugal does not have to borrow in the markets, he noted, so the immediate damage to government finances is limited

Still, with all the confusion about another bailout for Greece, “this adds to the perception that there might not be a ready solution,” Mr. Weinberg said. “It revives the concern that a multicountry sovereign default could happen.”

“They’re playing with dynamite in euro land,” he added.

Hopes that Greece’s problems might be brought under control soon were deflated after Standard Poor’s said Monday that a proposal by French banks to help Greece to meet its medium-term financing needs would constitute a de facto default because banks would be required to roll over loans for a longer term at a lower interest rate.

“We’re continuing to work for a possible solution,” Michel Pébereau, chairman of BNP Paribas, the biggest French bank, said Tuesday at the Paris Europlace conference, a gathering attended by hundreds of international bankers. If the current ideas do not work, Mr. Pébereau said, “we’ll come up with something else.”

French and German bankers were scheduled to meet Wednesday morning at BNP Paribas’s headquarters in Paris with central bank officials, under the auspices of the Institute of International Finance, an association of the world’s biggest financial companies, to discuss how to proceed, said people briefed on the plan who were not authorized to speak about it publicly.

Raphael Minder contributed reporting from Lisbon.

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