Portugal and Greece were downgraded by Standard & Poor’s (S&P’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 and a former UK 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 (ESM) and that senior unsecured government debt will be subordinated to ESM loans. Both aspects, announced after a meeting of European leaders in Brussels on March 25, are “detrimental to commercial creditors,” the rating company said.
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.
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The temporary European Financial Stability Facility (EFSF) forms the lion’s share of the ¤750-billion ($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 European Union summits this month,” VTB’s Mackinnon said. “They don’t feel there is a proper acknowledgement that debt restructuring and bank recapitalisation is required.”