Portugal: Moody’s hasn’t made any new friends in the euro zone by downgrading Portugal’s debt by four notches to junk status. The rating agency’s decision may look harsh and even unfair, since the Portuguese government is only a few weeks into implementing the austerity programme it agreed on in exchange for its euro 78 billion bailout by the euro zone and International Monetary Fund. But, Portugal doesn’t have the luxury to ponder what’s “fair” or not. It should listen to what its creditors are saying and act accordingly.
Suggestions that Portugal will need a second bailout are premature. Just because Greece needed more than one rescue package doesn’t mean that other bailed-out countries will follow suit. Portugal’s debt, currently at a little under 106 per cent of GDP, is high, but still well below that of Greece. It doesn’t have quite the same problem raising taxes. Moreover, the new government has a comfortable majority in Parliament, allowing it to implement both the austerity programme and structural reforms designed to boost long-stagnant growth.
But, who can deny that the risk exists? Even the authors of the austerity plan acknowledged in May that the package — approved by all political parties — was “challenging”. Shrinking the budget deficit from 9.1 per cent of gross domestic product last year to three per cent in 2013 would be hard on any country. As a result, the Portuguese economy is expected to remain in recession until early 2013. Besides, it’s not certain whether structural reforms will eventually deliver greater growth.
Lisbon also must not waver in its determination to shore up the banking sector — recapitalising the banks, and seeking a few foreign buyers for some institutions — even if this ruffles feathers. Moody’s decision may end up making Portugal’s recovery more difficult. The few bond investors who still hold Portugal’s debt because they track bond indexes will be forced to sell when it’s no longer index-eligible. Portuguese companies and banks will also see have their ratings cut, making their access to capital markets harder.This may be painful, but reflects current market concerns.
Portugal may not eventually need a second bailout. But, the risk it could will serve as a useful reminder of what it has to do.