If the objective is restored market access, the limits of exisitng crisis resolution arrangements were further exposed by Moody’s four-notch downgrade of Portugal. The FT has the story here. This bit is particularly important:
Moody’s cited the tortuous negotiations over Greece in its note, warning that although the likelihood of a restructuring in Portugal was lower than in Greece, the European Union’s “evolving” approach to providing further support “implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well.”
The full Moody’s statement is available via ft.com/alphaville.
London, 05 July 2011 — Moody’s Investors Service has today downgraded Portugal’s long-term government bond ratings to Ba2 from Baa1 and assigned a negative outlook. Concurrently, Moody’s has also downgraded the government’s short-term debt rating to (P) Not-Prime from (P) Prime-2. Today’s rating action concludes the review of Portugal’s ratings initiated on 5 April 2011.
The following drivers prompted Moody’s decision to downgrade and assign a negative outlook:
1. The growing risk that Portugal will require a second round of official financing before it can return to the private market, and the increasing possibility that private sector creditor participation will be required as a pre-condition.
2. Heightened concerns that Portugal will not be able to fully achieve the deficit reduction and debt stabilisation targets set out in its loan agreement with the European Union (EU) and International Monetary Fund (IMF) due to the formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.
The first driver informing today’s downgrade of Portugal’s sovereign rating is the increasing probability that Portugal will not be able to borrow at sustainable rates in the capital markets in the second half of 2013 and for some time thereafter. Such a scenario would necessitate further rounds of official financing, and this may require the participation of existing investors in proportion to the size of their holdings of debt that will become due.
Moody’s notes that European policymakers have grown increasingly concerned about the shifting of Greek debt held by private investors onto the balance sheets of the official sector. Should a Greek restructuring become necessary at some future date, a shift from private to public financing would imply that an increasingly large share of the cost would need to be borne by public sector creditors. To offset this risk, some policymakers have proposed that private sector participation should be a precondition for additional rounds of official lending to Greece.
Although Portugal’s Ba2 rating indicates a much lower risk of restructuring than Greece’s Caa1 rating, the EU’s evolving approach to providing official support is an important factor for Portugal because it implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well. This development is significant not only because it increases the economic risks facing current investors, but also because it may discourage new private sector lending going forward and reduce the likelihood that Portugal will soon be able to regain market access on sustainable terms.
The second driver of today’s rating action is Moody’s concern that Portugal will not achieve the deficit reduction target — to 3% by 2013 from 9.1% last year as projected in the EU-IMF programme — due to the formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system. As a result, the country may be unable to stabilise its debt/GDP ratio by 2013. Specifically, Moody’s is concerned about the following sources of risk to the budget deficit projections:
1) The government’s plans to restrain its spending may prove difficult to implement in full in sectors such as healthcare, state-owned enterprises and regional and local governments.
2) The government’s plans to improve tax compliance (and, hence, generate the projected additional revenues) within the timeframe of the loan programme and, in combination with the factor above, may hinder the authorities’ ability to reduce the budget deficit as targeted.
3) Economic growth may turn out to be weaker than expected, which would compromise the government’s deficit reduction targets. Moreover, the anticipated fiscal consolidation and bank deleveraging would further exacerbate this. Consensus growth forecasts for the country have been revised downwards following the EU/IMF loan agreement. Even after these downward revisions, Moody’s believes the risks to economic growth remain
skewed to the downside.
4) There is a non-negligible possibility that Portugal’s banking sector will require support beyond what is currently envisaged in the EU/IMF loan agreement. Any capital infusion into the banking system from the government would add additional debt to its balance sheet.
Moody’s acknowledges that its earlier concerns about political uncertainty within Portugal itself have been largely resolved. Portugal’s national elections on 5 June led to the formation of a viable government, both components of which had campaigned on the basis of supporting the EU-IMF loan agreement negotiated by the previous government. Moody’s also acknowledges the policy initiatives announced at the end of June demonstrate the new Portuguese government’s commitment to the programme. However, the downside risks (as detailed above) are such that Moody’s now considers the government long-term bond rating to be more appropriately positioned at Ba2. The negative outlook reflects the implementation risks associated with the government’s ambitious plans.
WHAT COULD CHANGE THE RATING UP/DOWN
Developments that could stabilise the outlook or lead to an upgrade would be a reduction in the likelihood that private sector participation might be required as precondition for future rounds of official support or evidence that Portugal is likely to achieve or exceed its deficit reduction targets.
A further downgrade could be triggered by a significant slippage in the execution of the government’s fiscal consolidation programme, a further downward revision of the country’s economic growth prospects or an increased risk that further support requires private sector participation.