Portugal’s Credit Rating Cut, But Euro Held Up Relatively Well

Portugal’s credit rating was cut two notches to A1 by Moody’s Investors Service on prospects for weak economic growth
and the government’s weakening financial strength. The cut widened the yield premium investors demand to buy the
Portuguese bond over comparable German debt by 4 basis points to 284 basis points compared with a high of 349 basis
points in May. This was despite the Portuguese government having announced plans to raise taxes and cut spending
earlier in an attempt to rein in its budget deficit, the fourth-largest in the region. Portugal recorded a budget gap of
9.3% of GDP in 2009 and it plans to trim its deficit to 7.3% in 2010 and 4.6% in 2011. “Even if Portugal makes good
on their pledge, its debt burden as a proportion of GDP will probably continue to grow over the next two to three years,
reaching almost 90% of GDP”, Moody’s said. On 2 July, Portugal said that its debt ratio will start declining in 2013 to
84.8%, from 85.9% in 2012 and 2011. Also, it aims to narrow its budget deficit faster than forecast previously and meet
the 3% limit in 2012, a year earlier than in a previous plan. Indeed, high-deficit nations such as Portugal and Spain
have already adopted austerity measures after Greece’s near-default led their borrowing costs to surge and prompted
the European Union (EU) to adopt a €750bn (US$941bn) emergency stabilisation fund.
The euro reacted negatively initially and it slipped to US$1.253/euro at 9:20 a.m. in London on 13 July, from US$1.260
a day ago. However, it recovered to US$1.2716/euro at 4:03 p.m. in New York, after Greece’s debt was oversubscribed.
Although the yield on the bonds was 10 basis point higher than April’s auction, the fact that Greece filled an auction at
a reasonable rate has encouraged investors that the nation will not default.
Meanwhile, EU officials said banks must try to raise money themselves before seeking state support if stress tests by
regulators reveal vulnerabilities. EU regulators are examining the strength of 91 banks in an attempt to reassure
investors about the institutions’ resilience to potential losses as the debt crisis hit the bonds of Greece, Spain and Portugal.
The stress-test results are scheduled to be released on 23 July.