Portugal: What does ‘junk’ downgrade really mean?

6th July 2011

The latest is reported on the Financial Times website (paywall). It has quoted the Portuguese government as having "criticised the US rating agency for failing to take into account new austerity measures and a "broad political consensus" in favour of tough fiscal discipline".

Investors in Portugese companies – the largest of which are listed on the PSI equity index have the most reason to be worried by the downgrade.

The ratings agency's decision to downgrade Portugal's bonds to Ba2 from Baa1, with negative outlook, sent Portugal's PSI equity index down 2.6 per cent while the country's credit default swaps have hit a record of 850 basis points, up 80bp for the day.

Moody's said it had based its decision on the likelihood of "default contagion" and fallout from the Greek debt crisis.

It said: "the voluntary" involvement of private creditors in Greek bailout efforts bodes ill for Portugal's ability to access capital markets. It suggests that bondholder burdensharing would be a precondition of future lending to Portugal, which in turn would scare off new creditors."

The re-rating of Portugal's debt could also impact on other eurozone countries facing financial crisis: the so called "Piigs" – Portugal, Ireland, Italy and Spain as well as Greece.

The BBC News website explains the impact of the re-rating in a Q & A.

It also explains how downgrading the debt ratings of eurozone countries has driven up the interest rates on government debt, meaning it is more expensive for these countries to borrow on the open market."

Although UK banks exposure to the debt is limited, the fragility of the eurozone could raise fears over the sustainability of the single currency itself.

However there is an up-side to the crisis – the weakening euro has lowered the cost of European trips.

In Greece for example hoteliers dropped prices by 5-10% at the start of the year because of the strength of the euro against the pound at that time.

"They recognised that the euro was strong and they wanted the business. A lot of prices have also fallen in restaurants."

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