The sovereign debt crisis in Europe entered a disturbing new phase with the downgrading of Portugal’s credit rating.
The decision by the Fitch Ratings agency has heightened concerns about Europe’s debt burden as speculation grows that Greece might need to be rescued by the International Monetary Fund.
It has also raised wider fears about the financial situation of Europe’s so-called PIIGS – Portugal, Italy, Ireland, Greece and Spain.
Portugal’s downgrade has taken the euro to a 10-month low against the US dollar, and an all-time low against the Australian dollar (which was buying as much as 68.41 euro cents this morning).
Like other small European economies hit by the global financial crisis Portugal has recently slashed public spending and raised taxes to reduce its massive deficit which is now more than 9 per cent of GDP.
The austerity program might be showing signs of promise, but not enough for the Fitch Ratings agency which has downgraded Portugal’s sovereign credit rating (which reflects its ability to service its foreign debt) from AA to AA minus.
“We’re downgrading because of the facts in front of us in terms of how much the debt is rising and how big the deficit is and how weak the economy looks,” said Fitch’s head of global economics, Brian Coulton.
He warns the downgrade carries a negative outlook and that, unless Portugal gets its economy in order, another one is likely.
“Its competitiveness over the last 10, 15 years… has really deteriorated quite a lot. It’s been running very large current account deficits, lost quite a lot of market share,” he explained.
“Along has come this fiscal shock and it’s just really, that combination of a pretty big fiscal shock with an underlying weak macro [economic] position is what’s given us concern.”
Portugal’s downgrade, while unsettling for global markets, does not mean the much feared scenario of sovereign debt contagion throughout Europe is a greater possibility.
‘Greece is going to default’
However, it does cloud the outlook for Greece, which remains at the epicentre of sovereign debt concerns.
Charles Diebel, an interest rate strategist at the Nomura investment house, see tense times ahead as the European Union struggles on how to formulate a rescue package.
“The Portugal downgrade I think is going to just make it more complicated for Europe to come together on institutional mechanisms and [a] pathway forwards in responding to these crises,” he said.
“And it’s actually going to make coming to a consensus on how to handle Greece a little bit more difficult.”
The euro fell to a 10-month low against the US dollar on Portugal’s downgrade, and its reputation could suffer even more as the EU powerhouses of France and Germany argue over who should pay for any bailout.
“Particularly in Germany, there is just strong popular opposition to bailouts for these other European countries, the southern European countries,” Mr Diebel added.
“And the added news about Portugal is actually going to make it harder for chancellor Angela Merkel to come to a consensus with the other Europeans later this week on how to handle the Greece bailout issue.”
The Greek prime minister George Papandreou has indicated that, without meaningful assistance from the European Union, he might approach the International Monetary Fund for a bailout.
That sort of talk has prompted economists to speculate in recent days that a Greek sovereign default is inevitable.
Now Paul Donovan from the Swiss investment bank UBS is saying it on the record.
“Ultimately, Greece is going to default at some point. I think it’s an impossible situation,” he said.
“What we need to do is keep things rolling over in the short term to minimise the contagion, minimise the fallout that comes from that.
“We don’t want a Greek default causing problems for an Ireland or Portugal or Spain. That would create a wider system crisis. It would be like 1997 in Asia all over again.”
Paul Donovan’s outlook for Greece might be gloomy, but he doubts prime minister Papandreou would carry out the ultimate threat of leaving the European Union.
“Not only do you leave the eurozone, you leave the European Union. Your banking system collapses. You automatically default on all of your debt, all of your companies default on all of your debt, you have civil disorder in the streets. I mean it’s a chaotic, chaotic situation. The cost of leaving is astronomic,” he said.
“Now Greece should never have joined with the euro in the first place but once it’s in it’s locked in in my view. It’s going to very difficult to get it to leave.”
Portugal’s downgrade and deepening concerns about debt levels not just in Greece but the United States and Britain saw Wall Street close half a per cent lower today. Commodity prices also fell with gold at a six-week low.
Even the usual safe haven of US Treasury bonds fell as investors worry about a massive supply of new debt.