Portugal’s credit rating was downgraded and its borrowing costs hit record-high levels

Portugal’s credit rating was downgraded and its borrowing costs hit record-high levels Thursday, a day after the collapse of the government in Lisbon raised expectations that the country would be forced to seek an international bailout.
Prime Minister Jose Socrates after announcing his resignation on Wednesday.
Portugal’s prime minister, José Sócrates, offered his resignation late Wednesday after his minority Socialist government failed to win parliamentary backing for another package of austerity measures. Over the past year, Lisbon had already implemented three rounds of spending cuts and tax increases, apparently without persuading investors that it could clean up public finances.

Portugal needs to borrow about €10 billion, or $14 billion, in April and June to refinance existing debt. A political vacuum now only adds to the chances that the government will have to seek financial support from its European Union partners and the International Monetary Fund — as Greece and Ireland have already done.

Speaking on the sidelines of a meeting of E.U. leaders in Brussels, Jean-Claude Juncker, the prime minister of Luxembourg who also presides over meetings of euro zone finance ministers, estimated Thursday that an aid package for Portugal would probably reach around €75 billion, in line with what analysts have predicted. That would provide Portugal with a financing cushion for several years, depending on how much would be required for recapitalizing banks.

During an interview with France 24 television, however, Mr. Juncker also insisted that Portugal’s woes should not be compared to those of Spain, a much larger euro economy that has also been in investors’ line of fire over the past year because of its budget shortfall.

“It would be absurd for financial markets to target Spain were Portugal to apply for a bailout,” Mr. Juncker said.

In fact, investor concerns Thursday appeared to be focused on Portugal.

The yield on the benchmark 10-year Portuguese government bond rose to 7.7 percent, the highest level since the inception of the euro, before falling back slightly. The Philippines currently has cheaper borrowing costs for bonds of the same duration. Meanwhile, the yields on the bonds of other euro zone members like Germany, France, Italy and Spain were stable.

“The markets agree that the fundamentals are in Spain’s favor but the situation is not without risks,” said Luís Cabral, an economics professor at IESE, a Spanish business school.

Portugal’s debt rating was downgraded two steps by Fitch Ratings and placed on review for a possible further cut. The rejection of austerity measures has “significantly increased the chances of Portugal requiring multilateral support in the near term,” it said.

The Portuguese government had argued that a further austerity package was needed to cut its budget deficit from an estimated 7.3 percent of gross domestic product last year to 4.6 percent this year. Instead, Eurostat, the E.U. statistics office, suggested that Portugal’s 2010 deficit needed to be revised slightly upward to take into account debt held by state-owned companies.

Analysts said that they anticipated an upward revision of both the 2010 debt and deficit figures.

A further challenge for Portugal is that its banks, which have been shut out of the markets over the past year, need to raise additional money by the end of April to comply with stricter capital requirements.

For Spanish banks, meanwhile, their combined exposure of €77 billion to Portugal is by far the largest among European institutions. Weighed down by bad loans to the property market, Spanish banks are also struggling to raise additional funding. Moody’s Investors Service added pressure Thursday by downgrading the credit ratings on 30 Spanish banks. Moody’s left untouched the ratings of the country’s three largest banks.

With a rescue of Portugal seen now by most analysts as almost inevitable, the debate shifted Thursday to its likely timing — and whether any bailout would precede the formation of a new government in Lisbon following an expected general election in about two months.

“They need to move sooner rather than later,” said David Schnautz, an interest rate strategist in London for Commerzbank. “They probably have the cash buffers to make it through April, but not June.” Mr. Schnautz said it was not clear exactly how much cash remained in the Portuguese Treasury, “but they can’t let it run down to the last €200 million or so without new lending agreements,” he said. Given that, he said, investors would expect to see some form of funding deal in place by late May.

On top of two benchmark government bonds expiring April 15 and June 15, Lisbon has €2.3 billion in shorter-dated bills expiring in July. It will also need to raise additional funds to cover domestic liabilities like social security, but has yet to formally schedule its next bond auctions.