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Portugal debt cut to junk rating by Moody's on fears another bailout looms

July 5, 2011 |  1:18 pm

Portugal's government debt was downgraded to junk status Tuesday, another reminder that the European debt crisis is far from over.

Moody's Investors Service slashed Portugal's rating to Ba2 from Baa1 and said the outlook remained negative. Any rating below Baa means the issuer’s debt no longer is considered investment grade.

The move sparked a modest bout of selling in U.S. stocks. The Dow Jones industrial average, which was treading water for the session after last week’s 5.4% surge, fell into the red after Moody’s decision. The Dow closed off 12.90 points, or 0.1%, to 12,569.87.

Portugal Moody’s said the downgrade was triggered by “growing risk” that Portugal would need a second bailout by the rest of Europe, and that private bondholders could be forced to participate in a bailout as a precondition for more aid.

The ratings firm also cited “heightened concerns” that Portugal wouldn't be able to slash spending fast enough to meet European Union goals set as part of the country’s initial bailout deal hammered out this spring.

Stocks rallied worldwide last week in part on hopes that Europe’s debt mess was easing. Greece’s Parliament approved new austerity measures demanded by the EU in return for more financial help.

But a potential sticking point in the latest Greek rescue is whether banks and other private investors that hold outstanding Greek bonds can agree to restructure the debt as a way of contributing to a second bailout -- a key demand of a group of German legislators.

A restructuring could mean investors would accept a cut in their interest earnings or exchange existing bonds for longer-term securities.

Another ratings firm, Standard & Poor’s, has warned that even a voluntary restructuring by investors could be considered a “selective default” by Greece. Even though everyone knows Greece is insolvent, actually labeling the debt in default could wreak havoc with the European financial system by potentially cutting off market funding to Greek banks that own hefty amounts of Greek bonds.

Banks and other private investors are scheduled to meet Wednesday to discuss how to proceed with a Greek rescue plan.

Moody’s, in downgrading Portugal, clearly is worried that a Greek deal with private bondholders could set the stage for Portuguese bondholders also to be forced into concessions.

"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," Moody's said.

The announcement came after European markets closed. Most European stocks fell modestly Tuesday. The euro currency slid 0.8% after Moody’s decision, falling to $1.442 from $1.454 on Monday. The euro had jumped 2.4% last week against the dollar.

Moody's rivals S&P and Fitch Ratings still rate Portugal's debt investment grade, though barely.

-- Tom Petruno

Photo: The Portuguese Parliament in Lisbon. Credit: Francisco Leong /AFP/Getty Images

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