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Rating Action:

Moody's downgrades Portugal's bond ratings to Baa1 from A3, still under review down

 The document has been translated in other languages

05 Apr 2011

London, 05 April 2011 -- Moody's Investors Service has today downgraded Portugal's long-term government bond ratings by one notch to Baa1 from A3 and placed the rating on review for possible downgrade. Concurrently, Moody's placed the government's (P)Prime-2 short-term debt rating on review for possible downgrade.

Moody's rating action was driven primarily by increased political, budgetary and economic uncertainty, which increase the risk that the government will be unable to achieve the ambitious deficit reduction targets set out in the update of its Stability and Growth Programme for 2011-2014 and put its finances on a sustainable trajectory.

The main triggers for the one-notch downgrade and review include:

1. The uncertain political outlook, following the resignation of the government after the rejection by the parliament of the additional budget measures announced on 11 March and resulting reduction in the speed and decisiveness of policy making;

2. The short- and medium-term funding challenges, set in the context of the recently agreed European Stability Mechanism (ESM), which contemplates debt restructuring as a distinct possibility; and

3. The medium-term implications of last week's revisions to the estimates for the budget deficit and outstanding government debt for fiscal consolidation.

The limited migration of the rating to Baa1 (and not lower) in today's action, reflects Moody's assessment that assistance would be provided by the other members of the Eurozone if Portugal needs financing on an expedited basis before it can obtain funds from the European Financial Stability Facility (EFSF). Moody's believes the new government will likely approach the facility as a matter of urgency.

The outcome of the review and the maintenance of the country's rating within the Baa level will be critically influenced by the capacity of the country to secure sustainable sources of funding over the medium term and the ability of its political institutions to stay the course of fiscal consolidation and structural reforms.

Portugal's country ceilings for bonds and bank deposits are unaffected by today's rating action and remain at Aaa (in line with the Eurozone's rating).

RATINGS RATIONALE

In Moody's most recent rating action on Portugal on 15 March 2011, the rating agency stated that the commitment of both major parties to fiscal consolidation was an important reason why Portugal's rating had remained at the low end of the A rating range. The failure of the parties to reach agreement over a further tightening of fiscal policy necessary to achieve the budget deficit target of 4.6% for this year -- and to implement further structural reforms needed to increase the flexibility of the labour markets, amongst other things -- has meant that this assumption has had to be qualified. Furthermore, the political vacuum created by the resignation of the government at a critical juncture illustrates the uncertainties surrounding the speed and decisiveness of policy making now and in the future. It also raises questions about the government's ability -- whatever the views of the respective parties -- to achieve the ambitious structural changes required.

It is very unlikely that the long-term debt markets will reopen to the Portuguese government or to the Portuguese banks to any meaningful extent until the government is able to take action to dispel doubts over its commitment and ability to implement the fiscal programme. That in turn raises the probability that the government will remain reliant on its Eurozone partners for support once the EFSF expires and the ESM is introduced. While the review period is intended to allow time to assess the implications of recent announcements by the European authorities for the medium term credit environment in Europe, it seems increasingly clear that any ESM lending will first require a solvency analysis by EU officials, and if there are doubts over a government's solvency -- which could be the case if Portugal were to remain reliant on support funding for a sustained period -- private creditors would be expected to bear losses as a condition of continued support.

Moody's also commented that although it was unclear how the government was going to fund its debt refinancing needs over the next few months, Moody's believes (based on its conversations with government officials) that the Portuguese authorities have adequate contingency plans in place should the government be unable to raise the needed funds in the market. In particular, Moody's believes ample and timely assistance would very likely be provided by the other members of the Eurozone if Portugal needed funds on an expedited basis, before it could obtain funds from the EFSF.

FACTORS TO BE CONSIDERED IN THE REVIEW

The resolution of the political predicament will have to await the general elections scheduled for 5 June and the consequent formation of a new government. The latter could take up to a month after the polls and the outcome is uncertain. Moody's central case remains that the incoming government would seek to demonstrate its continued commitment to fiscal consolidation. However, it is not clear how much support that government will command in the new parliament and the implications of this for its ability to implement an ambitious fiscal programme. As part of the review, Moody's will examine the policy framework introduced by the new government. Moody's rating conclusion will be heavily influenced by the scope, nature and achievability of measures announced to address the country's budgetary and economic problems.

Following the rejection of the measures announced on 11 March, Moody's believes that the government's current cost of funding is nearing a level that is unsustainable, even in the short-term. A critical part of the review will focus on the ability of the government to secure financing at a less elevated level, either through the capital markets or through EU support. In the highly likely event that the new government approaches the EFSF for assistance, Moody's will consider any subsequent agreement to assess both its impact on the government's debt metrics and economic structures, but also the likely implementation risks. At the same time, the rating agency acknowledges that the additional pressure that an EFSF programme could exert on fiscal consolidation would be credit-supportive.

Accessing the EFSF may also lead to a reduction in financing costs whilst Portugal draws on the facility. But as noted above it also raises questions over when the government would be able to re-access the capital markets and on what terms. The capital markets are increasingly focusing on possible downside risks to Portugal accessing the EFSF's proposed successor, the ESM. Therefore, the rating agency will consider and discuss with the authorities the likelihood of Portugal being able to re-enter the capital markets before the EFSF expires in mid-July 2013 and the implications for creditors if it cannot and instead needs to access the ESM.

Finally, Moody's will consider the impact of last week's revision to budget deficit and government debt figures. The rating agency acknowledges that the revision does not stem from incorrect reporting in the past and that whilst not previously on the government's balance sheet, the information was known. Our analysis will seek to confirm that the revision does not materially impact the fiscal dynamics or that if it does, the government is able to take compensatory measures.

Given that elections are being held to resolve the political situation, the review may take longer than its usual three-month review cycle. Nonetheless, the rating agency expects to conclude by the end of July. Moody's will revisit the rating sooner if (i) doubts emerge with respect to Portugal's potential support from other Eurozone members before the government can access the EFSF, or (ii) it appears likely that the incoming government will be less committed to fiscal consolidation and structural reform.

PREVIOUS RATING ACTION AND THE METHODOLOGY

Moody's previous rating action on Portugal was implemented on 15 March 2011, when the rating agency downgraded the government's long-term debt rating by two notches to A3 and assigned a negative outlook. It also downgraded the government's short-term debt rating to (P)Prime-2 from (P)Prime-1.

The principal methodology used in this rating was Moody's "Sovereign Bond Ratings Methodology", which was published in September 2008 and is available on www.moodys.com.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, and public information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of maintaining a credit rating.

This rated entity participated in the credit rating process. The rated entity or its related third party, if any, did provide the rating committee access to the books, records and other relevant internal documents of the rated entity.

The rating has been disclosed to the rated entity or its designated agents and issued with no amendment resulting from that disclosure.

Moody's Investors Service may have provided Ancillary or Other Permissible Service(s) to the rated entity or its related third parties within the three years preceding the Credit Rating Action. Please see the ratings disclosure page www.moodys.com/disclosures on our website for further information.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

London
Anthony Thomas
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

New York
Bart Oosterveld
MD - Sovereign Risk
Sovereign Risk Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service Ltd.
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Moody's downgrades Portugal's bond ratings to Baa1 from A3, still under review down
No Related Data.
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