Moody's downgrades Portugal credit rating

Ratings' agency Moody's has downgraded Portugal's rating by a notch from A3 to Baa1.

The agency said it expected a further cut given the country's budgetary, political and economic uncertainties.

Portugal, tipped to be the next EU country to require a bailout, is to hold a general election on June 5.

Moody's said the range of difficulties, including the upcoming general election on June 5, increase the risk that Portugal will be unable to achieve the outgoing government's ambitious deficit reduction targets over the coming three years and put the public finances into shape.

Moody’s also said the recent agreement to replace the current bail-out fund with the European Stability Mechanism from 2013 acted as an additional trigger for the downgrade as it contemplates the possibility of a debt restructuring within the euro area.

Though the election following last month’s resignation of the previous government complicates how Portugal can tap the EU’s current bail-out fund, Moody’s reckons other countries in the eurozone would provide Portugal with help if required in the interim period.

However, once the election is out of the way, Moody’s said it expects the new government will “likely approach the facility as a matter of urgency”.

Approaching its partners may become inevitable if Portugal’s ability to tap bond market investors dries up.

The country faces a couple of key tests over the coming months. As well as having to repay a €4.5bn loan in April, it has an almost €5bn bond repayment two months later.

Moody’s said 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 can take action to dispel doubts over its commitment and ability to implement its adjustment programme.

With the country’s borrowing costs seemingly hitting a record euro-era high on a daily basis, investors think it is becoming increasingly unlikely that Portugal will be able to deal with its problems on its own.

By early morning, the yield on Portugal’s 10-year bonds were up a further 0.04% to a prohibitive 8.63%.

Moody’s said it believes that the government’s current cost of funding is “nearing a level that is unsustainable, even in the short-term”.