Moody's downgrades Portuguese bonds to junk status
Guardian: Concerns over Portugal emerged as Angela Merkel urged European leaders to trust the evaluations of the IMF, the ECB and the European commission
The German chancellor, Angela Merkel
The German chancellor, Angela Merkel, is pressing the ECB to soften its stance on accepting Greek bonds. Photograph Antti Aimo-Koivisto/AP
A dangerous new phase in the eurozone crisis opened up on Tuesday after the ratings agency Moody's downgraded Portugal's debt to junk status and said that it would need a second bailout.
As the currency area's big banks meet in Paris on Wednesday to refine their plans for a second bailout of Greece, Moody's issued a devastating analysis of Portugal's finances as it cut the country's credit rating by four notches, pushing it into junk territory.
The agency said it had rising concerns that Portugal could not fully achieve its budget deficit reduction plans and was facing "formidable challenges in cutting spending, increasing tax compliance, achieving economic growth and supporting its banking system".
There was an "increasing probability" that Portugal would be unable to borrow at sustainable rates in the market, forcing a bailout on top of the €80bn (£72bn) it accepted from the IMF and EU in April.
The prospect of the continuing problems in Greece spreading to another of the eurozone's weak economies is a scenario politicians and finance chiefs in Europe have been determined to avoid.
Tuesday's developments came after Angela Merkel, the German chancellor, stepped up the pressure on the European Central Bank (ECB) to overlook its ban on accepting defaulted bonds as collateral for loans, as the chancellor sought to remove a significant roadblock to the latest Greek rescue package.
A day after Standard & Poor's delivered a potentially lethal blow to a key Greek debt-swap scheme, by ruling that it would amount to a "selective default" on the bonds involved, Merkel urged the ECB and other authorities to ignore the ratings agency's advice.
"I think it's important that we in the Troika – the International Monetary Fund, the European Central Bank and the European Commission – don't allow ourselves to relinquish our freedom to judge." Merkel said. "That's why I trust in the evaluations of these three institutions when it comes to specific procedures" rather than those of rating agencies.
Yesterday said Merkel, as Meanwhile on Tuesday Germany's constitutional court began hearing a case that will decide whether her government was right to agree last year's multimillion-euro bailout of Greece and the accompanying rescue package for other faltering EU countries.
The case has been brought by Peter Gauweiler, a renegade MP in Angela Merkel's conservative bloc, along with a group of professors who argue that the measures violate EU no-bailout provisions and German constitutional clauses protecting property and democracy. They have the support of the majority of ordinary Germans, who were fiercely opposed to "their money" being used to bail out less prudent countries.
The plans put forward by German and French banks last week would leave bondholders nursing losses, prompting S&P to rule on Monday that the losses would amount to a default. This was a severe blow to the proposals, contingent on Greece not reneging on its debt, because the central bank has said it will not accept defaulted bonds as collateral.
Merkel's comments add to mounting pressure on the ECB to make an exception for Greece and allow as collateral bonds that may have technically defaulted – but only because of a debt rollover agreed voluntarily by investors. Although the ECB is understood to be determined to stand its ground, economists believe it is increasingly likely that president Jean-Claude Trichet will have to find a way around the ban on defaulted bonds. The ECB has lent Greek banks €98bn and its continued support is essential for the economy's survival.
It is understood that the ECB is seriously considering requiring all three of the major ratings agencies to rule that the debt-swap proposals amounted to a default before refusing to take the bonds as collateral. Although S&P is the only agency to have publicly announced its view on Greece, the other two – Fitch and Moody's – are widely expected to reach the same conclusion, based on more general statements they have made recently about what constitutes default.
The eurozone's big banks will meet in Paris on Wednesday to refine their debt-swap proposals and they will be looking at ways to sweeten the deal for investors, as they try to satisfy Germany's desire for investors to share the losses, while persuading agencies that this is not a default.