Portugal pays heavily to borrow, S&P cuts Ireland

By Andrei Khalip and Carmel Crimmins

LISBON/DUBLIN (Reuters) – A successful Portuguese debt sale on Friday did little to cull expectations it will soon join the euro zone bailout list, while Ireland’s credit rating was cut after bank stress tests revealed another black hole.

Portugal sold 1.645 billion euros of short-dated bonds, but had to offer an interest rate of 5.79 percent, lower than other current market rates but 2.5 percentage points more than it paid at auctions of similar bonds last year.

The result means Lisbon is now having to pay a higher interest rate to borrow money for the next 15 months than Spain is paying to raise funds for 10 years — a clear indication of how much risk investors now attach to Portugal.

Portugal’s 10-year bond yields went on rising despite the smooth auction, hitting 8.77 percent, up more than a percentage point in the past week. Ireland’s reached 10.1 percent, nearly 6.5 percentage points higher than benchmark German Bunds.

Richard McGuire, a debt strategist at Rabobank, said that while Friday’s auction showed Lisbon could still tap the markets if needed, the trend was bleak.

“(Portugal) is fundamentally insolvent — i.e. it is clearly in a situation where debt will have to be issued to cover servicing costs, thereby resulting in a snowballing of liabilities,” he said.

Standard & Poor’s stripped Ireland of its last ‘A’ rating but the one notch cut and stable outlook was less severe than feared and it gave the thumbs up to stress tests which on Thursday showed its four troubled banks needed a further 24 billion euros to be properly capitalized.

S&P, whose rubbishing of a previous “final bill” for Ireland’s banking sector sent the country’s debt crisis into overdrive last year, said the assumptions underlying the latest round of tests were robust.

But rival agency Fitch took the shine off S&P’s modest downgrade when it warned it could cut its BBB+ rating on the back of weaker growth and a jump in the bank bailout costs.

A Reuters poll of economists found a consensus forecast of just 0.5 percent growth in Ireland this year, well below the official forecast of 1.7 percent and weaker than the 0.9 percent pencilled in by the European Commission and IMF.

Underscoring the tenuous nature of Portugal’s finances, the statistics agency had to restate the 2010 budget deficit on Thursday, increasing the shortfall to 8.6 percent of gross domestic product from 7.3 percent.

The adjustment was down to methodology and will not affect 2011 figures, but still undermines broader confidence.

Financial markets are convinced Lisbon will have to ask the European Union and International Monetary Fund for a bailout, but Portuguese leaders are adamantly opposed. Credit ratings agencies have already downgraded Portugal.

Caretaker Portuguese Prime Minister Jose Socrates, who resigned last week after parliament rejected his latest spending cuts, has made it a point of honor not to accept EU/IMF help and is likely to hold that line until new elections.

Portugal’s president dissolved parliament on Thursday and set June 5 as the date for the next polls, meaning the country is effectively in limbo for two more months.

While Portugal can probably go on funding itself for the next eight weeks — it has to refinance 4.3 billion euros ($6.1 billion) of debt in April and 4.9 billion in June — the cost of doing so is likely to go on being punitively high.

SPAIN MAY ESCAPE

The debt crisis in the euro zone has already consumed Greece and Ireland and shows few signs of relenting.

Greece, which agreed 110 billion euros of bilateral loans with the EU and IMF last May, is making efforts to cut spending and increase revenue to overhaul its economy, but questions remain about whether it can get on top of its finances.

The 24 billion euros extra bank bill for Ireland, which received an 85 billion euro package of aid from the EU and IMF in November, was in line with market expectations and, coupled with the European Central Bank’s decision to suspend collateral requirements for loans from Ireland, gave the Irish banking sector a lift on Friday.

The European Commission said it believed the stress tests had been “extremely rigorous” and that there should now be no more surprises lurking for the financial markets.

But Ireland still has accumulated bank liabilities of nearly 45 percent of GDP and will have total debts of well over 100 percent of GDP if forecasts from the stress tests are right.

If the European Central Bank raises interest rates next week as expected, the impact on growth and debts will be even greater.

Portugal finds itself in a similar conundrum. Its economy is forecast to contract by around 1.0 percent this year, according to the latest European Commission forecasts. As a result, the debt-to-GDP ratio will climb without the debt increasing.

Spain, though, continues to look as if it has done enough to stave off the pressure from financial markets.

While Spain shares many of the features of Ireland and Portugal — high deficit, high public sector debt, structural banking issues — it has bitten the bullet on making spending cuts and retooling its economy.

“Resilience in the Spanish macroeconomic performance since the summer of 2010, in spite of painful fiscal consolidation and very elevated unemployment, is likely into the next few years,” Deutsche Bank said in an economic report.

“This country should be able to deliver a positive, albeit slow, growth rate consistent with a sustainable path for public debt,” it said.

(Additional reporting by Sergio Goncalves and Shrikesh Laxmidas in Lisbon, and by Charlie Dunmore in Brussels; writing by Luke Baker, editing by Mike Peacock)

Portugal pays heavily to borrow, S&P cuts Ireland