UPDATE 2-EU bailout plan raises short-term default risk: Fitch

* ESM could help in long term but increases short-term risk

* Fitch says likely to cut Portugal rating if no bailout

(adds analysts, Fitch director, details on Greece, Spain)

By Ingrid Melander

ATHENS, March 30 (Reuters) – Plans for the euro zone’s new
bailout fund increase the risk in the short term that weaker
economies will default, Fitch Ratings said on Wednesday after
Standard & Poor’s downgraded Greece and Portugal due to similar
concerns.

Fitch said last week’s decision to give the future European
Stability Mechanism preferred creditor status could deter
private investors from buying the bonds of the weakest euro zone
states.

This would drive up these countries’ borrowing costs, making
governments more likely to resort to defaulting on their debts,
even before the ESM is created in 2013.

“In the short term, it potentially increases the risk of
sovereign default arising from the current crisis by making it
more, rather than less difficult for sovereigns currently under
stress to secure affordable medium and long-term financing from
the market,” Fitch said in a statement, which did not include
any announcements of rating cuts. [ID:nLDE72S1LY]

Standard and Poor’s cut Greece and Portugal’s ratings on
Tuesday over risks that the ESM would increase the likelihood of
debt restructurings.

The European Commission challenged S&P over the Greek
downgrade on Wednesday, saying it did not share the agency’s
view and had concerns about how credit rating agencies
functioned. [ID:nLDE72T18V]

S&P also cut Cyprus’s long-term sovereign rating to A- from
A on Wednesday, its second cut in five months, citing worries
about Cypriot banks’ exposure to Greek debt. [ID:nLDE72T1MQ]

PROTECTING TAXPAYERS

Many investors see a significant chance that Greece,
possibly Ireland and even Portugal will eventually have to
restructure their debts, saying the obligations they have
amassed are too big to be whittled away by austerity programmes.

Analysts said the concerns Fitch and S&P were expressing
about the ESM showed how difficult it was for the European Union
to decide to what extent private bondholders should be involved
in finding a solution to the bloc’s debt crisis.

“The EU is between a rock and a hard place. They have to
find the balance between protecting taxpayers’ interests and not
making it more difficult for highly indebted economies to access
markets,” said Diego Iscaro, at IHS Global Insight.

Others said the EU must tread carefully to avoid alienating
investors.

“If their intention is that all debt could be restructured,
if they came out and said that, that might unsettle markets even
more,” said Ben May at Capital Economics.

RATINGS

Fitch said that the outcome of last week’s EU summit was not
the main determinant for its euro zone ratings and that it was
still focused on public finances and macro-economic indicators.

The main short-term risks to Ireland’s sovereign rating
remained the recession and possible additional bank support
costs, it said, while it will keep judging Spain mostly on its
budget consolidation efforts and cost of restructuring banks.

Portugal’s A- rating, which is on credit watch negative, is
most at risk of a downgrade, said Paul Rawkins, Fitch’s senior
director for western Europe.

The agency, which cut Lisbon’s rating last week when the
Prime Minister resigned, warned on Wednesday it was likely to
cut it further soon if Portugal did not seek a bailout.

In the longer term, Fitch said, the ESM should help resolve
future debt crises and could help strengthen the credit profile
of highly indebted countries such as Belgium and Italy.

“Nevertheless, in the short term their ratings could still
come under downward pressure if current deficit reduction
targets are missed,” Fitch said.

The EU’s new bailout fund puts increased pressure on
Greece’s junk rating.

“For Greece, the programme relies on them regaining (market)
access in 2012 and that looks increasingly unlikely now,”
Rawkins told Reuters. “The implementation risk (to the current
EU/IMF bailout plan) is high and will get higher because the
measures they are required to take will become more difficult.”

Europe’s politicians have been openly critical of the credit
rating agencies and last year summoned executives including
Moody’s chief Michel Madelain and S&P’s President Deven Sharma
for a grilling before finance ministers.

The EU’s executive has told the agencies to watch their step
when judging a country’s financial health, saying it will probe
their work and could even set up a rival rating agency. But so
far, little has come of these threats.
(Editing by Ruth Pitchford)

UPDATE 2-EU bailout plan raises short-term default risk: Fitch