Europe's debt crisis deepened Tuesday as Greece suffered fresh blows and investors increasingly turned their guns on Portugal.
Portuguese bonds slumped Tuesday as bond holders took the view that the country's credit quality is deteriorating, even though its deficit and debt ratios are not as dire as Greece's.
Just hours later, Standard & Poor's cut the country's debt ratings given a weakening outlook and "the amplified fiscal risks Portugal faces." S&P also cut Greece to junk status as European stocks plunged and the euro fell.
"Investors are looking for the next weak link in the euro zone," Simon Ballard, credit analyst in London with RBC Dominion Securities, said in a phone interview. "That may be Portugal, though it's a bad day for everyone in Club Med."
Credit default swaps on Portuguese debt soared to as high as 380 basis points, up about 40 points from Monday, in early afternoon trading in Europe. That means it costs $380,000 (U.S.) to insure every $10-million of Portugal's debt against default. Credit default swaps in other Mediterranean countries also rose. Italy, which has one of the world's highest debt-to-GDP ratios, saw its credit default swaps widen by about 10 basis points, to 160 points.
"The contagion is definitely spreading and spreading quite rapidly to Portugal, Spain, Ireland and Italy," Mehernosh Engineer, a credit strategist at BNP Paribas, said in a report published Tuesday. "The market has been in a show-me-the-money mode for well over three months and the lack of guidance is slowly and steadily sowing the seeds of a double-dip."
Most European stock indexes were down by 1 per cent or more on fears the debt crisis is spreading. The euro lost 0.68 per cent against the U.S. dollar.
The market sentiment is deteriorating partly because of the uncertain timing and conditions of the Greek bailout package that is to be delivered by the European Union and the International Monetary Fund. On Monday German chancellor Angela Merkel said she won't release the funds until Greece presents a "sustainable" long-term plan to reduce its budget deficit, which stands at 13.6 per cent, after two upward revisions this year. Only Ireland's is higher.
Portugal's efforts to convince the market that it is healthier than Greece have so far been unsuccessful.
"We do not ignore that Greece's particular situation has contagion risks and we are feeling it," Finance Minister Fernando Teixeria dos Santos told reporters in Lisbon last Thursday. "The performance spreads in the market reveals that contagion risk."
Portugal's deficit, at 9.4 per cent, is considerably lower than Greece's. But it's still three times higher than the limit set by the EU. It debt, at 77 per cent of GDP, is nowhere near a high as Greece's, which stood last year at 110 per cent.
But Portugal is not growing, is economically tied to Spain, where the unemployment rate is 20 per cent. It suffered a debt downgrade recently and has yet to convince the capital markets that it has a credible austerity plan.
"We' don't know how Portugal's problems will be addressed," said Mr. Ballard, of RBC.
Some economists think Portugal may need a Greek-style bailout. Both countries face potential debt restructurings, under which the overall debt burden would be reduced through principal "haircuts," longer debt maturities or lower interest rates.
Portugal has pledged to cut its deficit to 2.8 per cent of GDP by 2013. Investors are not convinced it can do so, partly because the country's socialist government, led by Prime Minister Jose Socrates, lacks a parliamentary majority and may not be able to push through unpopular legislation.