A leading credit rating agency downgraded Portugal's debt Wednesday amid growing concerns about the government's ability to service its borrowings, another piece of bad news for the euro zone as it struggles to deal with a debt crisis.
Fitch Ratings said that Portugal's prospects for recovery were weaker than its peers in the euro zone, adding that this will put make it harder to shrink its budget deficit over the medium term.
"A sizable fiscal shock against a backdrop of relative macroeconomic and structural weaknesses has reduced Portugal's creditworthiness," said Douglas Renwick, Associate Director in Fitch's Sovereign team.
In 2009, Portugal had a deficit representing 9.3 percent of its national income. That was higher than the 6.5 percent forecast by Fitch as recently as September and underlines why the ratings agency lowered its rating on the country by one notch to AA negative.
Despite the downgrade, Portugal's debt is still considered investment grade and still a few notches above its rating of crisis-stricken Greece.
However, Fitch said the outlook remains negative and that a further downgrade could be in the offing if the recovery is not as strong as anticipated in the coming two years.
Fitch said the negative outlook reflects its concerns about the potential impact of the global economic crisis on Portugal's economy and public finances, given the country's structural weaknesses and high indebtedness across all sectors of the economy.
Fitch said the Portuguese government has to implement "sizable" spending cuts and tax increases to meet its target of getting its deficit to 3 percent of economic output by 2013.
Though, the government's recently announced budget plans were "broadly credible," Fitch said "the risk of macroeconomic disappointment — with knock-on effects to the deficit — is significant, particularly in the latter years of the government's projection."
Further underperformance in 2010 and 2011, on the budget or the economy in general, could lead to another downgrade, Fitch said.
Pressure for another downgrade could be eased, however, by a sustainable economic recovery, meeting deficit reduction goals and implementing further reforms to enhance the productivity and competitiveness of the economy.
Fitch also said that Portugal's rating was supported by a relatively strong banking system, membership in the euro and low historical volatility in inflation, growth and tax payments as well as a moderate debt service burden.
Broad political consensus on the need for action on the budget and reforming the economy were also considered a boon for the country's rating.
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