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Portugal scrapes by debt test as political crisis, bailout loom

Finance minister says current market conditions not "sustainable" in the medium-to-long term

Portugal's borrowing costs rose at a debt tender on Wednesday just hours after Moody's Investors Service cut the country's credit ratings and Prime Minister José Sócrates warned of a political crisis over deficit-cutting measures that could trigger the need for a bailout.

The debt management agency IGCP said it sold 1 billion euros in 12-month Treasury bills at an average rate of 4.331 percent, up from 4.057 percent at an auction for one-year paper held on March 2. The yield on the five-year government bond rose slightly to 7.75 percent, while the yield on the benchmark 10-year bond was also a tad higher at 7.44 percent. Finance Minister Fernando Teixeira dos Santos told parliament on Wednesday that current funding costs in the market are not "sustainable" in the medium-to-long term.

In an interview late Tuesday with SIC television, Sócrates, warned that if parliament voted against the latest batch of austerity measures to rein in the shortfall in its finances, the minority Socialist government would not be a position to continue.

"As I understand it, the consequences of a political crisis could aggravate the financial risks facing the country and push Portugal into having to seek outside intervention," the premier said. "I have been trying to avoid that scenario for the past six months."

Meanwhile, Moody's said late Tuesday it had downgraded Portugal's rating to A3, just four notches above junk status, accompanied by a negative outlook suggesting further cuts may be in the offing. Moody's cited the "significant challenges" facing the government in restoring its financial situation in an environment in which the economy is struggling.

Finance Minister Fernando Teixeira dos Santos on Wednesday echoed Sócrates by warning that if deputies rejected the new austerity measures it would "push the country toward external aid."

Just hours before a meeting last Friday of European leaders to approve beefing up the European Financial Stability Fund (EFSF) to help out euro-zone members in difficulties, Portugal unveiled further deficit-cutting measures amounting to 4.5 percent of GDP over the next three years aimed at narrowing the shortfall in its books from around 7 percent of GDP last year to 2 percent in 2013 as part of its Stability and Growth Pact (SGP) program to be presented to the European Commission. The measures included cuts in pensions of over 1,500 euros a month. Teixeira dos Santos told parliament on Wednesday that country is on track to meet its deficit target for this year of 4.6 percent of GDP.

The main opposition Social Democrat Party (PSD), whose support the Socialists require in parliament, has rejected the new measures. "The PSD is making full political use of the situation," Sócrates said. "I very much lament the opposition's attitude without them conceding any scope for concessions." The prime minister said he was open to negotiate on the government's SGP proposals.

Teixeira dos Santos said he wants parliament to approve the SGP program ahead of a European summit meeting slated for March 24-25 on the euro-zone debt crisis. "If parliament votes against the SGP this would mean the government would not be in a position to make international commitments at the European summit," Sócrates said Tuesday.

The new austerity measures threaten to tip the Portuguese economy back into recession. GDP shrank 0.3 percent in the last quarter of 2010 from the previous three years, although output was up 1.3 percent for the whole of the year. The Bank of Portugal is forecasting the economy will contract 1.3 percent this year, while the government is predicting growth of 0.2 percent.

"The government faces significant challenges, not least a less supportive economic environment," Moody's said in its statement. Gross domestic product is expected to "decline this year and experience a weak recovery at best in 2012," it said.

"Rising inflationary pressures could lead to an increase in the ECB's policy rate, which could aggravate the Portuguese government's funding costs and put additional pressure on private-sector borrowing costs," Moody's added. "Should oil prices rise further and remain high for over a long period, external imbalances would worsen, given Portugal's dependence on imported energy."

Portugal's Finance Ministry accused Moody's of being "hasty" but not taking into consideration the developments expected to emerge from the European summit later this month, while Teixeira dos Santos said the downgrade was "expected" to bring Moody's rating in line with other agencies. Fitch cut its ratings for Portugal to A+ from AA- at the end of last year when Standard & Poor's placed its A- rating under review with negative implications.

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