Fitch downgrades Portugal's rating to junk bond status

With the storm still raging in the euro-zone sovereign debt market, Fitch on Thursday said it had cut Portugal's rating to junk status, citing the country's deficit, heavy debt burden and poor economic prospects.

Fitch downgraded Portugal's long-term sovereign rating to BB+ from BBB-, with a negative outlook, implying further cuts might be forthcoming. Fitch said the sovereign downgrade does not affect corporate ratings.

"The country's large fiscal imbalances, high indebtedness across all sectors, and adverse macroeconomic outlook mean the sovereign's credit profile is no longer consistent with an investment-grade rating," Fitch said in a statement.

Portugal is the third euro-zone country to receive a bailout from the International Monetary Fund and the European Union after Greece and Ireland. The government has committed itself to punishing spending cuts and tax hikes in exchange for a rescue package of 78 billion euros.

The rating downgrade coincided with a general strike called by the country's main unions to protest the draconian austerity drive. The stoppage grounded flights and brought the subway system to a standstill.

Fitch said the downgrade comes within a worsening outlook for Europe as a whole, which will also impact on Portugal. The ratings agency said it now expects Portugal's economy to shrink by 3 percent next year, in line with an estimate by the European Commission, and slightly more than the government's forecast of a contraction of 2.8 percent. Output fell for the fourth quarter in a row in the period July-September driven by a slowdown in exports, and is expected to shrink by 1.8 percent this year.

"Over the next two years, the recession makes the government's deficit-reduction plan much more challenging and will negatively impact bank asset quality," Fitch said.

The agency said it expects the government to meet its target of reducing the budget deficit from 9.8 percent last year to 5.9 percent. It also said the budget for next year is well designed and based on reasonable GDP assumption, which should allow the administration to meet its target for the deficit in 2012 of 4.5 percent of GDP.

Banks at risk

On the positive side, Fitch said the structural reforms undertaken by the government of Prime Minister Pedro Passos Coelho will help enhance the country's competitiveness.

The agency warned the sovereign crisis will also impact the bank system, which "lends to one of the most indebted private sectors in Europe and is highly reliant on wholesale financing, access to which is now closed off."