Have you noticed? There’s something (other than an unusual frequency) about recent Moody’s ratings actions on eurozone peripheral sovereigns.
They’re all increasingly focused on whether the sovereigns can actually maintain market access in the first place, as a ratings red flag.
Exhibit A — Moody’s placed Portugal’s A1 credit rating on review for downgrade on Tuesday, possibly removing one or two notches.
As the agency explained (emphasis ours):
The main triggers for the review include:
(1) Uncertainties about Portugal’s longer-term economic vitality, which will be exacerbated by the impact of fiscal austerity;
(2) Concerns about Portugal’s ability to access the capital markets at a sustainable price; and
(3) Concerns about the possible impact on the government’s debt metrics of further support for the banking sector, which may be needed for the banks to regain access to the private capital markets.
So it’s not just the government’s own direct refinancing needs but also funding requirements of banks, which may end up on its balance sheet.
Moreover, public / private refinancing stress was precisely on Moody’s mind when it placed Spain on downgrade review last week in relation to heavy funding needs next year.
As Moody’s goes on, the liquidity problem is intimately bound up in ongoing concerns around Portugal’s solvency, however:
Moody’s says that an important driver of its decision to review Portugal’s ratings is its concerns over the economy’s sluggish growth, driven mainly by weak domestic demand. In addition, deflationary pressures as a result of fiscal consolidation and bank deleveraging may put additional downward pressure on nominal GDP growth.
The second key driver for the review is the cost that the government might have to pay to fulfill its funding needs for the next several years. “The markets have remained open to the Portuguese government,” adds [Moody’s Vice President and lead analyst for Portugal Anthony] Thomas, “but it is having to pay an elevated price, which if sustained will increase substantially its debt service costs over time.” The lack of success in reducing the budget deficit by much this year, excluding one-off measures, has added to Moody’s concerns in this regard.
Finally, Moody’s sees increasing challenges facing the banking sector that could have a financial impact on the government’s balance sheet. These include the banks’ reliance on the European Central Bank for funding. It is possible that the government may have to provide further support to the banks to help them regain market confidence and allow them to re-enter the private capital markets. Although the Portuguese banking sector has required very little assistance so far from the government, any such financing needs going forward could adversely affect the government’s debt metrics, depending on the circumstances and the amounts required.
In particular, this point on the EFSF is critical:
Regional and local debt market conditions will determine whether the Portuguese government will ultimately decide to move out of the private capital markets and approach the EFSF for funding. If it comes to pass, such a step could in fact positively impact Portugal’s credit risk profile by reducing short-term uncertainties and stabilizing the trajectory of the government’s funding costs. At the same time, however, the circumstances that might lead Portugal to seek liquidity support from official sources would likely also raise concerns about its medium-term prospects of regaining access to private market funding.
Two notes of caution, however. First, Moody’s five-notch downgrade of Ireland last week dealt with the consequences of what happened when Irish banks’ refinancing needs were indeed thrown on to the sovereign balance sheet. That’s the price of a realised liquidity shock.
Furthermore, it’s interesting that Moody’s didn’t discuss the European Stabilisation Mechanism here. It did when placing Greece’s ratings on downgrade review recently, given the way the ESM will facilitate bond bail-ins if Greece needs more eurozone support after 2013. That will be something to worry about over Portugal, too, if it does access the EFSF.
Oh, and that rollover risk?
Rollover is all – FT Alphaville