The Associated Press April 27, 2010, 2:23PM ET

Europe debt crisis spreads to Portugal

The government debt crisis that has shaken Europe's shared currency widened and intensified Tuesday as Portugal saw its credit rating cut -- and Greece's was reduced to junk status.

Stocks slid worldwide on the news of the double blow that increased the likelihood of a continent-wide debt meltdown and more market turmoil.

Ratings agency Standard & Poor's sent shock waves around the markets after it downgraded the debt of the two countries and warned that holders of Greek debt could take large losses in any restructuring.

That's not a huge surprise -- the markets increasingly expect Greece's debt will be restructured at some stage even after a euro45 billion rescue package from its 15 partners in the eurozone and the International Monetary Fund.

The real worry is that Greece's debt crisis is mushrooming to other debt-laden members of the eurozone.

One bailout can be dealt with but two will be stretching it -- can Germany, Europe's effective paymaster, continue to bail out the weaker members of the eurozone?

The downgrade of Portugal brought those fears to the fore, after weeks of unsuccesful efforts by European leaders to calm markets.

The crisis threatens to undermine the euro and make it harder and more expensive for all governments to borrow money -- the euro slid over 1 percent following the downgrades to trade at $1.3240, not far off an eight month low.

It has also disrupted cooperation between euro zone governments, with Germany resisting the idea of bailing out Greece unless strict conditions are met.

Nevertheless, most investors think that Greece will have enough money to avoid default in the coming weeks. The future is cloudier.

Both Standard & Poor's and the Greek finance ministry insisted that the country will have enough money in its coffers to make the euro8.5 billion bond payments due on May 19.

Even if it gets it, Greece faces years of austerity with living standards sharply reduced -- Standard & Poor's warned that the Greek economy was unlikely to be as big as it was in 2008 for another decade.

With the economy nosediving, debt repayments accumulating and the society restive and fearful, it takes a brave soul to back the Greek government, led by Prime Minister George Papandreou, to pull through without changing the terms of the debt repayments.

"The latest developments mean that the chances of Greece solving this situation without restructuring its debts are now dim," said Diego Iscaro, senior economist at IHS Global Insight.

As in the financial crisis following the collapse of Lehman Brothers in 2008, investors around the world are fearful about who holds what debt and how much.

Unsurprisingly, stocks tanked.

"We have the makings of a market crisis here," said Neil Mackinnon, global macro strategist at VTB Capital.

The FTSE 100 index of leading British shares closed down 2.6 percent, Germany's DAX slid 2.7 percent and the French CAC-40 in France ended 3.8 percent lower. On Wall Street, the Dow Jones industrial average was down over 100 points in mid-afternoon trading, while the broader Standard & Poors' 500 index fell back below 1,200.

Greek and Portuguese shares were pounded, down 6.7 percent and 5.4 percent, while their market borrowing costs went through the roof -- the interest rate for Greek two-year bonds jumped to a massive 18 percent. That's hardly surprising when one of the world's agencies does not even attach an investment-grade rating on the country's bonds. Junk status means that Greece will have to pay higher costs to borrow if it taps debt markets again.

Meanwhile the interest rate gap, or spread, between Portuguese and benchmark German 10-year bonds -- a key indicator of market skepticism -- rose 57 basis points even before the downgrade to hit 5.86 percentage points. The higher the gap, the less confidence in Portugal -- and it was the widest gap since the shared euro currency, which Portugal and 15 other nations use, came into circulation.

Both governments have imposed budget cutbacks against political resistance from unions at home. Markets have been skeptical that they can push through enough cuts, given political resistance, to put their finances in order.

Both governments responded with alarm at the downgrades.

Greek finance minister George Papaconstantinou siad the downgrade "does nor reflect the real state of our economy, nor the fiscal situation, nor the ongoing negotiations which has the very realistic propects that they will be completed successfully in the next few days."

Nevertheless, he said Greece would pull through.

"One wishes that Europe had acted a little differently. Three and four months ago we were saying that the mechnism must be ready and it must be detailed, that the markets must know what exactly is going. Unfortunately, for a series of political reasons, we are down to the wire," he said.

Meanwhile, Portugal's Finance Minister Fernando Teixeira dos Santos said the downgrade would only make things worse.

"This decision will not help markets to calm down, but will, on the contrary, contribute for their turbulence," Teixeira dos Santos said.

A further worry is that the crisis spreads to Spain, considered too big to be bailed out.

The crisis has also highlighted the inability of the rules set up to support the euro to keep governments from undermining the currency by running up big debts. Those rules limited deficits to 3 percent of grosse domestic product but have been widely flouted, and EU officials are talking about ways to strengthen them.

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AP Business Writer Pan Pylas contributed from London.


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