Tuesday, July 5, 2011

Portugal's Debt at Junk Status

Today, Moody's downgrades Portugal's national debt to junk status. This means a number things, foremost of which is that it closes large sectors of the debt market to Portugal, including pension funds, sovereign funds, value funds, and those investors that cannot, by virtue of their rules or strategies take on the types of risks implied by junk status.  More critically, this means that it will now be very costly for Portugal to restructure its public debt either by assets sales or the rewriting of covenants.

In some ways, the downgrade is not surprising. Portugal, Ireland, Greece and Spain are struggling to realign public spending entitlement, existing debt obligations, and tax revenue with the realities of slower consumption, lower productivity, and international competition from the emerging economies.

The U.S. has many of the structural problems (both private debt and public entitlements) currently experienced by the PIGS. Its still large domestic economy has allowed a delay of the critical fixes. It's not a good idea, however, to hope that the problems will go away if the economy re-inflates since the causes of the problems are not going to disappear.

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