Portugal raised €1 billion in a short-dated bond sale today but had to pay investors much higher rates of return after Moody's downgraded the indebted country.
The government debt agency said it sold the 12-month bonds at a rate of 4.331%, up from the 4.057% it paid only days ago on March 2 at a similar sale.
Demand also fell sharply - from 3.1 times the amount offered March to 2.2 times today as the Moody's downgrade rattled investor confidence in Portugal's ability to pay its way and avoid a debt bailout after fellow euroz one strugglers Ireland and Greece had to be rescued last year.
Such fears have driven yields - the rate of return buyers get on their investment - of Portuguese benchmark 10-year bonds way above 7% recently, an unsustainable level for the longer-term.
Ratings agency Moody's slashed Portugal's government debt rating late last night, dealing a new blow to the euro zone country's efforts to surmount its fiscal woes.
Moody's lowered Portugal's long-term government bond rating to A3 from A1, and gave it a negative outlook, citing concerns the government will not be able to balance its books amid 'subdued growth prospects'.
It questioned whether the country can implement dramatic spending cuts, as it faces political headwinds and the possible need to aid struggling banks and government-backed firms.
Moody's also cast doubt on Portugal's ability to quickly become more productive, a step that would boost growth-spurring exports and raise government revenues.
'Since the external adjustment is likely to take several years to complete, concerns about the growth outlook are likely to persist for some time,' the bond rater said.
The move came as Portugal's socialist minority government faced an onslaught after announcing a new austerity package Friday, raising fears it could fall. Finance Minister Fernando Teixeira dos Santos said the government would sharply cut spending this year to bring down the government deficit to a market-palatable 4.6%, and then to the euro zone limit of 3% in 2012.
But Moody's cast doubt on the government's ability to implement that package, despite the support for it from the European Union and financial markets. Instead of consolidating, Moody's said government spending may need to expand further 'in the event it has to provide financial support to the banking sector and government-related institutions, which are currently unable to access capital markets.'
Yet, Moody's also said Lisbon would face challenging market conditions, including an expected rise in euro zone interest rates, that 'will cause its debt affordability to weaken.'
Ironically, the Moody's downgrade is likely to add to Lisbon's difficulty to raise more financing. Portugal's debt stood at €143 billion in 2010, or 83.3% of GDP, far above the EU limit of 60%.
Last week the country struggled to raise new funds, with investors driving yields on its 10-year bonds at 7.4%, a level widely considered unsustainable.
Given Lisbon's conundrum - it might have to spend more to strengthen the economy, but lenders won't support such action - Moody's said a further downgrade of Lisbon's rating was 'likely' over the next one to two years.
