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European Debt Worries Deepen As S&P Downgrades Portugal, Greece

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Adding to recent concerns about the sovereign debt situation in Europe, rating agency Standard & Poor's lowered its sovereign credit ratings on both Portugal and Greece.

S&P cut Portugal's senior debt rating by one notch to BBB- from BBB. At the same time, the ratings on Portugal were removed from CreditWatch with negative implications, where they were placed on November 30, 2010.

The downgrade comes after the Bank of Portugal on Tuesday cut its economic forecasts for 2011 and 2012 and said substantial measures will be needed to meet the government's deficit-reduction goals.

Risks of a challenging economic and financial environment could negatively affect asset quality and profitability in the Portuguese financial system, potentially triggering the need for capital support from the government, S&P noted.

S&P said Portugal's fiscal deficit is likely to exceed the targets established in the Stability and Growth Programme by around 3% of GDP in cumulative terms between 2011-2014.

The uncertain outlook on the economy means that there are sizable downside risks to this relatively benign scenario, given the sensitivity of tax receipts to domestic demand and to imports, amid pressures on commercial banks to tighten credit, the agency cautioned.

Further, the rating agency said it has lowered its long-term sovereign credit rating on the Greece by two notches to BB- from BB+ and noted that the rating remains on CreditWatch with negative implications, where it was placed on December 2, 2010.

The rating agency said it aims to resolve the CreditWatch listing within the next three months, after the Greek government releases its final data on 2010 budgetary performance and fiscal trends in 2011 become clearer.

S&P also cautioned of growing risks to Greece's budgetary position, highlighted by what it viewed as the likely budgetary deterioration in 2010.

The agency sees a relatively higher cash deficit and larger outstanding spending arrears than planned and noted that the general government deficit could exceed the government's target of 9.6% of GDP. Further, it said Greece has not sufficiently tightened spending controls to prevent further accumulation of arrears in 2011.

S&P said the government still has significant borrowing needs and will likely need more help beyond the current 110 billion euros in rescue loans it has received from the IMF and other EU nations that use the euro.

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