Thursday, March 25, 2010

Portugal debt downgrade-- more lessons for the U.S.

The ratings service Fitch downgraded the government debt of Portugal from AA to AA- given concern over the level of debt and a budget deficit that last year was 9.3% of GDP.  This left the 10-year bonds of Portugal trading at a yield of about 1.25% over the benchmark German bund.

In response today the Portugal parliament (led by the left-leaning Socialist party) passed a resolution of support for an austerity program that includes welfare benefit cuts, reduction in military spending and government employee pay freezes.  The goal of the austerity program is to reduce the deficit to under 3% of GDP.

These significant steps by Portugal are what must happen when the market loses confidence in your country's debt.  We should not overstate the magnitude of this issue, since Portugal has a GDP of about $230 billion making it about the same size economy as our own Indiana.  The lesson we hope Washington leaders would learn:  don't wait to behave in a fiscally responsible fashion until the market forces it upon you.