Portugal banks threaten to shun debt

People walk past a shop window reflecting the old downtown of Lisbon March 29, 2011.

LISBON (Reuters) - Portugal's main banks have threatened to stop buying government debt, urging the caretaker cabinet to seek a short-term loan to tide it over a pre-election limbo that prompted another credit rating downgrade on Tuesday.

Financial sources told Reuters the heads of the country's leading banks met Bank of Portugal Governor Carlos Costa on Monday, telling him that the country urgently needs a bridge loan of up to 15 billion euros (13 billion pounds) to secure financing until a June 5 snap general election.

"The banks defend a bridge loan because they have practically no more margin of manoeuvre to buy Portuguese sovereign debt," one of the three sources said. "The banks are close to their limits of exposure to Portuguese debt, whose risk is deteriorating."

A bond-buying strike by Portugal's major domestic buyers could shut it out of financing from the markets, pushing it to seek a bailout like Greece and Ireland.

Moody's cut Portugal's sovereign debt by one notch to Baa1, saying it believed the caretaker government may need to seek urgent financing support from the European Union, before a full-blown bailout is requested by a new government.

The agency said it could cut Portugal's rating further before its next review in July if it saw that short-term support was not available from its euro zone partners.

Standard & Poor's and Fitch have already downgraded Portugal since the minority Socialist government resigned last month after parliament rejected its austerity package. Moody's rating is still two notches higher than S&P's and Fitch's.

Moody's lead analyst for Portugal, Anthony Thomas, told Reuters the caretaker government did not cite any short-term loan as part of its contingency plans for financing.

"The government has not mentioned anything like that to us," he said, adding that any short-term loan could come from European institutions rather than the International Monetary Fund as local media have suggested.

A European Commission spokesman said the euro zone's emergency lending facilities extend loans to countries that ask for help in an established procedure that involves strict conditionality. A source said no special "short-term loan" outside a negotiated financial aid programme was possible.

Spokesmen from largest listed banks Millennium bcp and Banco Espirito Santo (BES.LS) declined to comment on the banks' meeting at the central bank.

But Carlos Santos Ferreira, head of Millennium bcp (BCP.LS), Portugal's biggest private bank, said in a television interview late on Monday that it was "indispensable that the country seeks a short-term loan," of at least 10 billion euros.

Andre Rodrigues, a banking analyst at Caixa Investment Banking, said banks were pressured by the depreciation of the sovereign debt on their books, their own liquidity problems and forthcoming European financial stress tests.

"For banks, it's not a theoretical issue but a practical one," said Rodrigues. "It's an additional pressure factor to push Portugal into seeking a bailout or an interim loan."

OPPOSITION WOULD BACK SHORT-TERM LOAN

A short-term loan has been mooted by Portugal's opposition Social Democrats. The party's leader, Pedro Passos Coelho, suggested it in a Reuters interview last month.

Such a loan could soothe concerns around two big bond redemptions the country faces in April and June, which total about 9 billion euros.

It would be separate to any eventual bailout, which economists say is virtually inevitable.

The euro slipped from a five-month high versus the dollar early on Tuesday, knocked by the Moody's downgrade, but later recovered on expectations of euro zone interest rate rises <FRX/>. The cost of insuring Portuguese debt against default rose and the 10-year Portuguese bond yield jumped above nine percent. <GVD/EUR>

Portuguese bond yields have shot higher since the resignation of the government two years before its term ends and yields are scaling new euro-era highs on a daily basis.

The country held an extraordinary auction of one-year bonds last week, raising over 1.6 billion euros. It will offer up to one billion euros of 6- and 12-month Treasury bills on Wednesday, which analysts still expect to be placed.

Socrates, whose government retains a caretaker role until the elections, vowed on Monday to keep resisting any foreign financial rescue, including the short-term loan suggested by the opposition.

The government said on Tuesday it was firmly on track to meet this year's budget deficit goal of 4.6 percent of gross domestic product after cutting spending by an estimated 3.6 percent in the first quarter.

The finance ministry also said it was implementing cost-cutting measures that do not require parliamentary approval but were part of the government's austerity plan rejected by parliament last month.

A euro zone source told Reuters on Monday that finance ministers will discuss on Friday Portugal's options under the caretaker government, including whether it is capable of requesting EU financial aid.

(Additional reporting by Shrikesh Laxmidas, Elisabete Tavares, Andrei Khalip, writing by Axel Bugge, editing by Mike Peacock/Ruth Pitchford)