Portugal's debt is downgraded to junk status by Moody's

Moody's said Portugal faced "formidable challenges" with cutting spending and raising taxes

The credit ratings agency Moody's Investors Service has downgraded Portugal's debt to junk status.

The agency said there was a growing risk the country would need a second bail-out before it was ready to borrow money from financial markets again.

Moody's was concerned that if there was a second bail-out, private lenders might have to contribute.

Portugal's government said Moody's had not taken into account the strong backing for austerity measures.

It said that the programme of economic measures announced last week was "the only way to reverse the course and restore confidence" in Portugal.

Discussions are under way about the possibility of banks that have lent money to Greece waiting longer to be repaid.

Moody's said that prospect would scare private investors and make it even harder for Portugal to borrow money commercially again.

It said the talk of a private bail-out was "significant not only because it increases the economic risks facing current investors but also because it may discourage new private sector lending going forward".

Portugal, Greece and the Irish Republic were all given bail-out loans to give them time to repair their economies so they could borrow money normally again.

But Greece has already had to start negotiating a second bail-out.

'Formidable challenges'

The agency also said it was concerned that Portugal would not be able to achieve the deficit reduction targets set out as conditions for its first bail-out from the European Union and the International Monetary Fund.

It blamed this on "the formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system".

Portugal was supposed to cut its deficit to 3% of its gross domestic product by 2013, from last year's 9.1%.

'Contagion'

"The Portugal downgrade clearly is negative because as the downgrades spread from the weakest to the weaker, the market is now asking, 'if Portugal is downgraded, will Spain be next?'" said Cary Leahey, an economist at Decision Economics in New York.

"It's symptomatic of the contagion effects in the eurozone."

Moody's cut Portugal's rating by four notches from from Baa1 to Ba2.

The other two major ratings agencies still list Portugal as BBB, which is above junk status.

Moody's last cut Portugal's rating in April, predicting the original bail-out loans of 78bn euros ($112bn; £70bn) from the EU and the IMF.

The country was bailed out in May, when it could no longer manage its debts.

It was the third country to be bailed out, after Greece and the Irish Republic.

Portugal got into trouble because low growth in the economy made it difficult for the government to fund its spending.

It gradually lost competitiveness as wages increased and tariffs on cheap exports from Asia were cut.

When the financial crisis came, Portugal had a great deal of debt, which was suddenly much more expensive to finance.