LISBON (Reuters) – Portugal's caretaker government, fighting to avoid a bailout, said on Wednesday a political crisis had caused "irreparable damage" after borrowing costs rocketed as it sold a billion euros in short-term debt.
The sale of 6- and 12-month treasury bills brought some temporary relief for a country grappling with soaring rates, political uncertainty, rating downgrades and a warning by local banks they may no longer be able to buy government debt.
But the yield on 12-month T-bills spiked to 5.902 percent from 4.311 percent three weeks ago, and on six-month bills to 5.117 percent from 2.984 percent, highlighting the financial pressure ahead of big redemptions this month and in June.
"I suspect that as far as the market is concerned, funding at these levels can only be viewed as a temporary measure," said Peter Chatwell, rate strategist at Credit Agricole.
Portugal's cost of credit has leapt since the minority Socialist government resigned last month after a parliamentary defeat on tougher austerity measures, casting the country into political limbo. An early general election is set for June 5.
The finance ministry said the auction was a confirmation of the deterioration caused by the rejection of the austerity plan and promised to take all measures necessary to ensure liquidity and financing for the economy. But it denied talking with the European Union about how to meet borrowing needs.
"Current interest rates make it possible to conclude that the damage caused by the rejection of the austerity plan is irreparable," a ministry statement said.
The government previously has held out hope that by steadily meeting budget goals and cutting spending it could regain investor confidence.
It admitted last week that the 2010 budget deficit had hit 8.6 percent of gross domestic product, far above its 7.3 percent target, but said this year's goal of 4.6 percent would be met.
Local banks delivered an unprecedented warning to the government on Monday to seek a short-term emergency loan to soothe market concerns ahead of the election, saying that under current conditions they cannot continue buying government debt.
"There has been a very important signal from the banks for the future," said BNP Paribas analyst Ioannis Sokos. "Portugal can still make it through April, but probably won't get to June without a bailout."
MOODY'S DOWNGRADES BANKS
Adding pressure on banks, Moody's rating agency followed up a one-notch sovereign downgrade and cut the creditworthiness of seven local banks, citing concerns over their own situation and the government's ability to support them.
The banks concerned included state-run CGD and leading listed banks Millennium bcp, Banco Espirito Santo and Banco BPI.
Still, bank shares rose in tandem with rebounding European banking stocks on Wednesday, with Millennium and BES jumping 4.2 percent and 3.5 percent respectively. Still, the shares have fallen sharply in the last two weeks.
EU finance ministers meeting in Budapest at the end of this week will try to get clarity from the caretaker government on what sort of support, if any, it can seek ahead of the election.
The European Commission said on Wednesday there were no discussions about releasing aid because Lisbon has not applied for assistance.
Spain's Economy Minister Elena Salgado said European financing is available if Portugal asks for aid, but ruled out the possibility of Spain making a bilateral loan at this time.
The caretaker administration has said it will resist any bailout or a loan as they would impose tough conditions on the country. It has also said that as a caretaker administration it lacks the power and legitimacy to seek outside help -- a point hotly disputed by opposition politicians.
Lisbon's partners are anxious lest the financing problems reach a point of no return before a new government is in place, sapping confidence in the euro zone, but they cannot force Prime Minister Jose Socrates' hand.
"The situation is in the hands of the Portuguese government... it has to prove to its creditors that it is taking the right steps," IMF Managing Director Dominique Strauss-Kahn told Spanish daily El Pais on Wednesday.
Two business newspapers said the public social security fund has been selling overseas financial assets in the last few days to help finance the state by buying sovereign debt at auctions. Still, a Labour Ministry spokesman said the fund did not buy any treasury bills at Wednesday's auction.
Portugal's benchmark 10-year bond yield that hit a euro lifetime high of 9.06 percent earlier on Wednesday retreated sharply later, following Irish bond yields lower to end at 8.79 percent. But analysts said nothing has changed in their perception of Portugal.
They say the high yields are unsustainable. The fall in the value of the bonds also undermines its banks, who have been substantial buyers of government debt.
Portugal has to repay over 4.2 billion euros in maturing bonds on April 15, and then another 4.9 billion euros in June. Including coupon payments and deficit financing, its requirements until June are put at 12 to 15 billion euros.
"From the pure cash perspective, April should be OK, even with coupons and deficit financing, but then if the domestic bid disappears, there's not much room for maneuver," said David Schnautz, debt strategist at Commerzbank.
(Additional reporting by Shrikesh Laxmidas, Sergio Goncalves, Filipa Lima and Elisabete Tavares, writing by Axel Bugge, editing by Michael Roddy)
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