Things are getting serious in the market for sovereign debt. You know, the paper issued by countries with big deficits that need to borrow to stay in business.

Just before Thanksgiving Dubai World, a government-controlled conglomerate in Dubai, suspended debt payments. That raised doubts about the solvency of Dubai itself and of other member countries in the United Arab Emirates.

Those doubts led investors, lenders, and credit rating companies to take a closer look at other indebted countries that might face a tough time paying back what they owe.

And today that closer look claimed its first two victims. Standard & Poor’s Rating Service placed its A-rating for Greece on CreditWatch with negative implications. That’s a step that often leads to an actual downgrade on the country’s debt. S&P also downgraded its long-term outlook on the credit rating of Portugal to negative from stable.

You can understand why Standard & Poor’s is worried about Greece. (For more on what conditions add up to worry see my post https://jubakpicks.com/2009/12/01/making-a-list-checking-it-twice-what-countries-are-in-danger-of-default/ ) Absent budget cuts or higher taxes, S&P projects that Greece general government debt burden could reach 125% of GDP in 2010. That would be the highest among European countries.

As I noted in my post, however, it takes more than just a high level of debt to make the worry list. S&P (and investors and lenders) have to believe that the country’s government lacks the will and/or the power to rein in deficits. In the case of Greece, today’s warning stems from S&P’s concern that the plans outlined by the new government are unlikely to secure a sustained reduction in fiscal deficits and the public debt burden,” S&P said.

Elected just this October, the country’s socialist government has announced plans to cut the budget deficit as a percentage of GDP to 9.1% in 2010 from 12.7% in 2009.

Greece’s socialist government, elected in October, plans to cut the budget deficit as a percentage of GDP to 9.1 percent next year from 12.7 percent this year.

S&P lowered Greece’s credit rating by one step to A- in January 2009. That’s six steps below S&P’s top credit grade.

Portugal faces roughly the same problem, according to S&P. Just a little big further off.

The country’s economy looks weaker and its debt load more troubling than it did in the fall. In November the government said its 2009 budget deficit is likely to be near 8% rather than near 6% as previously estimated. S&P is now worried that Portugal’s debt to GDP ratio could climb to more than 090% by 2011.

The government has announced a plan to reduce the budget deficit to 3% of GDP by 2013, but, as in Greece, there’s good reason to doubt that the company can deliver. The Socialist government does not have a majority in parliament making any passing any legislation dependent on cooperation by coalition partners.   

Today’s two announcements, both involving members of the European Union, highlight one of the quandaries facing the European Central Bank and richer union members. Because both Greece and Portugal use the euro as their currency, the countries can’t use some of the customary tools for stimulating an economy (interest rate cuts), reducing a deficit, or increasing global competitiveness (depreciating the national currency). Both countries are among the weakest and least developed economies in the European Union and Greece especially has a long history of breaking the union’s rules on the size of its annual deficit. In fact the country has met the union’s target only once since it joined the European Union in 2001.

Right now the only thing keeping the ratings of Greece and Portugal as high as they are is membership in the European Union and a belief by investors that the union’s richest members will stand behind the debts of Greece and Portugal.

Any resemblance between this belief and the pre-Thanksgiving belief that a wealthy Abu Dhabi would stand behind the debts of Dubai is purely coincidental, of course, and shouldn’t worry investors or lenders one little bit.

Which is why Greek 10-year notes carry a yield 1.7 percentage points above that on German 10-year notes.