6th April 2011 by Shaun Richards
Last evening the caretaker Portuguese Prime Minister Jose Socrates gave a live television address to the Portuguese nation or at least that part of it which was watching!
I tried everything but we came to a moment that not taking this decision would bring risks we can’t afford……….The government decided to make the European Commission a request for financial aid.
Unfortunately Mr.Socrates was rather light on detail as according to the Reuters news agency he has added.
SOCRATES SAYS TRY TO GAIN BEST POSSIBLE TERMS IN NEGOTIATION FOR AID……….PORTUGAL PM SOCRATES DOES NOT SPECIFY WHAT TYPE OF AID, NOR HOW MUCH COUNTRY REQUESTING.
I don’t think anybody was expecting even a government which has proved to be such a poor steward of Portugal’s finances to ask for the worst terms! However somewhat true to form even the asking for aid is not well thought through and unclear.
What was the trigger?
I think that there were two recent triggers which influenced this move. The first was the bond tap on Friday where Portugal found a buyer for a quick issue of 1.645 billion Euros of a bond which expires in June 2012. On Friday I wrote.
Portugal has indeed sold in a bond tap some 1.645 billion Euros of debt which matures in June 2012 today. So she did need the cash did she not?And having had to pay an average of 5.75% on it she has been made to pay a high price for it. It was issued to a specific demand which I guess you spell China but could be Brazil….
The second took place today when the Portuguese debt management agency did this. It sold a total of 1 billion Euros of six and twelve month bills at interest-rates of 5.11 % and 5.9 % respectively.
So however short the funding Portugal was having to pay an interest-rate over 5% for it. In addition the situation got worse between Friday and today because on Friday she had to pay 5.7% for fifteen month funding but today for twelve month funding she had to pay 0.2% more rather than less as one might expect. So fifteen month money would cost over 6% now. Just to really rub in the deteriorating situation on the 2nd of March the Portuguese debt agency had issued a one year bill with an interest-rate of 4.33%. So in just over a month the cost of raising such money had increased by over 1.5%!
I think that even the Portuguese government could now see the writing on the wall. Virtually everyday Portugal was weaker than the day before and the dithering that has gone on will cost Portugal money at a time she can least afford it. This is because she has issued debt at a more expensive rate than she could have done if she had called for help as I first suggested back in September of 2010. The ensuing seven months have done a lot of damage to Portugal’s finances and credibility.
A Spectre waiting at the feast
On Thursday there are high expectations that the European Central Bank will raise its official interest-rate from 1 to 1.25%. In a country which has become more and more dependent on financing from the ECB a rise of 0.25% does matter as for Portugal every cent let alone Euro counts now. For example the Portuguese banking system is dependent on the around 41 billion Euros of liquidity it receives from the ECB.
Whilst in itself 0.25% is not a large amount it will be affecting a monetary system which is under considerable strain and back in 2007 we got used to unexpected problems emerging when financial systems became over-stretched. One more predictable effect will be that an increase in variable mortgage rates is likely to result affecting Portugal’s housing market.
Another factor has come from this and this has been strength of the Euro exchange rate. If you look at any of the peripheral nations in the Euro zone they talk of export-led growth but that growth is less likely now to come from markets outside the Euro zone as the currency has strengthened quite a bit from the panic of the early summer of 2010. Against the US dollar it stands right now at 1.433 and against the UK pound it stands at 1.135. Back it early summer last year it dropped below 1.20 versus the US dollar and nearly touched 1.24 against the pound. The expectation that the ECB will raise interest-rates has strengthened the Euro exchange rate considerably recently.
There have been other factors in Portugal’s recent demise and they are.
1. The revision to her fiscal deficit for which was made by Eurostat last week. i reported on this last week. If we retrace events Portugal’s government had been trying to claim that her fiscal deficit target of 7.3% of economic output or GDP had been met and indeed exceeded as she claimed to have a deficit of only 6.8%. Instead Eurostat insisted that a higher figure of 8.6% was the true figure and also insisted on higher revisions to figures for previous years.
2. If you add this to Portugal’s expected growth rate for this year (the Bank of Portugal estimates -1.3% and her government estimates -0.9%) then the fiscal deficit target of 4.6% of GDP for 2011 began to look unattainable. Even worse than that is the obvious thought that if you could attain it you probably would not want too! The reason for that is simple, if you look at the starting point from 2010 you would need such a severe does of austerity to hit this target that it might well send Portugal’s economy into a downward spiral. A downward spiral of austerity leading to falling growth leading to less revenue and higher spending leading to the need for more austerity and so on was a clear danger.
3. If we look further back in time we see that Portugal struggled to maintain much of a rate of economic growth even in previous good years. I posted on my previous Notayesmanseconomics blog a chart of Portuguese growth since 1990 and not only was it disappointing the trend was down. It is so revealing I feel that I show it again below.
As you can see there is a problem here. The best solution to the problems facing Portugal is economic growth but this hits the issue that she appeared to be on a deteriorating trend well before the credit crunch hit the world. Accordingly rather than the bank crisis which hit Ireland or the inability to collect tax revenue and financial misrepresentation which hit Greece it is a lack of belief that in the end has undone Portugal. Does anybody really believe she can throw off her past shackles and become an economic tiger?
4. The Portuguese government was unable to get her latest austerity measure through her parliament leading to a general election and political paralysis.
What will happen next?
The “troika” of the European Commission/European Central Bank/International Monetary Fund will come to Lisbon and start to run their slide-rule over Portugal’s finances. If they have any sense at all they will have some of this prepared. In terms of short-term finance should for example Portugal’s affairs be in such a bad way she cannot refinance the bond which matures on April 15th then the IMF would be the most likely source of quick funds. One of the many problems with the European “rescue” mechanism is that it moves at a pace that would be overtaken by your average sloth! So it will not be much use in the short-term.
If we look at who will provide the money the rule of thumb that was established back on May 10th 2010 was that two-thirds of the money will come from the European Union and one-third from the IMF. Most of the European Union money should come from the Euro zone nations but in the case of Ireland the mechanism for this was so little trusted that more than you might expect came from other European Nations.
How much will the UK contribute?
There is a European Commission mechanism for this called the European Financial Stability Mechanism and we are liable for 13.5% of it. Our share of the IMF is 4.53% and we are liable therefore for that percentage of any lending it may make.
Will the bailout work?
The track record is poor as both Ireland and Greece have deteriorated under the aegis of the Euro zone “rescue” mechanism. However unless there are fundamental problems uncovered with Portugal’s finances,which is a fear after what Eurostat has uncovered, she may get a slightly easier ride. In truth her situation has got so bad before she has called for a rescue then markets may not have much enthusiasm for driving yields higher.
If we look longer-term there is a fundamental problem which remains unanswered. The “rescue” will be a liquidity solution to a solvency problem and is accordingly doomed to failure. The beginnings of an answer would be substantial reform to improve her ability to grow her economic output. She needs supply side reforms such as an improvement to her educational system and a way of resisting the emigration tendency of her best and brightest.
So whilst Portugal may get a smoother ride than Ireland or Greece in the short-term unless there is a fundamental change the “rescue” is as unlikely to work as theirs in the longer-term.
Who should be worried now? Spain
Portugal has long considered itself as Europe’s defence mechanism for Spain. That defence has now fallen and I expect the focus to move to Spain. Recently there has been a tendency for the mainstream media to declare that Spain has been saved but this is a familiar mistake from this crisis period. Last week her unemployment rate rose again to 20.5% and it represents in one number the problems in her housing,banking and construction sectors.
The country most exposed to the failure in Portugal is Spain as her banks do a lot of business there and they are rumoured to be large holders of Portuguese debt too. With the close geographic proximity of the two nations sitting as they do on the Iberian Peninsula there are bound to be plenty of other connections too. So Portugal’s financial crisis will weaken Spain.
Also I have a final thought for you. The Euro zone is now weaker as for example Portugal provides 2.5% of the capital for the European Central Bank and up until now would have provided 2.5% of the Euro zone rescue vehicles. So not a systemic disaster but with Greece,Ireland and now Portugal it mounts up…. Just for future reference Spain is 11.86%