Portugal Debt Crisis - a closer look whether Portugal is next in line
Thursday, 6 May 2010 | 
European Affairs
There is always a risk, but I don't think it will go the Greek way unless Greece goes to hell, but it is bad in Portugal but not as bad as in Greece.
The current government is led by the Socialist Party led by Socrates the Prime Minister (http://en.wikipedia.org/wiki/Jos%C3%A9_S%C3%B3crates ). And to confuse everyone, including the Portuguese people, the main opposition party is called the Social Democratic Party, PSD, led by Passos Coelho (http://en.wikipedia.org/wiki/Pedro_Passos_Coelho), but it has nothing to do with Social Democracy like Olof Palme etc. No, they are more like Christian Democrats. But the name says it all. Everything political is gauged towards the left! Or to fool people to vote for them "because everyone has a little socialist heart somewhere in the pocket if not in the body". Even the small right wing party is called the Democratic and Social Centre - People's Party! The political climate is therefore quite leftish in rhetoric.
Socrates to the left, Passos Coelho to the right
Since Portugal joined the EU they benefitted from EU social cohesion funds etc. What did they do with the money? They built roads! At the same time they lost the shoe making industries and other industries that left high tax high salary countries like Sweden to set up plant in Portugal soon thereafter left the country to hunt for even lower salaries and low taxes. The main receiver of Portugueses exports is Spain!
Portugal does not have the same level of chaos in the touristic real estate sector like Spain. Spain is suffering from 100,000s of illegal dwellings and over 1,000,000 touristic dwellings that are worthless. The halt was delayed slightly as the foreigners left investing in Spain, and the Spaniards kept buying for another year, but now that has stopped too. Take all off-plan building projects that has stopped half-way. There is a law stipulating that there shall be a bank guarantee for finish building the dwelling and 80% of the off-plan projects don't have it! Building Societies can own 10,000s of empty apartments! The jewel resort Marbella suffered from the largest scandal in the last few years (http://panaviationtraining.com/ ).
Now to the willingness to bring down deficit in Portugal. The socialists call the current events with the bond yields rising "speculative attacks", while getting lowered two notches to A- by S&P, just four slots away from being in the same rating as Greece. The public sector workers have been on strike regularly this year. Portugal is only behind France and Greece in terms of number of strikes called. The good thing is that the Socialists and the Social Democrats joined in a show of unity last week. With their new plan Portugal will fall below the EU's target of budget deficit of 3% in 2013. They call for 1.7 bn EUR spending cuts and increase of taxes. Will it be enough? Next to put Portuguese bonds on review is Moody's. I guess their downgrade will come next week (one or two notches). But there are some very small chances that the Portuguese will agree to scrap some public spending projects: the new Lisbon airport, the third bridge over river Tagus and the high speed train between Madrid and Lisbon. The current finance minister believes they don't need to scrap these projects though!!
The Portuguese Iron Lady Manuela Ferreira Leite (http://en.wikipedia.org/wiki/Manuela_Ferreira_Leite) has been side-lined. She was finance minister at Barroso's time (2002-2004) and she was the party leader of the PSD until March this year. She was cutting spending ruthlessly and there was hopes she could have become the next prime minister in the election last autumn. Instead Socrates the socialist won. For me and even some Portuguese she was the best hope to dare doing the necessary cuts.
Portugal has a good statistical system and never lied about their data, in great contrast to Greece. I worked with Eurostat when the Euro was introduced. I remember late-night meetings at the Airport Center in Luxembourg (I worked as a consultant dealing with FDI data) where the top politicians from Greece and Italy met the top directors of the Commission to "agree" on data. It has never been a secret by the European Commission that the Greek statistical data were/are shite! For many years Greece never submitted any data for the national accounts to Eurostat! Eurostat statisticians used a methodology called "partner declaration": If you know the imports from Greece to UK, published by the ONS in the UK, then Eurostat used those data as "exports from Greece to UK". Apply that method as much as you can and you have a hum about the data, but you don't have any correct and complete data. You need to estimate (=guesstimate). Then there are other methods to estimate increases and decreases over the years. So the official financial data that took Greece into the Euro was a total fantasy. That is a fact known by the ECB, Eurostat and the European Commission at the time.
It's not too late for Portugal but they have to face hard times if they want to keep sovereign power of their own economy.
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Irish Bailout May Unleash Market Vigilantes on Portugal
A resolution of the Irish debt crisis may shift the burden of speculation to Portugal.
While officials such as European Central Bank Vice President Vitor Constancio predict a bailout of Ireland will reduce financial pressures in the euro region, analysts from Citigroup Inc. and Nomura International Plc say any relief would be short-lived as investors turn their focus to the next-weakest peripheral nation. The markets indicate that country is Portugal with 10-year bond yields of 6.88 percent, compared with 8.26 percent in Ireland and 11.62 percent in Greece, which received rescue funds in May from the European Union and International Monetary Fund. Portuguese Finance Minister Fernando Teixeira dos Santos said Nov. 15 that while “there is a risk of contagion,” that doesn’t mean the country will seek financial aid. “Portugal isn’t in the situation that it is now because of Ireland,” said Steven Mansell, director of interest-rate strategy at Citigroup Global Markets Ltd. in London. “If Ireland reaches an agreement to tap the European Financial Stability Facility or some other mechanism to support its banking sector, I don’t think that will alleviate the pressure on Portugal.” The government has forecast that economic growth in Portugal will slow to 0.2 percent in 2011 from an estimated 1.3 percent this year. Portugal has made less progress at taming its deficit than some of the other peripheral nations. In the first nine months, the central government’s deficit rose 2.3 percent from a year earlier. That compared with a decline of more than 40 percent in Spain and more than 30 percent in Greece.
Record Yields
While Portugal has no plans to sell more bonds this year, so-called market vigilantes drove up yields on its debt during the past month amid doubts about the country’s efforts to reduce the budget deficit. The 10-year yield reached a euro-era record of 7.25 percent on Nov. 11, 484 basis points higher than benchmark German bunds of similar maturity. Portuguese 10-year yields are little changed this week, while Irish yields fell 10 basis points. The spread between the 10-year Portuguese bonds and German bunds rose 6 basis points today to 410. Investors who push up yields to alter government policy are known as vigilantes, a term coined in 1984 by economist Edward Yardeni, president of Yardeni Investments Inc. in New York. They were credited with forcing Bill Clinton to cut the U.S. deficit after he came into office in 1993, helping drive 10-year Treasury yields down to about 4 percent by November 1998 from above 8 percent in 1994. While Irish and Portuguese bonds probably would rise with a bailout agreement for Ireland, any gains wouldn’t change the underlying problems for peripheral Europe, according to Charles Diebel, head of market strategy at Lloyds TSB Corporate Bank.
Greece Than Ireland
“Wait a few weeks and the markets will just go for someone else, with Portugal at the front of the queue,” London-based Diebel said. “The vigilantes pushed Ireland into the same situation Greece is in. Why would you conclude they won’t do the same to Portugal?” Ireland’s debt crisis was triggered by the rising cost of bailing out the nation’s banks, including Anglo Irish Bank Corp. and Allied Irish Banks Plc. While Portugal doesn’t face a crisis in its financial industry, it has a larger debt burden and the country has almost 10 billion euros of debt that comes due during the first half of 2011, data compiled by Bloomberg show. Teixeira dos Santos, the finance minister, said in parliament two days ago that Portugal wants to continue financing itself in the markets.
‘Significantly at Risk’
“Portugal needs more cash than Ireland does because they go to the market on a regular basis,” said Nick Firoozye, head of interest-rate strategy at Nomura in London. “The market may move onto Portugal at some point because it’s significantly at risk.” While Ireland started to reduce spending in 2008, Portugal has been slower to address its fiscal deficit, the fourth- largest in the euro region, and the government failed to reach an agreement with its biggest opposition party on the 2011 budget plan until the end of last month. Portugal has proposed to lower its total wage bill for public workers by 5 percent, freeze hiring and raise the so- called value-added tax by 2 percentage points to 23 percent. The government is counting on exports such as paper and wood products to support expansion. Portugal’s economy unexpectedly grew 0.4 percent in the third quarter from the previous three months, beating economists’ estimates for a contraction, as exports rose and imports grew at a slower pace. Still, the Organization for Economic Cooperation and Development yesterday forecast the economy will swing to a contraction of 0.2 percent next year. “Their view on fiscal consolidation is still premised on an excessively-optimistic growth projection,” Citigroup’s Mansell said. “Portugal is hugely reliant on the fortunes of its neighbors and it takes a huge stretch of the imagination to see growth remaining buoyant.”
Moody’s downgraded Portugal's credit rating two notches to A1
Moody’s, the rating agency, downgraded Portugal by two notches on Tuesday, citing the country’s deteriorating public finances.
The US rating agency cut Portugal’s long-term credit rating to A1 from Aa2 on concerns over its debt to gross domestic product and debt to revenue ratios, which have risen rapidly over the past two years.
The agency warned that Portugal’s debt to GDP ratio would approach 90 per cent, while its debt to revenue ratio would rise to 210 per cent over the next two or three years.
This means Portugal will remain highly indebted while its economy struggles to recover.
The move follows similar downgrades of sovereign debt ratings in Greece and Spain this year amid concern over the ability of southern European countries to control soaring budget deficits.
José Sócrates, Portugal’s centre-left prime minister, said in a recent interview with the Financial Times that his government would do “whatever it takes” to meet a commitment to cut the deficit to 2 per cent of GDP in four years.
“Performance over the past six months has exceeded expectations and I’m confident the plan we have set out will deliver the intended results,” he said.
Under pressure from international financial markets, Portugal has introduced a series of increasingly harsh austerity measures to bring its public finances under control after the country’s budget deficit soared from 2.6 per cent of gross domestic product in 2008 to a record 9.6 per cent last year.
Anthony Thomas, a senior analyst in Moody’s sovereign risk group, said on Tuesday: “We remain concerned about the economy’s medium-term growth potential.”
The agency says a more severe deterioration in the country’s debt metrics in the event of higher interest rates or weaker economic growth cannot be completely ruled out.
Portugal’s finance ministry said in a statement on Tuesday that the rating cut “stems from the international financial crisis, which in the first half of 2010 had “materialised into high sovereign debt stress”.
After 12 years with an unchanged rating, Moody’s was now realigning Portugal’s sovereign debt rating with those of other international rating agencies, the ministry added. “This was already anticipated by financial markets.”
The ministry said fiscal consolidation was “a necessary condition for a sustained economic recovery.
“By placing the rating under a stable outlook, Moody’s is signalling its confidence in the current economic policy strategy of the Portuguese government.”
The euro fell against the dollar and Portuguese equity and bond markets came under pressure, as investors said Moody’s announcement was a sign that the country had a long way to go in reforming and reviving its economy.
Moody’s rating of A1 remains an investment grade, but is lower than that of Fitch and higher than that of Standard & Poor’s.
Meanwhile, Greece sold €1.625bn of 6 month bills on Tuesday in its first debt sale since the it was offered emergency loans on May 2. The auction saw good demand, with a bid to cover ratio of 3.64, although Greece had to pay high yields of 4.65 per cent, up from 4.55 per cent in a previous auction of April 13.
Portugal’s banks turn to ECB for €36bn
The funding of Portuguese banks from the European Central Bank more than doubled last month, as financial institutions struggled to access international capital markets. Portuguese banks borrowed €35.8bn from the ECB in May compared with €17.7bn in April, according to the Bank of Portugal. The country was also forced to pay extremely high yields to sell five-year bonds as investors demanded big premiums amid the continuing worries over high debt levels in the eurozone.
It was forced to pay average yields of 4.657 per cent, almost 1 percentage point more than the 3.701 per cent paid at an auction at the end of May.
Steven Major, global head of fixed income research at HSBC, said: “These yields are approaching that magic number of 5 per cent that is likely to be charged by the European stability fund. “If the yields keep going up at this rate, then they will be paying much more than 5 per cent next month, which is arguably unsustainable.” Another banker agreed: “These yields are not sustainable. Portugal will have to access the emergency stability fund if they continue to rise at this rate.” However, Portugal raised €943m, more than the amount they had indicated they wanted to borrow of €800m, and the auction was covered 1.8 times, which is usually a sign of success.
Portugal’s external debt set to rise
If Portugal doesn’t start exporting goods and reducing imports and reliance on imported energy, her external debt will reach 230 billion euros by 2013. This was the stark warning from economist Dr Henrique Medina Carreira at a lunch organised by the British-Portuguese, South Africa and German chambers of commerce in Lisbon on Monday. This imbalance resulted from a lack of coordination between public demand and private demand, as both the Portuguese State and private sector spent more and borrowed more than it was earning from transactional goods receipts. In other words, Portugal was spending too much on the back of loans raised on the international financial markets to fuel internal demand. And with the disappearance of the Escudo and the capacity to devalue the currency, Portugal’s productivity grew little as she was unable to sell traditional goods abroad in an increasingly competitive market. Between 1974 and 1986, the economy grew 2.5 per cent per annum, between 1986 and 1995 it grew 3.6 per cent and between 1995-1999 1.9 per cent. On average over the 35 years, the economy grew by 2.5 % per annum. This is in stark contrast to the 1960s, the end of the Salazar years, when the economy was growing at an accumulated rate of 106 per cent for the decade. From 1986 until Portugal joined the Euro the limitations on political powers as a consequence of joining were not that great. The main consequence was losing complete border and customs autonomy. That period 1986-1999 was relatively favourable, the average growth rate of 3.6 per cent predominated while the price of crude fell from 1984 onwards which was “very significant” and there was a growth in the economy which favoured the country. With increased foreign investment from 1986 and Portugal’s joining the EC there was also an increase in exports. But the enlargement of the 27 EU Member States following the collapse of the Soviet Union, with the entry of new states in central Europe, began to bring disadvantages to Portugal. “These industrialised countries had highly qualified work forces, low labour cost regimes and an organisation that was superior to Portugal’s with consequences on investment attractiveness. “Many of the companies that had been operating in Portugal then headed for this central European area,” said Medina Carreira. “This new phase of Capitalism basically meant the absolute unfettered and free circulation of capital, production and goods, which is why capital investment has been flying to countries where the returns are greater,” he added. “This means that if we don’t have the right conditions in terms of attracting investment, we’re excluded internationally and this is one of the most serious problems we’re facing and is something we haven’t been able to resolve,” he said. Portugal’s entry into the Euro was the single most decisive factor on what has been happening in the country over the past 25 years. “We lost the Escudo which meant we couldn’t emit currency or devalue it in times of crisis. It also meant an end to independent, autonomous interest rates with the Exchange Rate Mechanism and the Euro. “The Exchange Rate Policy was therefore the heaviest consequence for Portugal because Portugal could no longer, like many countries still do, devalue the currency to boost exports and competitiveness. We also lost budgetary and deficit autonomy with the EU’s Stability and Growth Pact agreement,” he said. The Private Sector, which should, together with the State, have been regulating things, spent more because the interest rates were low leading to internal demand going through the roof with grave consequences on Portugal’s External Debt. In 1996, the external debt stood at eight billion euros, now it stands at 190 billion euros and will rise to 230 billion euros by 2013. In conclusion, he said Portugal simply isn’t producing anything: computers, cars, oil, natural gas and now even food products are all imported. Internal demand cannot alone satisfy economic growth and generate wealth. Only external demand can save Portugal from a slow and inevitable decline, Medina Carreira said.