Soaring sovereign bond yields and a deteriorating economy drove Portugal one step closer to a second bailout as the Greek government and private creditors yet again were unable to announce a deal to crunch Greece’s crippling debt.
The spectre of failing economies on both Eastern and Western fringes of the Mediterranean triggered fears that debt-crisis contagion had come roaring back after a brief interlude inspired by the determined effort of its Italy’s new Prime Minister, Mario Monti, to coax Italian bond yields down to sustainable levels.
As all 27 European Union leaders met in Brussels on Monday for a debt-crisis summit, where growth measures and the Greek debt “haircut” were at the top of the agenda, yields on Portugal’s 10-year bonds rose to about 16 per cent, well more than twice the level considered sustainable. Portugal took its first bailout, worth €78-billion (about $102-billion), from the EU and the International Monetary Fund last year, after its yields surpassed 7 per cent.
Portuguese bond yields began to soar in mid-January, when the credit ratings agency Standard & Poor’s downgraded the country’s debt to non-investment grade, or junk. The current cost of insuring the debt implies a 70 per cent chance of a default within five years.
Since the downgrade, the yields have surged by four percentage points and business and consumer confidence in Portugal hit record lows.
It’s virtually certain that Portuguese bond yields have climbed partly in reaction to negotiations to cut the face value of Greece’s privately held bonds by 50 per cent, an effort that, if successful, would trim the country’s national debt load by about €100-billion. The debt haircut is required before the EU and the IMF pay out Greece’s second bailout, worth €130-billion. If it fails, Greece faces a disorderly default.
Private investors fear that the Portuguese government would attempt the same exercise, even though the EU has said the treatment would apply only to Greece.
“How do you preclude Portugal, Ireland, and indeed Spain from demanding the same deal as Greece if the negotiations succeed?” asked Marshall Auerback, global portfolio strategist and director of Toronto’s Pinetree Capital. “The answer: You can’t.”
As Portugal’s economy deteriorates, a second bailout, Greek-style debt restructuring or even exodus from the euro zone loom as possibilities. “Not only will a second aid package be required, but the recognition that a debt restructuring may be necessary is increasing,” Marc Chandler, chief currency strategist at Brown Brothers Harriman, said in a Jan. 24 report.
Almost all of Portugal’s key economic indicators are going in the wrong direction.
The European Commission forecasts that Portugal’s national debt will reach 100 per cent of gross domestic product this year, up from 83 per cent in 2010. Its budget deficit is expected to remain stuck at about 6.4 per cent of GDP, according to Deutsche Bank, and the Bank of Portugal expects gross domestic product to shrink by 3.1 per cent this year, twice as bad as last year’s figure.
Some economists think a 5 per cent contraction is not out of the question. Unemployment is climbing relentlessly. The national jobless rate is 13.2 per cent and the youth unemployment rate, at almost 31 per cent, is the euro zone’s fourth highest.
It seems that both the Portuguese government and the bailout sponsors underestimated the rot in the Portuguese economy and the amount of time and effort it would take to reduce it. The new centre-right Portuguese government is making aggressive efforts to close the budget gap. But Société Générale said the effort is faltering, noting that “a lack of expenditure control and shortfalls in sales of real estate and other concessions contributed to an overrun of 1.6 per cent of GDP.”
Lisbon is responding by ramping up its austerity measures. A one-off surcharge on personal incomes taxes was introduced and the value-added tax (VAT) base is being expanded. But Europe is learning that piling austerity on austerity has pushed down growth, as it did in Greece and is doing in Spain, where economic output fell 0.3 per cent in the fourth quarter and the jobless rate is surging. Spain, with a 22.9 per cent unemployment rate, and 50 per cent youth unemployment, has the EU’s highest jobless numbers.
As growth falters throughout the EU, the IMF is suddenly taking a softer stance on austerity programs. In a note published Sunday, Carlos Cottarelli, the IMF’s director of fiscal affairs, acknowledged that the IMF might have jumped the gun in urging governments to step up their fiscal consolidation efforts. “In the current environment,” Mr. Cottarelli said, “I worry that some might be going too fast.”
