Lisbon in Limbo
EUROPE, 17 Jan 2011
Hendrik Ternieden – Der Spiegel
Portugal Fights Desperately to Regain Trust
Portugal succeeded in raising more than a billion euros in a Wednesday bond issue. The country’s leaders are praising the success, but investors remain skeptical. Despite lower-than-feared interest rates on Portuguese debts, the country will likely have to request an EU bailout soon.
Seven percent. That’s the crucial figure — at least if you believe Fernando Teixeria dos Santos, Portugal’s finance minister. If interest rates for long-term government bonds climb above 7 percent, the country will need international aid, the minister believes.
In recent months, interest rates on Portuguese debt have climbed steadily, and observers held their breath as the country issued its first long-term bonds of the year on Wednesday. It was meant to be the first test of whether Portugal can continue to refinance itself. The answer, it would seem — at least for smaller sums of debt — is yes. On Wednesday, around €1.25 billion flowed into the state coffers with an interest rate of around 6.8 percent on 10 year bonds. Given the news in recent days, things could have gone a whole lot worse.
The auction went “relatively well,” said Portuguese President Anibal Cavaco Silva. But the bond issue was only the beginning. Silva said the government still had a “lot of work.” Portugal will have to raise as much as €20 billion this year in order to finance old and new debt.
But what does the first debt test in Portugal really mean? Is trust building in the markets as a result of Portugal’s austerity efforts? Or will the country be left with no choice but to take advantage of the fund established last year to help crisis-ridden members of the euro zone? And what do the developments in Portugal mean for the future of the common currency?
What’s the Current Outlook for Portugal?
Portugal’s current outlook isn’t good. The entire country is groaning under the weight of major structural problems. In recent years, the economy has barely grown and in 2011 the country could fall back into a recession. The latest central bank forecasts suggest the economy could contract by 1.3 percent, though the government is more optimistic, predicting slight growth. The country has implemented an austerity program that has reduced the 2011 national budget by 4.6 percent.
Portuguese Prime Minister Jose Socrates says his country is making progress in reducing its deficit. In 2010, Portugal even managed to push its budget deficit below the target of 7.3 percent of GDP, Socrates says. He said the markets were reacting positively to “Portugal’s good conduct in bringing about the government’s goals — reducing the deficit and bring the public accounts back into order.” European Currency Commissioner Olli Rehn praised the country this week, saying it was on the right track.
Ultimately, though, it won’t be political affirmations that count. Ireland also long staved off calls for the country to accept EU aid — after all, that money comes with extremely difficult conditions. The far more important factor is market trust. Rolf Langhammer, vice president of Germany’s Kiel Institute for the World Economy (IfW), says the most important goal for Portugal right now is to regain that trust.
Ultimately, it is the investors who determine the conditions under which governments obtain fresh money. Should interest rates rise too high, it is only a matter of time before countries can no longer afford new debt.
Why Was this Week’s Small Bond Offering So Important?
Governments across Europe looked to Wednesday’s offering with great apprehension, with the issue being described by some as “D-Day” or a “litmus test,” despite the fact that Portugal only needed to issue bonds valuing €1.25 billion. Both China and Japan had pledged to invest in European bonds. Yet despite these pledges of help, the risk premiums for Portuguese bonds had continued to rise.
Wednesday’s sale was considered a test for coming issues. If the interest rates had been set too high on Wednesday, then market trust in Portugal would have continued to decline in the coming months and interest rates would rise further. The country would then be left with no choice but to seek aid from the EU-IMF euro rescue package. “We are able to do our work by ourselves,” Socrates told reporters during a visit to a trade fair in Frankfurt on Wednesday.
Do the Markets Believe Portuguese Leaders?
Not really. The interest rate on Wednesday’s offering was lower than it has been, but the rates are still far too high. “Penalty interest” is the term used by Commerzbank analyst David Schnautz to describe current interest rates for Portuguese bonds. He said the fact that the European Central Bank purchased Portuguese bonds in recent days helped to shore up the interest rates. “But the markets remain skeptical,” Schautz says.
Following the offering, Portuguese Finance Minister dos Santos expressed hope that the distrust was abating and that interest rates would continue to drop. But analyst Schnautz says the issue was too small to make a difference. “The clock is ticking ruthlessly against Portugal,” he added. What concerns the Commerzbank analyst more is the fact that Portugal will have to raise a total of €9.5 billion through bond issues in April and June. “That doesn’t leave much time or breathing room,” Schnautz says.
Will Portugal Have to Seek a Bailout?
Most investors now believe Portugal will have to seek aid from the EU. “That’s the consensus,” says Commerzbank analyst Schnauz. Kiel-based economist Langhammer believes that an EU-IMF bailout will be the only way the country can win back the trust of markets. And it is the only opportunity for the country to get loans at lower interest rates.
On Tuesday, the Portuguese daily Publico reported that technical preparations are already being made for a possible EU bailout worth €60 billion to €100 billion. Although a dispute has broken out among senior officials at the Portuguese central bank over whether to accept a bailout, the government is still officially opposed. “We don’t need anything else than confidence,” Prime Minister Socrates says.
What Will Happen Next within the Euro Zone?
Officials at the European Commission, the EU executive, are currently urging member states to increase the size of the euro rescue fund in order to calm markets. “It is important for the markets to know that the EU and euro zone leaders are committed to doing whatever is necessary to preserve that financial stability,” Barosso said on Wednesday. A number of newspapers have reported this week that the issue will be discussed at a meeting of euro zone finance ministers on Monday.
In Germany, Chancellor Angela Merkel expressed reserve on Wednesday over Rehn’s proposal to expand the fund. “I don’t want to comment further right now,” she said. However, the chancellor did state that “Germany will do whatever is needed,” following a meeting with Italian Prime Minister Silvio Berlusconi on Wednesday.
That, says IfW economist Langhammer, is what will send the most decisive message to the markets: Beware speculators, we can expand our measures at any time!
If Spain were to follow Portugal as the next country to require a bailout, then the €750 billion European Financial Stability Facility (EFSF) would indeed need to be increased in size. Spain’s economy is considerably larger than Portugal’s and in 2011 alone, €120 billion in state bonds are due. Furthermore, because Spanish banks have invested massively in Portugal, other European countries fear there could be a domino effect. Spain has long been considered the next potential candidate for a bailout. The country succeeded in issuing fresh bonds on Thursday morning, but interest rates are rising. In November it could obtain fresh money at 3.58 percent, but by this week the figure had risen to 4.54 percent. Nevertheless, the rate was lower than the 4.8 percent some analysts speculated it might be faced with.
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