I agree with Ricardo Reis. I had argued that the “pheripheral” countries banks should be resolved in a May 2010 column in Vox (and in a paper in 2009). The discussion about privatizing the CGD is not really relevant at this point. The banking system is well on route to be nationalized.
Portugal has to restructure its external debt (see German Economists Open Letter, Eichengreen, Rogoff, Financial Times op-ed, and my contributions at Vox and Expresso,). The reduction in Portugal's external indebtedness has to be sufficiently large. In my view Portugal’s net external indebtedness has to be restructured to well below 25% of GDP (from 85.3% at the end of 2010 plus FDI net external debt). I argued this point in an interview to Expresso. This means both private and public external debt has to be restructured. Banking sector net external debt (of approximately 50% of GDP at the end of 2009) represents a large percentage of Portugal’s net external debt.
Therefore, the country has to quickly create a bank resolution law, as done by England following the financial crisis. The aim of a bank resolution process is to reduce the banking system liabilities to put it in a more sound footing. A by-product of this process is that the banking system net external debt falls to more sustainable levels.
The key to restructuring Portugal’s sovereign debt is through changes in the law (Lei Quadro da Dívida Pública), as suggested in a paper by Bucheit and Gulati (2010). Nearly all of Portugal’s Government debt is sovereign debt governed by Portuguese law and jurisdiction (I am not sure about the conditions of that private placement of debt to the Chinese). After all, the conversion from the Escudo to the Euro was done through law changes.
What we face now in the European Union is not a normal negotiation. It is a negotiation between creditor and debtor countries with an economic value without precedent in the history of the Eurozone and probably in the history of the European Union. At the end of 2009, the non-consolidated net external debt of the Eurozone “pheripheral” countries was €1.3 trillion (gross: €4.2 trillion including Ireland’s IFSC). To this you have to add the external debt of a number of countries in the Eastern Europe block. So, game theory suggests that the incentives for opportunistic behavior between EU partners are huge, because the stakes are simply so large. I argued this point in a recent Vox column.
This is why it is now of outmost importance that Portugal refuse to accept the current “aid” of the EFSF/FMI or the ESM after 2013. This aid will substantially reduce the leverage Portugal has to negotiate with creditor countries if, as expected, it results in a change in the governing law and jurisdiction applicable to a part of Portuguese government debt. These are not aid plans, these are plans put together by creditor countries. In my view, not only are they detrimental to the debtor countries, they are detrimental to the Eurozone and the European Union as a whole (see my column in DN and this Independent.ie analysis that candidly and humorously makes pretty much the same point). There are instruments Portugal can use in the meanwhile to obtain further financing without compromising the conditions of its sovereign debt.
Finally, I agree with Pedro Pita Barros that it would be an error to leave the Euro and I believe the problems in the Eurozone can still be addressed.