Thursday 10 March 2011

Does Portugal need a bail-out?

Here are the views on this key question as contributed by some of the economists writing in this blog:

Alvaro Santos Pereira:
Absolutely. There is no doubt in my mind that Portugal will be bailed out, whether that is done through the “conventional” means that have been used by Greece and Ireland, or whether Europe gets its act together and agrees on a permanent framework to deal with these situations (a big if, indeed). Still, in both instances, Portugal needs to solve rapidly the acute liquidity shortage that threatens to dampen even more the country’s economic activity.

Why is a bailout almost inevitable? Because the credit constraints and the lack of financing of the economy are untenable, the debt dynamics are unsustainable, and because, frankly, there is a self-sustaining belief that Portugal is the next country to fall in the European sovereign debt domino.

Independently of what will happen in the next few days, the fact is that Portugal has a very serious debt problem in its hands, which will likely not go away with a mere bailout. Just to put things into perspective, in 2011, Portugal will have its highest public debt (as % of GDP) of the last 160 years, and the largest external debt in the last 120 years. Our public debt will be higher than 91% of GDP, and that does not even include the debt of public enterprises or the future debt already committed with the private-public partnerships that substituted for public investment in the last decade. In addition, the country’s gross external debt amounts to more than 240% of GDP, and net external debt is around 110% of GDP. The economy has not grown significantly in the last decade, and there is no major indication (with the possible exception of exports) to make us believe that we are on a prelude for an unforeseen economic miracle. To make things worse, government policies have been close to disastrous, and have only aggravated Portugal’s economic ailments. In short, the situation is dire, and it is difficult to envision any scenario in which a bailout will not take place, even though the latter might not be enough to help resolve Portugal’s debt problems in the medium and long term.

The fact is that the only reason that has prevented Portugal to ask for a bailout are the political costs that will be associated with such a decision. Everyone in Portugal knows that as soon as the country is rescued, the government will (deservedly) fall and new elections will be scheduled. That is the sole reason that has made the Portuguese government so reluctant to activate the bailout mechanisms. It’s not national pride, it’s really high political costs. The prime-minister and the government don’t want to be judged by History for being responsible for the most serious financial crisis that Portugal has experienced since it was forced to declare bankruptcy in 1892. Alas, they are and they will. And, unfortunately for us, even their stubbornness will likely not be enough to prevent an more-than-probable bailout.

Pedro Lains:
Yes it does. But no, thanks.
Where should we look at to find the answer?
The Government is not interested because it would have large political costs. So let’s look elsewhere.
The IMF is probably interested in the bailout, as they are part of its business. So, most analysts linked to the Fund say that it should be asked for. Merkel’s government follows this line of thought.
Would medium term average sovereign debt interest rates be reduced with a bailout? Apparently that was not the case with Greece and Ireland. Saying the sooner the better does not help either.
Portuguese bankers and those voices in Europe that favour the deepening of European integration are against. Bankers in Portugal fear the bailout because, they say, it would reduce (domestic and foreign) deposits. The pro-deepening people argue that a European response would be enough to curb interest rates on peripheral sovereign debt. Interestingly the head of the European rescue fund also says no, that it is not needed for now.
So, I guess that my reading of these different positions leads to the conclusion that at this stage the costs of a bailout would be higher than its benefits.

Pedro Pita Barros:
Portugal can benefit from a bail out. Is it essential? Not necessarily, depends on what price is to be paid for it. An Irish-like intervention will not help much. If that's what is on the table, then I would say no to the bail out. The bail out is worthwhile only if the discipline mechanism does not include to a considerable extent high interest rates.

Pedro S. Martins:
Yes. Things need to change as the current combination of high debt and high interest rates is clearly unsustainable. It's not equitable to burden young people and the future generations with so much debt and all the taxes that follow. The bail-out would mark a clear threshold in the management of the Portuguese economy and prompt much-delayed reforms that can restore productivity growth and ensure this decade will not be completely lost.

Paulo Trigo Pereira:
With 6% yields in 2 year sovereign bonds issued this Wednesday, Portugal has reached interest rate levels on sovereign debt that are unbearable. Although there are good signs that fiscal consolidation will reduce the primary balance in 2011 (mainly through the increase of tax revenues), part of this reduction will be offset by increase in debt interests so that public deficit will not decrease as much as it could.

GDP growth in 2011 is unpredictable, basically given the uncertainty on exports, but it is reasonable to assume a recession this year around 1%, and since fiscal consolidation will have to continue in 2012, a close to zero growth in 2012. Under this scenario, unemployment rate will keep its actual two digits, and long term yields, with or without bail out (see the cases of Greece and Ireland), will remain above 7% in the next two years starting to decline in the second half of 2012, when (and if) there are good signs that reduction of public deficit is sustainable and will continue in 2013. Available data suggests that we are in a consolidation path, but some time is needed to gain credibility.

Under this framework it seems wise to have immediate access to the European Financial Stability Facility (EFSF) covering most of our gross borrowing requirements for the next two years, while yields would remain high. The exact amount will depend on the expected privatization revenues over these two years.

The access to the EFSF should be carefully worked out with a reasonable agreement not only with respect to the yields (around 5% is acceptable), but also all the “package” of measures that will be included in the memorandum of understanding.

Finally, a bail out has to be demanded by the prime minister, and domestic political debate has mixed this demand with a political crisis and general elections. The two issues should be disentangled. And in order to do so a political agreement should be set between the government and the main political party.

A development of this argument will be set out in my “Público” article this Friday 11th March (in Portuguese). Simulations of savings in interests having access to EFSF, with two scenarios, done by myself and João Duque will be presented at Instituto Superior de Economia e Gestão, Friday 11th at 6pm in Auditório 2 (Rua do Quelhas).


  1. Are we truly on denial?

  2. If we get bailed out we still need to pay it! So that’s look at the pros and cons of a bailout:

    - Potentially cheaper marginal fund (but our stock of funding is still cheaper than the current cost of a bailout
    - An external bailout creates more pressure to cut the public debt faster

    - Bailout debt is much harder to restructure and as such decreases optionality for Portugal (i.e. you can tell a bunch of small German banks and insurance companies that you won’t pay 100c on the dollar on your bonds anymore, but you can’t tell the IMF or the EU that you won’t pay them!)
    - Bailout is an admission of failure that the market doesn’t look kindly at (e.g. look how Greek and Irish bond yields are much higher than Portuguese, which means that despite the bailout there countries remain unable to fund in the market)
    - Bailout decreases the space of manoeuvre for the Portuguese government and as such decreases optionality for Portugal (e.g. IMF is pressing Greece to start privatisations ASAP against a bad market for Greek assets - Greece will have to sell low)

    As you can see above, very simply, a bailout doesn’t solve anything!

    With our without a bailout, Portugal will have to decrease its public debt until the markets are satisfied*. But a bailout takes options away from Portugal. And as any person with a bit of common sense knows, options have value.

    Of course you can argue that Portugal cannot decrease its public debt enough, which is why we might as well fund ourselves with a bailout. But that’s a fallacy. We can decrease our public debt by decree (if we believe there’s no other way), by defaulting! But if we get bailed out it will be much harder to do that. Ireland and have Greece have already found that out, the hard way.

    I do understand why some rational people want a bailout for Portugal. But we have to understand their motivation:
    - Northern Europe: they lent us the money so they are the ones that have the most to loose if we default. That’s why they want to tie us in with the bailout
    - IMF: their business is to do bailouts. So they want us to do a bailout!
    - Some PSD and CDS politicians in Portugal: They know that if the current Gov. asks for a bailout they will win the elections and they won’t have to be the ones asking for a bailout!

    But I really struggle to see how a rational, educated person (i.e. not blinded by ideology) can honestly believe that a bailout is good for Portugal!

    Ok, I might be too harsh on Paulo Trigo Pereira, but he’s just crunching the numbers and he forgets that the market is driven by expectations.

    Being bailouted would prove to the market that Portugal is uneable to manage its own economy and would drag Portugal to the same swamp as Ireland and Greece. Portugal wouldn’t grow out of it quickly because no one wants to invest in a crap economy! To really reset market expectations Portugal has to do the unexpected and avoid a bailout!

    Any thoughts?



    * Notice that the markets could be satisfied with the current level of debt if they felt that Portugal was more trustworthy. Reinhart and Rogoff argue that the tipping point for excess debt is historically only above 80 to 90%. And Japan, Belgium and Italy, for instance, have much higher levels of debt…

  3. Of course a bailout is needed. Simply there is no alternative. The government has been claiming that it does not need financial assistance , but it has also been claiming that the scope of the EFSF has to be enlarged. What for? Obviously, because EFSF assistance is unavoidable.
    Portugal has virtually lost the access to markets: The IGCP decision two weeks ago to auction 1 billion only at 2 years is quite revealing of this. Irrespectively of what the government announces (tax increases of 15%, deficit reductions of 50%, success in expenditure reduction, new austerity measures), markets do not react. Yields are picking up and they are picking up because they are just too high and markets are convinced that they will keep increasing until something drastic is done.
    A bailout would allow longer term financing for the contry and a lower interest rate on debt. The comparison with Greece and Ireland is not reasonable, because the Portuguese debt is much lower and so is the risk of default. So, after a bailout, yields on secondary markets need not to increase.
    Miguel Lebre de Freitas

  4. With the current Japanese tragedy heightening risk aversion in the markets, there would be little chance that ECB will raise rates in the short run. Spain the least exposed to the debt problems in the PIGS category. At govt yield of 4.2%, they seem to be able to make it out of the crisis in whole.

    European outlook:Intrinsic Value