Posts tagged ‘Portugal’
“As a bear case it is a tempting proposition. Just when we have all started ignoring Europe, a new bailout or political upset will come along and upset the apple cart again.”
So this blog speculated all of seven days ago. Since when, two shock ministerial resignations in Portugal threatened to bear the point out directly.
Markets appear to be considerably less fragile than they were a couple of years ago, but this is still the kind of surprise they can do without. On Wednesday the Portuguese stock index fell by more than 5% and the country’s ten year bond yield rose from 6.5% to an intraday high of almost 8%. It looked as though the European drama was about to begin yet another deadly act.
Perhaps it was fortunate that attention was distracted by revolution in Egypt that very day. This was received more favourably by local markets, with the Egyptian Exchange index 7% higher on yesterday’s close. And as of this afternoon, negotiations in Portugal seem to have headed the crisis there off: bond yields have settled below 7% again and the equity market has recovered about half its lost ground so far. (German finance minister Wolfgang Schäuble did make one ominous comment though: “I think the euro is now viewed on the world’s financial markets as so stable that domestic political situations in individual countries … don’t mean a crisis for the stability of the euro as a whole.” So we can’t be out of those woods yet.)
If nothing else, the relatively sanguine response to these events tells us something about market confidence. The absorption of Portugal’s left-field political turmoil in particular is worthy of note. Above all, however, they remind us that we cannot plan for tail risk, and we certainly cannot be sure exactly what the view round the next corner is going to look like once we get there.
Lacking omniscience, we have a clear choice. We can allow ourselves to be spun into a dizzy panic by day-to-day news flow and volatility. Or we can follow the fundamentals, watch what happens to pricing – and try not to get so thunderstruck we lose the conviction to exercise our judgement accordingly.
It is fair to say that markets were blindsided on Tuesday by the decision of Moody’s, the credit rating company, to junk Portugal. Confidence was creeping back in after Athens took its austerity medicine, securing the release of emergency funds – and then, wham! – a cent off the euro, a down day for equities and a two point jump in Portugal’s 10 year yield.
From Moody’s full statement it is clear that their main concern is the possibility that private sector creditors may be expected to incur losses in a hypothetical future renegotiation of Portugal’s bailout. This concern arises from the possibility that such private sector losses will form part of the renegotiation of the bailout of Greece.
Given that no details on Greece’s second bailout are available yet this looks a little precipitate. The Portuguese certainly think so, pointing out that the new government has only been in office for a month and is fully committed to implementing the austerity measures which form part of the country’s existing bailout package – a package which was itself only agreed in May. Furthermore, since the EU’s finance ministers are meeting on Monday and Tuesday of next week and discussions on the Greek bailout are ongoing, some have accused Moody’s of trying to influence the outcome.
Whatever the truth of this, the relevance of these rating company decisions is being challenged. The ECB have suspended the ratings requirements on Portuguese debt, meaning it can still be used as collateral for lending – exactly as they did for Greek paper last year. And although Moody’s and its peers may consider a rollover of private lending an event of default, ISDA – the International Swaps and Derivatives Association, key arbiters in the world of over-the-counter derivatives – have said that they will not, and that such a rollover will not, therefore, trigger the settlement of credit default swaps.
If central banks and derivative market participants are beginning to ignore credit ratings, perhaps their days are numbered. That would certainly suit a number of European polticians who are taking Moody’s decision personally.
Before we get carried away, however, let’s remember that two percent leap in Portuguese bond yields. In the bond markets – whether for better, or as in the case of the subprime fiasco, for worse – credit ratings still count.
At some point in the future, those countries in receipt of emergency lending will need to go back to the bond markets to raise funds. When they do, it looks as though an adequately strong credit rating will still be required.
No, not the one between Mr Osborne and Mr Balls on Wednesday – the one between Portuguese prime minister Jose Socrates and the country’s opposition parties the same day. Portugal’s government saw its latest package of austerity measures defeated, Socrates resigned, the country is heading for an election and (so the consensus believes) a Greco-Irish bailout courtesy of the EU / IMF.
The consensus view finds support in recent bond market movements – specifically in the widening of the spread of Portuguese government debt over that of Germany. (Similar moves preceded the Irish bailout last November.) In fact, ten year Portuguese paper yields 4.3% more than Germany’s at time of writing – this remains well short of Greece and Ireland, at +9.1% and +6.4%, but well clear of Spain and Italy too (+1.9% and +1.5%).
Furthermore, Mr Socrates’ likely successor as Portugese PM, Pedro Passos Coelho, has been a bit cagey about his commitment to fiscal discipline and the avoidance of bailouts.
Before we treat the bailout as a foregone conclusion, however, let’s look at the numbers.
Portugal’s budget deficit on a Maastricht basis peaked in calendar ’09 at 9.3% – bigger than the eurozone average but much lower than equivalent figures for Greece, Ireland and Spain. The deficit for 2010 is estimated at 7%, and on the proposed measures was targeted to reach 4.6% this year. In the Greek and Irish cases, a large part of the problem was that deficits into 2010 were continuing to widen.
Taking a thoroughly non-random example to compare: the UK’s 2009 fiscal deficit on the same basis came in at 11.4%, is estimated at 9.8% for last year and forecast to come in at 7.9% in 2011.
Now Portugal has other problems. Its growth rate for the last ten years averaged a miserly 0.7% p.a., and unemployment, though stable, is rather high for comfort at some 11%. But it is clearly in a stronger fiscal position than the countries which have already been bailed out.
One view of Portugal’s vote this week is that it was about politics rather than economics. That Mr Coelho and his supporters are happy to continue on the path of deficit reduction – albeit by different means – but that they also want to overhaul a sclerotic economy viewed as increasingly corrupt. They must also understand that a bailout would come with austerity measures attached that would be harsher than those they have just voted down.
Ultimately, as one senior European politician put it, “Portugal won’t be left alone by the other Europeans.” We have already noted that such an attitude augurs well for the euro’s long term survival. But evidence that the eurozone’s less responsible borrowers are capable of getting their houses in order independently would bode even better.