EU Summit Begins In Post-Portugal Collapse Chaos: What, If Anything, To Expect; A Look At Portugal's Imminent €70 Billion Bail Out

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Goldman's Dirk Schumacher summarizes what to expect out of the EU Summit which begins today, and why following yesterday's Portuguese government collapse, it may well be another toothless formality:"Yesterday's resignation of the Portuguese prime minister Socrates, after
parliament rejected the government's consolidation program, does not
necessarily imply that EU leaders will not be able to take any decisions
at today's summit...The resignation of Socrates, however, may now mean that it will take
longer before the Portuguese parliament will be able to vote on todays
summit outcome - how long will depend on whether there will be early
elections or whether the current parliament will be able to form a new
government. According to Portuguese law new elections cannot take place
before 55 days after the parliament was dissolved and it may then also
take a few weeks to form a new government
." In other words, any decisions made today will not be ratified for at least two months, long after Portugal will be in dire need of funding to roll its April maturities, as has been long discussed on Zero Hedge.

From Goldman Sachs:

EU summit starts today. Government heads of the EU27 will meet today and tomorrow in Brussels to discuss, and approve, the reform of the EFSF, the establishment of the ESM as well as the reform of the economic governance of the Euro-zone. Earlier this week, finance ministers already agreed on several details which now need to be approved by government heads.

One topic that apparently needs further discussion is the schedule for capital payments into the ESM. After a meeting with coalition MPs in Berlin chancellor Merkel now seems to prefer a reduction of the initial capital injection of €40 billion in 2013, though there seems to be no disagreement that the final capital base in terms of paid-in capital of the ESM should be €80 billion as agreed by finance ministers earlier this week.  

Yesterday's resignation of the Portuguese prime minister Socrates, after parliament rejected the government's consolidation program, does not necessarily imply that EU leaders will not be able to take any decisions at today's summit. It was clear from the beginning that any decision by government heads taken today would need to be approved later by parliaments in any case. The resignation of Socrates, however, may now mean that it will take longer before the Portuguese parliament will be able to vote on todays summit outcome - how long will depend on whether there will be early elections or whether the current parliament will be able to form a new government. According to Portuguese law new elections cannot take place before 55 days after the parliament was dissolved and it may then also take a few weeks to form a new government. 

And a press release just issued from the Open Europe think tank summarizes why the next step, the bail out of Portugal, will cost E70 billion, to start.

New Open Europe briefing: Portuguese bail-out could amount to €70 billion

With EU leaders meeting today in Brussels in a bid to agree a new ‘grand bargain’ to save the eurozone, Open Europe has published a briefing arguing that Portugal looks set to be the next country to apply for a bail-out from the EU and the IMF.

Yesterday, the Portuguese government failed to win parliamentary approval for fresh austerity measures, leading the Prime Minister, José Sócrates, to resign, putting renewed pressure on Portugal’s finances. This could leave the country without a permanent government for months, as new elections are not expected until May, at the earliest – hugely complicating any bail-out negotiations.

Open Europe estimates that to cover Portugal’s deficit and bond repayments for three years, the bail-out would have to be between €60bn and €70bn.

However, the briefing argues that a bail-out is unlikely to solve any of Portugal’s fundamental problems and it would be cheaper for the country to move straight to restructuring, combined with a limited cash injection from the EU and IMF.

Portugal’s problems also illustrate why the reform package discussed today by EU leaders will not stamp out persistent tensions and increasing divergences between different countries within the eurozone.

Open Europe’s economic analyst Raoul Ruparel said:

“A bail-out of Portugal now looks virtually inevitable. But the cases of Ireland and Greece clearly illustrate that the EU’s strategy – to throw good money after bad – is failing. Rather than simply taking a bail-out, it would be better in the long run for Portugal to restructure its debt.”

“A Portuguese restructuring package rather than just another bail-out would shift some of the cost away from taxpayers and onto investors. It would also allow Portugal greater flexibility to achieve the necessary reforms needed for long term stability.”

“A new Portuguese government will have a clean slate on the issue of economic reform. It should use this fresh start to tackle underlying problems facing the economy through a debt restructuring, rather than just taking on more high priced debt in the form of an EU bail-out.”

To read the full briefing, click here:
http://www.openeurope.org.uk/research/portugalrestructure.pdf

Key points:

·         Portugal is getting ever closer to asking for a bail-out. Following the resignation of Prime Minister José Sócrates, after a series of austerity measures were voted down by Parliament, Portugal is now without a permanent government. Due to constitutional rules an election is not expected until the end of May.

·         In 2011, the country needs to refinance 25% of its national wealth – in relative terms, this is even more than Greece. The country’s borrowing cost has been above 7% for 38 consecutive days. Greece and Ireland lasted 13 and 15 days respectively at these kinds of rates before asking for a bail-out.

·         We estimate that a bail-out package for Portugal would need to be between €60 and €70 billion. This should allow Portugal to cover all bond repayments as well as any government deficits for three years.

·         However, a bail-out is unlikely to solve any of Portugal’s fundamental problems. Both Ireland and Greece are already looking to renegotiate their bail-out terms. This illustrates that short term loans are simply not sufficient.

·         Portugal’s cost competitiveness relative to Germany has decreased by 21% since the introduction of the euro. An increase in ECB interest rates, which is widely expected next month, will also lead to a decrease in the availability of credit and domestic demand in Portugal. This could cause Portuguese GDP – already estimated to shrink by 1.4% in 2011– to contract further.

·         Although we expect a bail-out, we believe a more viable solution would be to restructure some of Portugal’s debt. In the long run this may prove cheaper despite a larger initial cost, since, unlike in the case of a bail-out, it would cut Portugal’s debt rather than increase it. It would also reduce the burden on taxpayers, instead transferring more of it to investors. Crucially, the longer Portugal waits, the costlier a restructuring will be for the country, since its debt is expected to continue to build up over the next three years.

·         In order for a restructuring not to spread contagion to Spain, it would be best to combine it with a limited bail-out, which would involve smaller contributions from member states, since more of the cost is borne by investors.

·         The hope is that Portugal will use the cash and breathing space, freed up through a restructuring, to invest wisely in its own economy, including pushing through more economic reforms. However, the country will still be stuck with an over-valued currency, and the unanswered question of whether it can ever become competitive as long as it shares a currency with radically stronger economies such as Germany.