Things In Portugal Are Getting Worse

Despite media rumors that the Portuguese foreign minister Portas, who resigned on Tuesday precipitating a complete collapse in Portugual bond prices and ushering in the latest European political crisis, has agreed to stay in the government as a Deputy PM and economy minister (nothing like some title inflation-pro-quo), things in Portugal are rapidly turning from bad to worse. To wit:


The main reason for the collapse appears to be the near consensus developing this morning that no matter what the government does at this point, a second bailout of the small country is inevitable.


Take what UBS economist Gyorgy Kovacs and strategist Justin Knight wrote in a client note:

  • Political crisis makes Portugal’s exit from EU78b Troika program in 2014 and subsequent return to bond markets unlikely write
  • A second bailout may be necessary if Troika program delayed
  • Austerity fatigue in population with country in third year of recession and unemployment above 18%
  • Continued political instability may require primary market purchases by ESM of Portuguese debt in 2014
  • ECB would avoid OMT as beneficiary country must be able to access open market, likely only after several bond issues

Then there was also Bloomberg's economist David Powell:

Portugal appears increasingly likely to require a second bailout package from its international creditors.


Investors seem to be losing confidence in the sustainability of the Iberian nation’s public finances. The spread between the 10-year sovereign yields of Portugal and those of Germany has risen by 157 basis points to 624 basis points since Monday. The nation has moved increasingly toward insolvency since it was pushed out of financial markets. The debt-to- GDP ratio was projected by the IMF, in its seventh review of the country under its bailout package, to reach 122.9 percent by the end of this year versus 108 percent at the end of 2011, the year during which Portugal lost market access. That report was published last month.


The fund’s economists forecast a peak of that ratio to materialize next year. They looked for a rise to 124.2 percent by the end of 2014 and a decline to 123.1 percent in 2015 and 120.5 percent in 2016.


The forecasts are dependent on the country meeting its budget deficit reduction targets. The IMF staff looked for the primary budget deficit, a measure that excludes the interest costs of government debt, to decline to 1.1 percent of GDP this year from 2 percent of GDP last year. They also forecast the deficit to be transformed into a surplus of 0.4 percent of GDP in 2014, 1.8 percent of GDP in 2015 and 2.4 percent of GDP in 2016.


Those numbers would have contributed to the total budget balance starting to be in positive territory as early as this year. That figure was forecast to be in surplus by 0.8 percent of GDP in 2013, in deficit by 1.4 percent of GDP in 2014, and in surplus by 1.2 percent of GDP in 2015 after including “residual” factors — which encompass asset changes — privatization receipts and payments on government debt. That surplus seems unlikely to materialize.


The secretary of state for the budget, Luis Morais Sarmento, announced on June 28 that the budget deficit widened to 7.1 percent of GDP in the 12 months through March. That compared with a deficit of 6.4 percent for the calendar year of 2012 and 4.5 percent in the 12 months through March 2012, according to the country’s statistics agency.


The finance minister quit after failing to meet the IMF targets. Vitor Gaspar wrote in his resignation letter on Monday: “The repetition of this slippage undermined my credibility as finance minister.” He added: “The risks and challenges of the near future are enourmous.”


One of the major challenges is the stabilization of the economy. Output has declined for 10 consecutive quarters. The most recent year-over-year measure of GDP growth stood at minus 4 percent. Total production is 8.6 percent below its pre-crisis peak. It is at the lowest level since 2000,  indicating more than a “lost decade”.


The banking system also appears to be facing serious funding problems. The year-over-year rate of growth of deposits, excluding those of monetary financial institutions and central government, stood at minus 7 percent in May.


Portugal will probably be unable to access the ECB’s Outright Monetary Transactions program to facilitate its return to financial markets. Mario Draghi said at the monthly press conference in March: “You know that OMTs cannot be used to enhance a return to the market.”


He elaborated in April: “I have defined what we mean by the return to the markets by a country. It has to be able to issue across the whole maturity spectrum, in sizeable amounts to a variety of buyers, and we have also specified other features, which continue to apply.”


That suggests the Troika may be asked for more financial assistance. The current program is scheduled to be wrapped up by next spring with the 12th and last review to be published on May 15.

A visual summary of the Portuguese situation comes courtesy of Bloomberg Brief's Niraj Shah:

And, of course, there is the GDP...

Luckily, Portugal has the ECB's OMT to save it should the country which the crisis had forgotten for so long, suddenly finds itself with an inverted yield curve. Oh wait...