Portugal needs a debt restructuring not a bailout

(PresseBox) ( London, )
Following the news that Portugal has finally admitted that it needs a bail-out from the EU, Open Europe argues today that a short-term 'bridge loan' or a full-scale bail-out would be a mistake, and could possibly store up more problems for Portugal and the eurozone further down the road.

Open Europe has outlined the various bail-out options available to Portugal, but argues that the only credible long term solution to Portugal's problems is a restructuring of Portuguese debt, combined with a limited cash injection.

Due to the uncertainty surrounding the size and structure of any bail-out the total amount is not yet clear, but Portugal would need between €70bn and €90bn to cover its funding costs for three years.

Raoul Ruparel, Economic Analyst at Open Europe, said,

"The most important question is still not being asked: will a bail-out solve any of Portugal's problems? The fact is it won't. Asking the European Central Bank to take on more junk bonds, or piling more taxpayer-backed loans on Portugal's already heavily indebted economy is not a long term solution. It will leave both the country and the eurozone more exposed to meltdowns in future - possibly on an even greater scale."

"The current bail-out orthodoxy isn't working and won't solve any of Portugal's long term problems. A restructuring, unlike a bail-out, would cut Portugal's debt rather than increase it. It would also reduce the burden on taxpayers, instead transferring more of it to investors."

To read Open Europe's briefing: "The cost of a Portuguese bail-out and why it's better to restructure", click here.


Key Points:

- A debt restructuring is the only option that will solve anything

A bailout does little to solve Portugal's underlying problems, the country is insolvent as it has little prospect of being able to repay its massive debt burden. The debt burden is also only set to increase over the next few years. Portugal is also massively uncompetitive; its cost competitiveness has decreased by a huge amount, especially compared to Germany.

A restructuring would impose losses on bondholders rather than putting the burden solely on taxpayers. It would also stop the recycling of debt around the EU, which only serves to increase the problems and the exposure of the stronger countries to the weaker ones. As we've seen in Greece and Ireland, the bailout has changed little; they still face massively high borrowing costs and cannot afford the current costs of repaying the bailout. In the long run a restructuring may also prove cheaper despite a larger initial cost, since the level of debt is set to rise further in the near future.

To avoid fear spreading in the markets in the event of a Portuguese restructuring, it would probably have to be combined with some sort of cash injection to serve as back stop against contagion to other countries, most critically Spain. This would likely take the form of a more limited bail-out fund, under which government liabilities would be much lower.

- Portugal needs at least €70bn - €90bn

Below is a breakdown of exactly what costs Portugal faces in the coming years and what the possible bail-outs could cover.

Total cost of a Portuguese bail-out: €70bn
Debt maturing this year = €16.8bn (Short and Long term from April onwards)
Debt maturing in the next three years = €23.8bn (Long term only)
Deficit for the next three years = €24.74bn (Apr 2011 - mid 2014)
Banking sector aid = €5bn

Total amount of a Portuguese bail-out: €80bn
Debt maturing this year = €16.8bn (Short and Long term from April onwards)
Debt maturing up to the end of 2014= €30.4bn (Long term only)
Deficit for the next three years = €27.1bn (Apr 2011 - end 2014)
Banking Sector Aid = €5.7bn

Total amount of a Portuguese bail-out: €90bn
Debt maturing this year = €16.8bn (Short and Long term from April onwards)
Debt maturing up to the end of 2014= €30.4bn (Long term only)
Deficit for the next three years = €27.1bn (Apr 2011 - end 2014)
Banking Sector Aid = €15.7bn

- A bridge loan: the worst of all worlds

There has been a lot of talk about the possibility of Portugal getting some sort of "bridge loan" and trying to soldier on until a new government comes to power after the 5 June elections. However, a bridge loan would really be the worst of all solutions. In the first place, this smaller bail-out would have to be condition-free, since there is no Portuguese government to enact or negotiate the conditions at the moment. Secondly, and most importantly, a bridge loan would be nothing but a precursor to a full-scale bail-out to be negotiated with the new government. This just increases the amount of debt Portugal is taking on and increases the moral hazard of the bailouts in general due to lack of conditions. At the end of the day, neither of these two bail-outs would help solve the country's underlying problems. Portugal is basically insolvent and its economy will remain highly uncompetitive while it stays within the eurozone.

- Will it spread to Spain?

Given the strong links between their economies, Spain's exposure to Portugal is significant. However, the common assumption that if Portugal were to restructure, contagion would quickly spread to Spain is far from certain - although contagion could happen in a "perfect storm" scenario. Spain's banking sector exposure to Portugal is large, but manageable, as it is estimated to be around €62.2 billion. This is around half the UK's exposure to Ireland, in nominal terms (two countries which have a similar proximity and relationship to that of Spain and Portugal) and around 6% of Spain's GDP. Spain's total exposure to Portugal is also less than 9% of GDP.

Nonetheless, other economic problems in the eurozone could intervene. A Greek restructuring and an Irish bail-out renegotiation this year, as well as potential negative market reactions to weak banking stress tests and inconclusive EU summits, are all factors which, combined with a Portuguese restructuring, would make the spread of contagion to Spain more likely. In addition, there are also several possible developments inside the Spanish economy which could potentially trigger a run on Spain should they coincide with a Portuguese restructuring. To give an example, in the light of Spain's massive amount of private debt (much of which takes the form of variable rate mortgages), the interest rate increase announced by the ECB a few hours ago could decrease disposable income across the Spanish economy, thereby decreasing domestic demand and possibly harming employment.

Below is a rough estimate of how much Spain would need if it got into financial difficulty. They're based on covering Spain's total funding, including the potential cost of recapitalising the banks for 2012-2014 (if you add 2011, this amount will go up).

Total cost of a Spanish bailout: €365bn
Recapitalising banks = €60bn (based on Moody's assessment)
Debt Maturing (including interest) 2012 - 2014 = €190bn (Spanish Ministry of Finance)
Fuding the deficit 2012 - 2014 = €115bn (based on significant deficit cutting measures, from 9% end of 2010 to 2% end of 2014)

Given the size of this figure though, it is nearly impossible to estimate what individual countries' contributions to a rescue would be. At the moment none of the EU bailout funds have enough money to cover Spain and therefore a new fund would need to be created, the rules of which are impossible to estimate.
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