This article by Ambrose Evans-Pritchard talks about the trouble in Portugal and how it disproves the myth Europe is suffering from just a “Greek Problem:”
Yields on Portugal’s 10-year bonds climbed to 14.39pc on Thursday. Credit default swaps measuring bond risk have reached 1270 points, pricing a two-thirds chance of default over the next five years.
While some of the latest damage reflects forced selling of Portuguese debt after Standard & Poor’s cut the country’s credit rating to junk status last Friday, there are deeper worries that sharp fiscal cuts by the free-market government of Pedro Passos Coelho may prove self-defeating.
Mr Passos Coelho has been praised by EU leaders and the International Monetary Fund for delivering on austerity, but the risk is that severe tightening – without offsetting monetary and exchange stimulus – will push Portugal into the same downward spiral that has already engulfed Greece.
Jurgen Michels, Europe economist at Citigroup, said Portugal’s economy will contract by a further 5.8pc this year and by 3.7pc in 2013, a far sharper decline than official forecasts. The peak-to-trough collapse would be 13pc, a full-fledged depression.
“As this gets worse it is going to be extremely difficult to go ahead with more austerity measures: political contagion will start to come through,” he said.
A new study by the Barometer for Democracy shows that confidence in Portugal’s democracy has fallen to the lowest since the end of the Salazar dictatorship. Barely more than half retain faith in the system and 15pc pine for “authoritarian” rule.
While Portugal’s public debt of 113pc of GDP is lower than Greece’s, the private sector has much larger debts and the country’s total debt-load is higher at 360pc of GDP – much of it external debt.
“There is huge private sector deleveraging going on and the banking system has big problems. It is unclear how much of this private debt is going to end up on the state’s door-step,” said Mr Michels.
“Without a sizeable haircut to its debt stock, Portugal will not be able to move into a viable fiscal path. We expect a haircut of 35pc at the end of 2012 or in 2013.”
Wow. Here’s the kicker:
Portugal is a troubling case for EU officials, who insist that Greece is a “one-off” case rather than the first of a string of countries trapped in a deeper North-South structural rift. The official line is that Portugal will pull through because it has grasped the nettle of retrenchment and reform.
Europe’s leaders have vowed that there will be no forced “haircuts” for holders of Portuguese bonds. If the country now spirals into a Grecian vortex as well they will have to repudiate that promise or accept that EU taxpayers will have to shoulder the burden of debt restructuring.
While all eyes are on Greece, it is the slower drama in Portugal that will ultimately determine the fate of the eurozone.
Get ready for some serious banking issues in 2012.