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Sooner rather than later

19 Oct 2016 By Neil Unmack

Portugal has delayed its day of reckoning for another year. The country should avoid a debt downgrade after promising further tax increases. That will keep Portugal’s debt eligible for ECB money-printing, which should keep its debt yields down. Yet Lisbon’s high debt load and weak growth makes restructuring likely.

Portugal has moved aggressively to defend its BBB rating from ratings agency DBRS, and avoid its debt being cast off the ECB’s bond-buying teat. Frankfurt has so far bought 22 billion euros of Lisbon’s debt, more than the state issues in a year. The left-wing coalition government is raising taxes on property and sugar in a bid to both keep DBRS on side, and satisfy its supporters’ desire for a “budget of the left”.

The country now expects the budget deficit to fall to 1.6 percent next year, from 2.4 percent this year. In practice, the deficit will probably be higher: the government’s estimates for 2016 are optimistic, and next year’s growth may not match the 1.5 percent it expects either. The International Monetary Fund reckons it will grow just over 1 percent, before taking into account the fiscal squeeze. The numbers may be off, but with the deficit falling DBRS is expected to hold fire.

Still, Portugal seems stuck. It suffers from weak growth, high unemployment, sickly banks and towering public and private debt. Despite ECB purchases, markets are demanding a premium of 3.2 percent to hold its 10-year debt over German securities. Even with ECB President Mario Draghi’s aggressive monetary policy, it can barely bring down its public debt from 129 percent of GDP. That leaves it very vulnerable to any economic downturn, or a rise in global interest rates.

The most logical solution would be a debt restructuring. That won’t be easy. About 30 percent of Portugal’s debt is held by the European Union and IMF, and its banks hold about 43 billion euros of sovereign debt, equivalent to three quarters of their reserves, according to ECB data. Foreign investors, the easiest targets, own less than 40 percent of its bonds.

Next year may be a better time to grasp the nettle. Greece will likely negotiate its own debt restructuring, and the passing of Germany’s election should make compromises easier. The effect of the ECB’s purchases may be waning then anyway, as markets push up yields. The reckoning is coming, just not yet.


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