Time Unlikely to be a Healer for Portugal's Economy

Despite comparisons with Greece, Portugal is not in entirely the same situation, at least not yet it isn't. Crucially, Portugal is currently under no obligation to deal with international or national creditors to increasing government debt issuance courtesy of joint aid programme administered by the EU and the IMF

The aid programme which aims to allow Portugal to return to normal market funding in mid 2013 stands at 78 billion euros of which 56 billion euros is provided by the EU and the remaining 26 billion euros by the IMF under the Extended Fund Facility. The recent mission statement concluded at the end of February found little to protest against and it appears the next installment of aid financing for Portugal (14 billion euros in total) will be delievered in April according to plan. 

So far so good. 

On the time scale currently employed by the market to assess the progress on the eurozone debt crisis mid 2013 is far away in the distant future. In other words, Portugal has time and while I am as certain as an economist can be that the country will need debt restructuring, the time between here and there may still prove crucial. 

Recent comments by European Central Bank’s Vice President Vitor Constancio suggest that while the headlines from the ongoing mission reiterate that progress is ongoing and according to plan the actual ability of Portugal to re-enter the market in 2013 is still not clear cut. 

Quote Bloomberg

The question of whether Portugal can sell debt or needs additional aid from international creditors “only poses itself in September next year,” Constancio, who is Portuguese, told reporters in Copenhagen today after a meeting of European finance ministers. “Until then, we have to see if this progress consolidates, allowing the return to the markets without a new program.” Meanwhile, “fortunately” market conditions have improved for the country, he said.

Portugal’s aid plan assumes the country will regain access to medium and long-term sovereign debt markets in 2013, with the program’s last disbursement to be made in June 2014, the International Monetary Fund said in December. European leaders declared then that Greece’s situation is “exceptional and unique” and said they don’t foresee bondholder losses in other nations that seek assistance.

No country that has been subjected to debt relief/aid programmes by the IMF and EU has so far been able to access debt markets on normal market conditions. Indeed, it appears that the only thing we can say for certain is the prospect of returning to normal declines proportionally with the time spent under IMF/EU custody.  

In the 3-4 years since the crisis broke out the bold statement by any country that it was now fully funded until a given date has, in all cases, been the coup de grace (remember Ireland?). Either the end result has been more debt aid by the IMF and EU through the effective rollover of existing aid arrangements or, in the case of Greece, a debt restructuring. 

The problem is that the time frame politicians and EU/IMF economists consider to be reasonable for recovery and a return to normal have persistently been proven too optimistic. The obvious effect of this is that aid and bailout programmes have so far been extended. Kicking the can down the road can be a powerful remedy, but the condition is that the time is well spent and that the structural mechanisms for a recovery are there in the first place. In most cases, both has so far been missing.  

Whether Greece represents a roadmap for Portugal remains to be seen. I believe it is, but there is an alternative. All across Eastern Europe the IMF is in many cases nearings its third debt rollover deadline. Being under IMF stewardship is truly like Hotel California where you be able to enter but where leaving is difficult if not impossible. 

In this context, the 1 trillion firewall recently being served up is important. On the face of it, it appears inadequate not because of its size, but because the end effect may not be a viable way out for struggling European economies. However, it will give the EU and the IMF a drastically enhanced ability to continue rolling external debt/aid obligations. However, if the underlying mechanisms that should lead to economic recovery are not there even 1 trillion euros will eventually fall short of the task. This is especially the case if Italy and Spain were to enter the bailout equation. 

If Portugal represents the next eurozone country to face crunch time the problem with a debt restructuring are all too well known from the Greek case. As country after country spends longer under IMF/EU wardship (and perhaps even also sells bonds to the ECB) external liabilities become increasingly tilted towards official holdings. As we know, from the Greek case, this means a small pie for debt restructuring and thus a higher haircut for the private sector holding. Indeed, this process in itself is a critical determinant for why these economies will never be able to return to normal funding conditions.

No private entity will want, let alone be allowed to by its regulator, to buy debt from a non-domestic sovereign where you are essentially subordinate to 40-50 percent of the existing debt outstanding.

Nomura’s Dimitris Drakopoulos and Lefteris Farmakis have done the hard work on Portugal (courtesy of FT Alphaville) and their analysis is, in my opinion, crystal clear. The key is the following (my emphasis);

Total Portuguese state debt outstanding in 2011 of €174.8bn consisted of:

a) €104bn local law PGBs (the most easily restructurable portion of debt, if investors have taken lessons from Greeceā€Ÿs local law restructuring techniques),

b) €4.7bn in foreign law bonds,

c) €17.4bn in Saving and Treasury certificates,

d) €12.6bn in T-bills, and

e) €35.9bn in official loans.

Note that this concept differs from the general government headline debt figure as reported to Eurostat, which was €183.bn in 2011 or 107% of GDP.Of those categories, only (a) and (b) are straightforwardly restructurable, making for a total of just under €110bn. Category (c) refers to securities held by retail investors, who are generally exempt from debt restructurings, while T-bills and official loans (especially IMF loans) would probably fall outside any PSI exercise. In effect, only 62% of total Portuguese debt is immediately restructurable as things stand (vs. 72% in Greece at the end of 2011). 

FT Alphaville's Joseph Cotterill furthermore adds; 

That’s a very useful list, by the way. It’s not

easy to extract debt stats about Portugal from the sources available…

But Nomura don’t break out ECB holdings of Portuguese bonds in the above! We all know now that these holdings are senior, so they get subtracted as well. It leaves just under half – 49 per cent – of Portuguese debt that can be restructured.

The math here is very clear. With only about 50 to 62 percent of the debt outstanding liable to restructuring the idea that Portugal may return to the market under "normal" conditions is ridiculous, especially if we assume that this includes the prospect of international creditors doing the bid.

However, there is an important difference between Portugal and Greece. Where Greece had a substantial part of its debt outstanding held by foreign creditors the restructurable debt in Portugal is mainly held by domestic corporates and banks. This is due to the increasing re-nationalisation of sovereign risk on the back of the crisis and specifically the ECB's LTROs which have incited banks to buy their respective sovereign's debt. This adds another layer to the Portuguese case in the sense that if the private sector gets hosed, it will mean domestic banking and corporate defaults. The ensuing re-capitalisation would be impossible for Portugal to deal with without EU/IMF help. 

This points towards kicking the can down the road as long as possible and thus the Eastern European outcome where the IMF/EU simply rolls liabilities. However, just as was the case with Greece, Portugal is likely to find it impossible to lower its debt level without a lump sum reduction in its debt level through restructuring. For now though, it appears that time, while not a healer, is still on the politicians' and IMF economists' side.