Fears revive of Portuguese PSI

By:
Peter Lee
Published on:

The immediate panic over severe strains in Portugal’s coalition government in reaction to voters’ austerity fatigue is raising fears beyond a delayed restoration of market access.

With yields on Portuguese 10-year bonds rising to 7.2%, up from 5.25% in mid-May, investors are fearful that the general rise in interest rates accompanied by political panic at austerity fatigue is quickly reviving the eurozone sovereign crisis.

Vitor Gaspar, the former Portuguese finance minister
Vitor Gaspar, the Portuguese finance minister, had obediently followed troika instructions to cut the country’s deficit after receipt of its bailout two years ago, and as recently as April – when Portugal sold 10-year bonds – the country looked on track to graduate from its support programme as a model student.

However, even in Portugal, fiscal consolidation has taken the blame for prolonged economic contraction, and support for the PSD/CDS coalition – voted in when a majority of the country appeared to support fiscal adjustment – has evaporated.

So when Gaspar quit two days ago in the wake of growing evidence from the polls of unpopularity for the governing coalition, Paulo Portas, the head of the junior collation partner, the CDS, and also the country’s foreign minister, rebelled at attempts to replace Gaspar with a deputy deemed likely to continue the same policies.

With many analysts now predicting early elections as the most likely outcome and with the opposition Socialist party now ahead in the polls, investors want to know if this political turmoil might have wider ramifications.

The initial instinct of Barclays analysts Antonio Garcia Pascual and Fabio Fois is: “The market impact of this political crisis is likely to be very significant for Portugal but less so for other periphery countries.”

They cite two reasons. First, even if the troika programme stalls and there are delays in upcoming disbursements – the eighth programme review was about to start, just as the two ministers resigned – there are no immediate large cash needs for the Portuguese Treasury, which has sufficient liquidity to meet the €9.7 billion bond payments coming due in September 2013, and there are no other large payments due in the rest of the year.

Second, a socialist victory in new elections, while likely to steer the country towards more pro-growth policies and lead to requests for further relaxation of fiscal targets, might not usher in radical change, as the socialists did sign the memorandum of understanding with the troika in 2011.

Paulo Portas, the head of  CDS and foreign minister
Nevertheless, the chances of early restoration of full market access for Portugal have been hit hard. The Barclays analysts note: “Portugal has so far achieved about two-thirds of the more than 10 percentage points of GDP of fiscal consolidation required under the troika programme to put the public debt dynamics on a downward sloping path.

“Under the programme, public debt is estimated to peak at slightly over 124% of GDP by 2014. But in our view, public debt is more likely to reach nearly 134% of GDP by 2015 under the current government programme.

“Given the ongoing political events, the risks are evidently to the downside, not only because of further relaxation of fiscal targets, but also as a result of plausible negative shocks to the envisaged growth path, the possibility of the government having to absorb further off-balance-sheet SOE contingent liabilities, and additional bank recapitalization costs.”

Analysts at Bank of America Merrill Lynch are worrying once more about a possible bondholder bail-in for Portugal, after the loss of support for fiscal consolidation and eroding social cohesion now combining with the rise in market interest rates and debt service costs.

“In the euro area, Portugal was one of the most impacted sovereign names, recording a large widening in spreads to Germany and an even more significant rise in yields,” they say.

“The risk is that the combination of such higher yields and political uncertainty reduces the prospects of Portugal regaining full market access in the next year, and hence leads to expectations of a new ‘full’ programme being required.

“This could, in turn, result in further sharp repricing of PGBs, on the basis that PSI may be required as a part of a new programme.”

And their concerns are not just for Portugal: “Recent news coming from Ireland, Portugal and Greece are bringing the periphery back to the stage, and tension could build in the second half of the year, although not likely before the German elections: in addition to the negative fiscal news we expect in Spain before year-end, Cyprus, Portugal and Greece could also deliver negative surprises in the next 12 months.”

As we approach the anniversary of “whatever it takes”, the first hint of rising market interest rates has revealed how fragile Europe’s progress has been.