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Philip Moore, Nathan Collins
Spain dominates the headlines, but Portugal's torturous bid for stability even with billions of euros of aid - and litany of painful structural reforms - throws into sharp relief the depth and expected longevity of the eurozone crisis.
For a stark illustration of the extent to which eurozone states must embark on serious structural reforms while ensuring near-term solvency even with billions of euros in aid you could do worse than look at Portugal.
Although the Spanish bailout has dominated the headlines, a large number of Portuguese banks were the recipients of a recapitalization plan from the government. The Portuguese government announced on Monday that it planned to inject up to 6.65 billion into three banks: BPI, BCP and state-owned CGD. The former two also plan on carrying out separate rights issues by September.
While this is expected to bring core tier capital ratios at the three banks up to 10% by the end of the year, its also set to have an substantial dilutive effect on the banks. Nomura analysts expect the earnings dilution to be around 85% at BPI, and more than 100% for BCP. There is also concern over the banks ability to repay the contingent convertibles, given the weak earnings outlook at Portuguese banks.
Although the capital infusion will strengthen the balance sheet of the banks, it does little to improve the weak and uncertain outlook facing the sovereign," states Nomura analyst Daragh Quinn. "On its own, this will not be enough to restore confidence in the Portuguese banking system, as the macro factors continue to remain challenging.
Portugals problems arent restricted to the banking sector. As Euromoney magazine noted in its June issue, the country faces serious problems with competitiveness and is set to undergo a period of painful structural reform. This looks to be far from easy, as Morgan Stanley research points out Portugals household and corporate debt has reached 223% of GDP. For reference, the eurozone average is 168% Portugal looks like it will need to deleverage faster and further than its peers.
This process is under way. Deposits are on the rise and loan-to-deposit ratios are falling; the banking systems total loan-to-deposit ratio has dropped from 167% in June 2010 to 139% at year-end of 2011. Not quite at the 120% level demanded by the Bank of Portugal and the International Monetary Fund, but getting there.
Evolution of customer deposits in Portugal
No signs of a run there
Source: Banco de Portugal
Nuno Amado, chief executive of BCP, sees this as something to take heart from. "Part of that is the result of more restrictive lending conditions, part of it is a sharp fall in demand from corporate and mortgage borrowers," he says. "You see, everyone is deleveraging, not just the banks, so there is much less appetite for debt in the market. This is a virtuous circle in this economy, as long as there is financing available where it makes a difference.
A recent Barclays Capital analysis says that rather than create an opportunity for convergence, Economic and Monetary Union membership led to a wider gap in per capita income between Portugal and the euro area average. Portuguese productivity has been low: the competitiveness of the country has dropped by more than any other, except Greece, since the inception of the euro. This has been accompanied by a falling export market share, leading to dismal GDP growth.
Portugals competitiveness isnt helped by a distinct lack of concrete vocational skills in the populace. A recent Commerzbank report points out that around 70% of the population lacks a vocational qualification compared with the Organization for Economic Cooperation and Development average of 27%, and just 15% in Germany.
While Portugal used to be able to compensate for the lack of a skilled workforce with lower wages, these wages long ago rose above those paid in more competitive countries in central and eastern Europe.
This is a problem that can seemingly only be fixed by extensive structural reforms. In other words, with increasing debt-to-GDP ratios in the run-up to the global crisis, Portugal has little choice but to dramatically reduce leverage ratios and crimp its once-generous welfare state if it has any chance of economic survival.