Shock and awe. That's what one economic analyst said is needed from the European Central Bank (ECB) if Portugal is to avoid becoming the next in an ever growing line of bailout recipients. But when the ECB announced on Thursday, Dec. 2, that it would extend the deadline for its emergency liquidity funds without specifying whether or by how much it was increasing its bond-purchasing program, it seemed to give the teetering Iberian country only a respite, not a rescue.
During a press conference in which President Jean-Claude Trichet announced that the ECB would prolong measures to provide ready cash to Portugal's (and other countries') banks but declined to mention an expansion to the bond program, the euro fell almost a cent. That changed later in the day when it became clear that the ECB had in fact begun quietly buying bonds in Ireland and Portugal, a move that brought down the borrowing costs for each country and gave the euro an immediate boost. "They did go for moderate shock and awe quadrupling the size of their purchase tranches," says Barcelona-based macroeconomist Edward Hugh. "Will this be enough? It remains to be seen whether this will be a Band-Aid in the short term."
Diego Iscaro, senior economist with London's IHS Global Insight consultancy, believes it will. "In principle, it gives Portugal more time," he says. "What we're seeing now is that these bond purchases are easing pressure. It's not a solution, but it gives Portugal time to sort out the situation and regain the confidence of the markets."
There's a lot of lost confidence to regain. Portugal's problems differ from those of Greece and Ireland its fiscal reporting is much more accurate than the former's, and its private banks aren't as indebted as the latter's. But Portugal's debt-to-GDP ratio stands at 76%, and in 2009 its deficit was 9.3% the fourth highest in the euro zone. Earlier this week, Standard & Poor's warned that the country's sovereign debt rating, currently an A, could be downgraded in the next three months.
In the first 10 months of the year, Portugal's government spending actually rose 2.8%, an increase that Financial Minister Fernando Teixeira dos Santos attributed to a concentration of interest payments. Improved tax revenues and the transfer of pension funds from Portugal Telecom, the nation's biggest phone company, to the state treasury will reportedly allow the government to meet its deficit goal of 7.3% for 2010. On Wednesday, Dec. 1, it auctioned 500 million euros in treasury bills, which will allow it to cover 95% of its funding needs for 2010.
In the meantime, the government continues to withstand pressure to take a bailout. On Nov. 26, it approved a budget designed to reduce the deficit to 4.6% in 2011 through a mixture of wage cuts, tax increases and pension freezes. "The measures should help calm the market," says Iscaro, "but the government has to show it can implement them. In the first part of the year, fiscal enforcement was quite lax because they didn't want to kill off the recovery."
Of course, austerity measures may help balance the budget, but by themselves they won't restore the Portuguese economy to health. In fact, by raising taxes and reducing people's spending ability, they may well harm it. "At some point, all this austerity becomes counterproductive," says macroeconomist Hugh. "It's like cutting off your finger in public to show you're a tough guy, because that's what the market demands. But you also need a plan to show how you're going to stimulate growth."
João Talone, general partner of Magnum Capital, an Iberia-based private-equity firm, agrees. "Portugal has one of the lowest growth rates in the euro zone," he says. "It must now improve its productivity. We need to support exports and become more competitive with salaries."
Like many of his fellow countrymen, Talone resists the idea that a bailout is inevitable and resents the thinking that Portugal is especially blameworthy in the current crisis. "This is an institutional problem, and it should be treated institutionally," he says. "Look how quickly the U.S. intervened in 2008. The ECB should be doing the same thing. Compared to the U.S., its bond-purchasing response is timid."
Timid or not, the ECB's bond purchasing has had some effect; Friday the euro continued its moderate rise. But even if Portugal meets its financial targets in 2010, many analysts predict a contraction in the economy for 2011. And with Portugal hanging in the balance, a contagion scenario, in which Spain (whose own economy the ninth largest in the world continues to falter despite severe budget cuts) and then Italy (with its 112% debt-to-GDP ratio) require their own rescue packages looks increasingly likely. "Portugal is a detail," says Hugh. "The ECB has to show it can handle the big issue."