Some Weigh Restructuring Portugal’s Debt

As Europe struggles to come to grips with its debt crisis, which has deepened with the collapse of Portugal’s government after it pushed for yet another round of budget cuts, three numbers stand out: 12.4, 9.8 and 7.8.

lisbon portugal
Ilan Arad | Getty Images
lisbon portugal

Those are the interest rates currently paid on 10-year government bonds for Greece, Ireland and Portugal.

That they remain so high — compared with just 3.24 percent on German bonds — shows that investors remain unconvinced that Europe’s haphazard strategy for bailing out troubled, highly indebted countries has succeeded a year after it began.

As heads of state huddled in Brussels on Thursday, with a possible rescue of Portugal on their minds after similar bailouts of Greece and Ireland, the question remained: would Europe accept a resolution it has long resisted — forcing investors to take a loss on their bond holdings to keep the crisis from spreading?

While European stocks were stable on Thursday, credit markets remained uneasy, as the ratings agency Fitch downgraded Portuguese government debt and Moody’s de-rated 30 banks in Spain.

If investors become more nervous about Spain — with a much bigger economy than Portugal’s, with higher levels of bank debt — the relative calm of the last couple of months could evaporate.

A bailout of Portugal — perhaps to the tune of 80 billion euros ($113 billion) — remains the most likely if not the safest possibility, because it could prove to be another stop-gap measure that might not keep the crisis from spreading.

As the number crunchers from the European Central Bank, tax experts from the International Monetary Fund and other members of the bailout bureaucracy prepare to descend upon Portugal, preaching more budgetary pain and sacrifice, some economists argue that the smarter approach would be to restructure Portugal’s existing debt instead of piling more of it on.

While it may be too soon for final judgment, these economists note that the early returns on the 200 billion euros used to finance Greece and Ireland are less than promising.

Both countries continue to struggle to generate the cash to become solvent again despite getting support from their European partners.

In Greece, the central bank is forecasting that unemployment will hit 16.5 percent this year. Support for the Socialist government of George Papandreou and his reforms continues to erode, with a recent poll showing that just 35 percent of Greeks would vote for him again.

In Ireland, it now seems that the banks whose bad lending brought the country to its knees may need even more than the 35 billion euros already allocated to them by the European Commission and the I.M.F.

For proof that the market sees a debt restructuring as inevitable, interest rates on 10-year bonds for Greece and Ireland are higher now than when those countries received their bailout money.

Finally, in Portugal, after four cost-cutting austerity packages that have covered the usual areas like pension reform, spending reductions and tax increases, the people have had enough.

The lesson is clear, argues Barry Eichengreen, an economist and an expert on the euro and its origins — sustained austerity that is not supplemented by some form of debt reduction in which the holders of bank or government debt are forced to take a loss is not just unworkable but unfair as well.

“When you reduce the incomes of the people who service the debt but you don’t reduce the incomes of the bondholders, you won’t reduce the level of debt,” he said.

“Some might call it shared sacrifice, but some people are not sharing.”

While the argument against restructuring has been that the risks of contagion are too high, it is becoming increasingly clear that the real reason behind Europe’s reluctance to accept losses on Greek, Irish and Portuguese debt is that the cost to European banks would be prohibitive.

This week, Standard & Poor’s estimated that in a worst case of severe economic contractions in Greece, Ireland, Spain and Portugal, banks in Western Europe would need to raise 250 billion euros — more than half the amount in the European Financial Stability Facility.

Even so, the European Union remains unwilling to confront this issue head on. With its first stress test for its banks having been widely ridiculed, it has embarked on a second one. In light of the optimistic assumptions it is making on the value of Greek and Portuguese debt, this round is unlikely to be seen as much of an improvement.

“The banks are obviously putting pressure on Europe to not restructure,” said Raoul Ruparel, an analyst at Open Europe, a Europe-focused research organization based in London.

“But there is no real reason to impose such a cost on taxpayers when investors and banks have the ability to absorb these costs.”

In a report he published this week, Mr. Ruparel estimated that a bailout of Portugal would cost as much as 80 billion euros. It is an affordable figure, and that has been reflected in the lack of reaction from global markets and the euro as the Portuguese crisis has worsened.

But, he argues, a cheaper way to attack the problem would be to go to the root of the issue and restructure the country’s debt — a form of default, because it would mean reducing the debt or easing the payment terms, or both — and use a smaller amount of public money to help the process.

At 75 percent of gross domestic product, Portugal’s debt is not as high as Greece’s. But its laggardly growth rate (the weakest in the euro zone) and its terrible competitive position relative to Germany make raising the money needed to refinance its obligations extremely difficult.

That amount is estimated to be 25 percent of its output for this year.

Even with money coming in from a bailout, taxpayers will be responsible for an even higher level of debt, as in Greece. Starting in 2014, that country must come up with cash equal to 8 percent of its national income to pay its annual interest cost.

In a fixed currency zone, where countries do not have the luxury of devaluing, no country has produced that type of surplus via tax increases and spending and wage cuts.

“It would be unprecedented,” said Mr. Eichengreen, the economist. “But then the euro zone itself is unprecedented.”