Portugal & The European Sovereign Debt Crisis Colgate Finance Club 10 April 2011 Charles Onis ‘14

What’s been happening in Europe? Since May 2010, a sovereign debt crisis has arisen in many European states. A sovereign debt crisis arises when the government of a sovereign state fails to pay back its debt in full. The fear that a government will fail to honor its debts result in a dramatic rise in the interest rate. In 2010, concern about rising deficits and debt levels across the world, along with a wave of downgrading of European government debt created alarm in financial markets.

Greece For most of 2010, such a debt crisis was focused on Greece, where there was concern about the rising cost of financing government debt. The initial currency devaluation that Greece faced with the introduction of the Euro in 2001 helped to finance the borrowing, as Greece was able to borrow due to lower interest rates their government bond could command. The 2008 global financial crisis had a particularly large effect on Greece. Two of the countries biggest industries are tourism and shipping, revenues from which fell roughly 15% in 2009.

Greece (cont.) To keep within the monetary union guidelines of the EU, the government of Greece consistently and deliberately misreported the country’s official economic statistics. It was found that Greece has paid Goldman Sachs and other banks hundreds of millions of dollars in fees since 2001 in order to arrange transactions that hid the actual level of borrowing. This allowed Greece to spend beyond its means while hiding the actual deficit from EU overseers. In 2009, under the government of George Papandreou, Greece revised its deficit from an estimated 6% to 12.7%. This rose in 2010 to 13.6%, one of the highest in the world relative to GDP.

What’s been happening in Europe? (cont.) Concern over the crisis in Greece reduced confidence in other European economies. European states with already high deficits such as Ireland (14.3%), Spain (11.2%), and Portugal (9.4%) suffered more as a result. (This led to these countries, plus Greece, receiving the offensive acronym PIGS) Normally sovereign states escape from such a “debt trap” through monetary policy such as lowering interest rates or increasing the money supply. But countries that use the Euro as their common currency cannot devalue their currency, and the countries in question refused to consider some sort of bankruptcy process, nor do they display the strong economic needed to escape from the trap.

What’s been happening in Europe? (cont.) In April 2010 the EU ministers agreed to Greece’s bailout terms. In May of 2010, the 27 member states of the EU agreed to create the European Financial Stability Facility (EFSF), a legal instrument aimed at preserving financial stability by providing financial assistance to Eurozone states in crisis. The EFSF would reach these goals by selling bonds and using the money raised to make loans from a pool of €440 Billion for use by any Eurozone Nations in need. Such bonds would be backed by guarantees given by the European Commission, the Eurozone member states, and the IMF.

What’s been happening in Europe? (cont.) In April 2010 the EU ministers agreed to Greece’s bailout terms. The EU’s emergency measures suspended fears that the Greek debt crisis would spread directly to other countries, but it was mostly too late for countries with already high deficits. While Greece’s debt crisis was caused by its deliberate misreporting of statistics, Ireland’s was caused by its decision to guarantee the enormous debts of its reckless banking sector during the 2008 financial crisis. Ongoing financial problems in The Republic of Ireland resulted in the government being forced to request a bailout EU in November 2010.

Portugal Last Thursday, Portugal became the third EU nation to request a bailout. On Friday, European finance ministers began negotiations, along with the IMF for a roughly €80 billion rescue package for Portugal. Portugal’s mishandling of its finances, and thus the cause its debts, has its roots in faulty government spending methods as far back as These include: Encouraging over expenditure and investment bubbles through unclear public-private partnerships. Funding numerous ineffective and unnecessary external consultancy and advising committees and firms. Allowing considerable slippage in state-managed public works. Inflating top management and head officers’ bonuses and wages. Persistent and lasting recruitment policy that boosts the number of redundant public servants. Risky credit and public debt creation. Mismanaged European structural and cohesion funds.

Portugal (cont.) Such practices were so engrained in Portugal’s government that it was incapable of forecasting or preventing the deficit until Later, it proved incapable of doing anything to rectify the situation even when the country was on the verge of bankruptcy in “The government had a cash problem, but was just kicking the can down the road,” - Ricardo Costa, deputy editor of the weekly newspaper Expresso. Portugal has benefitted from last year’s planning by the EU, particularly given the widespread assumption that it would need to ask for a bailout, as the European Central Bank (ECB) had already set aside a fund for Portugal.

Portugal (cont.) Portugal’s next steps will likely be fighting off the political and economic costs of austerity. Both Portugal’s opposition party and its bankers have made it clear that they would no longer support the government’s decision to unload government debt, even if they could just offload it to the ECB, as government bonds were approaching junk status. While Portugal’s prime minister Jose Socrates has made it clear that he intends to fight for as low an interest rate as possible, Portugal is in no position to bargain. Antonio Nogueira Leite, former Portuguese secretary of treasury and advisor to Portugal’s opposition party, said that the main issue is that, as Greece and Ireland have shown, bailout packages “don’t really take into account the arithmetic of the debt. Once austerity sets in, the country does’t generate the means to be able to pay for the already incurred debt.” The main problem isn’t that not only is Portugal not growing enough, they’re not growing at all, and if the economy doesn’t grow, Portugal won’t emerge from this problem in the next decade.

Effect on the Market While the markets dropped when both Greece and Ireland applied for bailouts last year, Portugal’s announcement barely troubled investors. The Euro rose, Italian and Spanish bond yields remained close to 12- month lows, and bank stocks rose. This is attributed to the fact that Portugal’s bailout has long been expected, but also due to the perception that Spain has been able to break from its status as one of the countries brought down by the sovereign debt crisis. Spain’s bond’s yields for month’s ago were 5.45% (6% is where a bailout becomes plausible). This week they had dropped to 5.06% Despite this good news, Spain’s recovery prospects depend on banks being able to borrow at low rates, given how quickly the market can turn, especially given the market sentiment and political risks across Europe, Spain’s position could change for the worse any day.

Sources NYTimes - In Portugal Crisis, Worries on Europe’s ‘Debt Trap’ - anted=1&_r=2&ref=business anted=1&_r=2&ref=business Wall Street Journal - No Time for Euro Complacency html html The Economist - Portugal seeks help, And then there were thre Diario de Noticias - Meet the real weight of the state - ) Wikipedia – 2010 European sovereign debt crisis - present)#cite_note-86 present)#cite_note-86