Portugal Suffering Greek Contagion Pressures EU Bonds (Update1)
April 27, 2010, 5:34 AM EDT(Updates prices in fourth, 11th paragraphs.)
By Emma Ross-Thomas and Jim Silver
April 27 (Bloomberg) -- Portugal risks becoming the new Greece.
With a higher debt burden and a slower 10-year growth rate than Greece, Western Europe’s poorest country is being punished by investors as the sovereign debt crisis spreads. The risk premium on Portuguese bonds rose to more than double the past year’s average this month. Portugal’s credit default swaps show investors rank its debt as the world’s eighth-riskiest, worse than for Lebanon and Guatemala.
“We do not ignore that Greece’s particular situation has contagion risks, and we are feeling it,” Finance Minister Fernando Teixeira dos Santos told reporters in Lisbon on April 22. “The performance of spreads in the market reveals that contagion risk.”
Greek bonds tumbled yesterday, and yields held near the highest since at least 1998 today, on speculation over the timing of the European Union bailout package for Greece. Portuguese spreads, the extra yield that investors demand to hold its debt rather than German equivalents, jumped to 227 basis points today, the most since at least 1997.
Hobbled
Portuguese Prime Minister Jose Socrates’ push to convince investors his country will avoid Greece’s fate is being hobbled by an economy that’s expanded less than an annual average of 1 percent for a decade and is reliant on tourism and industries such as cork and pulp.
While Portugal’s public debt of 77 percent of gross domestic product is on a par with that of France, the burden including corporate and household debt exceeds that of Greece and Italy, at 236 percent of GDP. The savings rate is the fourth-lowest among 27 members of the Organization of Economic Cooperation and Development, according to the Paris-based group’s data.
“The reason we’re concerned about Portugal is not because its public sector debt ratios are excessively high, it’s more that the Portuguese economy doesn’t really grow,” said Kenneth Wattret, chief euro region economist at BNP Paribas SA in London.
‘Conspicuously Vulnerable’
EU policy makers’ difficulty in containing the Greek crisis is stoking the threat of contagion, just as the near-collapse of Bear Stearns Cos. in 2008 undermined other U.S. banks, exacerbating the credit crisis.
The risk for Portugal is that investors who are trying to protect their portfolios from a Greek-like rout will dump holdings of small euro countries, such as Portugal. Once that happens, surging bond yields could put Portugal in the same spiral that Greece is trying to escape.
Portugal is among countries that are “conspicuously vulnerable” and may need a bailout, said Kenneth Rogoff, a professor at Harvard University in Cambridge, Massachusetts, in a telephone interview.
Credit default swaps on Portuguese debt, which insure against default, reached 315.5 basis points today. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year. An increase in swaps signals deterioration in perceptions of credit quality.
The International Monetary Fund in Washington said last week that Greece’s fiscal crisis may spread to other European countries. Investors are trying to avoid being caught by the “next Greece,” said Olaf Penninga, who helps manage 140 billion euros ($187 billion) at Robeco Group, an 80-year-old Rotterdam-based asset manager.
‘Self-Fulfilling Prophecy’
Portugal plans to raise as much as 25 billion euros this year, equivalent to 15 percent of GDP. That compares with 21 billion euros last year, according to the national debt agency.
“As spreads get higher the problems are getting bigger: it’s a self-fulfilling prophecy,” Penninga said in a telephone interview. “It will get more difficult now for Portugal to tap markets.” Robeco reduced exposure to Portuguese bonds last year and sold the last ones in March.
Portuguese companies have responded to slow growth at home by expanding outside their borders. Lisbon-based Cimpor-Cimentos de Portugal SGPS SA, one of the world’s 10 biggest cement companies by market value, gets more than three-quarters of its revenue from outside Portugal, and Jeronimo Martins SGPS SA, the biggest Portuguese retailer, gets most of its sales from Poland.
Portugal’s PSI20 stock index climbed 14 percent in the past year, less than half as much as Germany’s DAX and the Stoxx Europe 600 Index.
No Share Sales
The country’s 236 percent debt burden last year compares with 205 percent in Italy and 195 percent in Greece. As Portugal’s private sector took on debt, the country’s savings rate fell to 10 percent in 2008 from twice that in 1995, while growing in Germany, according to OECD data.
Mota-Engil SGPS SA, Portugal’s biggest construction company, increased its ratio of debt to operating profit to 7.5 in 2009 from less than half that four years earlier as it expanded into building and operating highways. Bank loans increased 24 percent last year, according to the annual report of the Oporto-based company, which hasn’t raised money by share sales since 1997.
The lack of savings at home lies behind the Portuguese government’s dependence on foreign investors to fund the deficit, and the vulnerability of its bonds to shifts in sentiment.
About 15 to 17 percent of outstanding public debt is held by Portuguese investors, the debt agency estimates. In Spain about 54 percent of bonds and bills are held domestically, the Spanish Treasury says. Overseas investors held 6.2 percent of Japan’s government bonds as of the end of December, according to the Bank of Japan’s quarterly flow of funds report.
Two Haircuts
Rising borrowing costs may force Portugal and Greece to restructure their debt, said Stuart Thomson, who helps oversee $100 billion at Ignis Asset Management in Glasgow, Scotland, and doesn’t hold Portuguese debt. He expects a “Greece haircut first; three months later a Portuguese haircut,” he said in an interview.
“Debt devaluation is the new currency devaluation in the euro zone,” said Thomson, who used to holiday in Portugal before the euro-sterling exchange rate made it more expensive for U.K. tourists.
Detailed Plan?
Socrates has pledged to cut the deficit from 9.4 percent of GDP last year to 2.8 percent in 2013, below the EU’s 3 percent limit and sooner than Ireland’s target of 2014.
Ireland, which had the largest deficit in Europe last year, cut public sector wages and raised taxes to rein in the shortfall. Irish yields, which were higher than Portuguese levels throughout last year, are now below those on Portuguese debt.
“The Irish government has very clearly outlined a reform plan, a very detailed plan,” said Michiel de Bruin, head of European government bonds at the Dutch unit of F&C Asset Management Plc in Amsterdam. “The market seems confident that Ireland can implement all those things,” whereas there’s uncertainty as to “whether Portugal can reform its budget and its economy,” he said.
Socrates, a Socialist, has been running a government without a parliamentary majority since being re-elected in September, making it harder to push through unpopular legislation in this country of 10.6 million. The opposition Social Democrats have refused to support the government’s efforts so far, abstaining during the vote on this year’s budget bill and a four-year deficit-reduction program.
Pension Overhaul
Portugal needs to reduce regulation of labor and product markets and encourage households to save, the IMF said in a Nov. 29 report. Labor costs have risen 3.4 percent a year in the last decade, compared with 1.7 percent in Germany, and Portugal has the lowest productivity in the euro region, according to the EU’s statistics office.
Still, Socrates, 52, has shown before that he can take unpopular measures. In 2006 he overhauled the pension system and in 2008 faced down some of the biggest demonstrations in decades to push through a plan to evaluate teachers. The year he was first elected in 2005 the deficit was 6.1 percent of GDP; he slashed it to 2.6 percent in 2007.
Ricardo Reis, an economics professor at Columbia University in New York, said that Portugal’s underlying economic indicators are stronger than Greece’s. Even so, contagion would mean “a run on Portugal if Greece falls.”
The IMF raised the prospect of contagion on April 21, saying “if unchecked, market concerns about sovereign liquidity and solvency in Greece could turn into a full-blown sovereign debt crisis, leading to some contagion.”
If the EU fails to resolve the crisis in an “amicable and speedy way” then there may be “other dominoes to fall,” former Bank of England policy maker David Blanchflower said in a Bloomberg Television interview on April 23. Spain and Portugal may be “in some degree of trouble,” he said.
--With assistance from Joao Lima and Anabela Reis in Lisbon, Matthew Brown and Abigail Moses in London, Giovanni Salzano in Rome, Simon Kennedy in Washington, Mayumi Otsuma in Tokyo and Ainhoa Goyeneche in Madrid. Editors: Anne Swardson, John Fraher
To contact the reporters on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net; Jim Silver at jsilver@bloomberg.net
To contact the editor responsible for this story: John Fraher at jfraher@bloomberg.net
