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Portugal’s government collapse complicates Europe’s problems

By Mohamed El-Erian
March 24, 2011


By Mohamed A. El-Erian, chief executive and co-chief investment officer of PIMCO. The opinions expressed are his own.

The fall of Portugal’s government yesterday will add complexity to a regional policy approach that has failed to make much of a dent in solving the acute debt problems in the periphery of the euro zone. Portugal must now work with European partners to find a way to join Greece and Ireland in the EU/ECB/IMF intensive care unit. It will not be easy, and Portugal will engage only reluctantly given this ICU’s poor track record in returning patients to good health.

Portugal embarks on a new election campaign at a delicate moment in its financial history. It must meet sizable debt repayments in the next three months (almost EUR 10 billion) at a time when soaring risk spreads have essentially shut the country out of international capital markets.

The alternative — that of substituting  genuine market access with emergency IMF/ESFS funding — is far from straightforward. Without a government, Portugal is hard pressed to make credible policy commitments in exchange for such funding.

Despite this, it is unlikely that Portugal will default in the next few months. Instead, some messy ad hoc mechanism will probably be used to bridge the country to a new government. Judging from the experience of other countries, this will include placing new government securities in domestic banks that can then be exchanged for real money at the ECB.

This further abuse of the ECB’s balance sheet would be understandable if it were a means to a sustainable solution. It is not. Portugal will simply end up joining Greece in yet another holding pattern, this time under the auspices of a bigger group of regional and multilateral entities.

Over a year into the debt crisis, the collective designing Europe’s response has managed to limit disorderly debt contagion but is yet to come up with an approach that solves the problems of the highly indebted peripheral economies. Yes, some countries (particularly Spain) have been given time to strengthen their defenses in order to reduce the risk of disorderly contamination. But the challenges of the most indebted have become more acute, not less.

Excessive debt stocks have risen rather than fallen. Borrowing costs remain at prohibitive levels. Market-discounted private sector claims are being paid in full, transferring the burden from creditors to stretched tax payers and public services. Unemployment, already at alarming levels, continues to rise. And the countries are no closer to regaining a path of economic growth and prosperity.

Admittedly, the external environment has not helped. High oil prices and the appreciation of the Euro saps energy out of these weakened economies, day in and day out. The ECB’s hawkish monetary policy statements, while warranted for the Euro zone as a whole, add instability to these economies’ struggling financial and housing sectors.

This difficult environment is an irritation but not an excuse. From the beginning, multiple observers have argued that, while the European approach can buy time, it cannot overcome solvency problems by piling new debt on top of old debt. A better way is needed to deal with the debt overhangs, preferably through orderly and voluntary restructuring such as those implemented earlier in Uruguay and elsewhere.

It appears that a growing number of European officials may be coming to this conclusion, albeit grudgingly and slowly. Having lowered the risk of contagion to countries such as Italy and Spain, efforts are intensifying to put in place in 2013 a restructuring mechanism that could be applied to countries in the ICU.

The longer Europe persists with a policy approach that has visibly failed to improve conditions in the ICU, the greater the probability of cascading costs and risks. The costs will be felt in even larger shortfalls in output, employment and human welfare; and the risks will come in the form of an erosion of the ECB’s credibility and its future effectiveness, as well as even larger banking system vulnerability.

The time has come for a more decisive European approach, especially since firewalls have been bolstered. Let us hope that, at their Summit this week, European leaders will forcefully recognize that 2013 is not soon enough.

Photo: Pigeons fly around the main square of Lisbon Terreiro do Paco in Portugal, November 23, 2003. One of the most ancient cities in Europe Lisbon is dominated by its river Tagus and its cosmopolitan atmosphere. REUTERS/Jose Manuel Ribeiro


Please have a look at these numbers:

European Union: 500 million people, GDP € 11 808 billion
Portugal: 10 million people, GDP 167 billion

Whatever Portugal’s politicians do has little effect on the Euro:
Suppose the entire country falls into the sea (which would be a tragedy because the Portuguese are extremely friendly), the EU income would fall by 1,4 %. Another example ? The US Fed is printing the entire GDP of Portugal every other month.
Let’s keep things in the proper perspective.

Posted by FBreughel1 | Report as abusive

1. There is a consensus in Portugal that debts have to be paid to the creditors. This financial disaster is the result of PM Socrates’s mismanagement of public finances and a lack of competence in making the economy to grow. Unfortunately PM Socrates, heading a minority government, agreed an austerity package without support from the Parliament and without any consultation with the President as he is formally supposed to do so. It was an illegitimate manoeuvre. The Portuguese government fell due to an irregular policy process, a behaviour that could not be accepted by Portuguese lawmakers. Alternative measures could achieve the same targets. The greetings from Europeans colleagues he received yesterday in Brussels are an irony.
2. If Chanceler Merkel was heading a minority government after WWII, and had to negotiate with USA any repayment of debts, she would have asked the German Federal Parliament for support.
3. EU cannot make impose the adoption of policies in Portugal with political support. Joao Santos Lucas (Portuguese citizen, permanent resident in Singapore)

Posted by jslucas | Report as abusive

The problem is not relative size of the economies, the problem is in obvious EU paralysis to quickly implement necessary measures to SOLVE the solvency of its members
and related to that the labour/pension/medicare costs (and related to that competitevness) problem.
That pose two problems: First, the excessive risk to the investors in potentially facing sovereign debt crisis (reflected in the cost of borrowing) and the limits the
ability of a single country to tackle the problem in the usual way – devalvation of the national currency.
That does not leave much confidence in the future of the Euro …
Regarding the US print shop, it is a surprise for me that everybody eagerly accepts the paper for their goods/services …. what leads to another problem how to replace USD as defacto world currency …

Posted by MM_CAN | Report as abusive

The Portuguese tried to prevent a downward spiral by budget cutting and instead she has caused herself to fall apart. My brief comments on my blog at: 1/03/portugals-woes-lesson-for-us.html

Posted by JosephDrake | Report as abusive

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