Portugal’s government collapse complicates Europe’s problems
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