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The Portuguese caretaker Prime Minister Jose Socrates has finally agreed to put common sense ahead of partisan electoral politics and request a conditional bailout from the European Union (although noticeably not yet from the IMF)1. Approaching only the European Commission initially reflects the political nature of this decision and its timing. The fact that the European Commission president is Jose Manuel Barroso, a former Portuguese prime minister, probably played a role. In addition, the resentment among Portuguese toward the IMF for its previous involvement in Portugal in the 1970s and 1980s made a direct approach to the fund more difficult. These initial considerations are largely irrelevant, however. In keeping with the precedent from earlier joint bailouts and new EU rules, the IMF will end up playing the same prominent role it did in Greece and Ireland. This is what EU finance ministers decided in Hungary in early April2.
Portugal's long overdue request for an international conditional bailout is a constructive move. It means that the Portuguese economy will escape a highly damaging 3 months of suspended animation without any access to credit until after the scheduled new elections on June 5th.
Faced with €4.2 billion in debt refinancing requirements later in April, Portugal's ongoing efforts to escape a conditional bailout through persistent reductions in the maturity of its government debt offerings, financial repression of its banks – i.e., leaning on them to purchase its debts and undertake a series of "back alley" private bond placements has come to an end. In the run-up to the April auction, the major Portuguese banks finally stood up to financial repression and refused to continue to buy government debt3.
Portugal's last debt auction in the first week of April, in which it sold 6- and 12-month paper for a yield of 5.12 and 5.90 percent respectively, merely rammed home the untenable financial position facing the government in Lisbon and all other private Portuguese creditors.
At these rates, it would be financially cheaper for the Portuguese government to borrow at medium-term maturities from the European Financial Stability Fund (EFSF), the European Union's new bailout mechanism. From the perspective of Portuguese taxpayers, the cost of continuing to shun aid from the European Union and the IMF, for political reasons, was clearly seen as irresponsible by Prime Minister Socrates.
In addition, by agreeing to accept a conditional bailout, with the likely result of closing off the markets for 2-3 years, the Portuguese government has given the country's long-suffering private companies a better chance to maintain access international credit markets. Following the Socrates resignation in March, Portugal is now headed into an IMF-type economic reform program, improving the chances that foreign lenders will provide at least short-term credit to private Portuguese borrowers at rates determined by the individual company's line of business and individual circumstances, rather than merely at a premium linked to Portuguese government rate.
The additional policy clarity and reform resulting from an imminent IMF-type program for Portugal should further improve the general growth prospects of many Portuguese private companies. As described here on RealTime previously, the principal economic challenge facing Portugal is a structural growth problem and the need to liberalize what is now (after Greece) the most sclerotic economy in the euro-zone.
As made explicit by EU finance ministers, the Portuguese program conditionality will entail far reaching labor and product market reforms to help rectify this situation. Three focus areas have been identified for Portugal's program by EU finance ministers4;
1) An ambitious fiscal adjustment to restore fiscal sustainability (e.g. austerity)
2) Growth and competitiveness enhancing reforms to remove rigidities in the product and labor markets and encourage entrepreneurship and innovation; this should include an ambitious privatization program (e.g. structural reform)
3) Measures to maintain the liquidity and solvency of the financial sector (e.g. banking sector reform)
These reforms would provide an opportunity for Portugal to escape the low-growth malaise prevailing since shortly after its adoption of the euro. In short, accepting the conditional bailout from the EU/IMF is the best long-term economic news for Portugal for a decade!
The circumstances compelling Portugal to a new economic destiny is also good news for the euro area as a whole. Contrary to the situation earlier in the economic crisis, where financial market contagion threatened to go from small peripheral euro-zone members to larger members like Spain and Italy, financial markets reacted with a shrug to Lisbon's recent predicted announcement. This illustrates the particular success of Spain's economic reform program since May 2010. It also reflects well on the operational status of the new euro-zone institutions as they have dealt with requests of this kind. Indeed, Spanish bond yields fell immediately after the Portuguese announcement5. There should be few obstacles for the EFSF to issue bonds to finance an assistance package to Portugal even at short notice, just as they did following the Irish bailout request late last year. With the political request for conditional aid now launched, it seems likely that financial aid could (if required) reach Portugal in time to assist in the scheduled debt redemptions in mid-April.
Perhaps the strongest signal of how far Europe has progressed since the early days of the crisis in May 2010 came on Thursday, April 7. It was then that the ECB carried out its pre-announced 25 basis point interest rate increase as if nothing had happened. The central bank didn't even mention Portugal in its opening statements describing its monetary policy decision6. Portugal is clearly not a situation that requires any additional policy innovations, and indeed the ECB is likely to be quite pleased by seeing its last major "Securities Market Program (SMP) client" turn to conditional financial aid instead of attempting to carry out its unconditional secondary market interventions. As a result, the ECB's reliance on the SMP is likely to shrink materially in the future.
This reduction in the "crisis usage" of the ECB balance sheet will now clear the way for the central bank to introduce a new more permanent and conditional medium-term liquidity facility for banks under restructuring. Such an "application only medium-term facility" would be another potentially beneficial development in the euro area. By making medium-term liquidity provision for euro area banks without access to private markets conditional on these banks pursuing some form of restructuring/recapitalization, the ECB would – in addition to prudently insulating itself against excessive exposure to individual banks – gain a very powerful tool to "encourage/coerce" euro area banks, the EBA, and their national regulators to speed up their bank restructuring/recapitalizations.
Ending the ECB's unconditional "fixed-rate-full-allotment liquidity provision" to euro area banks—and replacing it with a conditional medium-term liquidity facility—would have another beneficial effect. It would extend the "assistance under conditionality strategy" model of the EFSF/ESM adopted by EU leaders to deal with sovereign debtors to liquidity provision in the euro area banking sector.
If adopted by the genuinely independent ECB, this expanded model would be a far reaching and highly beneficial quid-pro-quo strategy that would accelerate the solution to Europe's banking crisis—and to continent's broader economic ailments.
Notes
1. http://www.bloomberg.com/news/2011-04-06/portugal-seeks-eu-bailout-after-yields-surge.html. Approaching only the EU initially, indicates the political nature of the decision and its timing. The fact that the European Commission president is Jose Manuel Barroso, a former Portuguese PM, have likely played a role, while the politically manufactured resentment against the IMF for its previous involvement in Portugal in the 1970s and 1980s made a direct approach to the IMF more difficult. This, however, will be semantics, as the IMF per the
2. http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/121401.pdf
3. http://online.wsj.com/article/SB10001424052748704013604576248254141025180.html?mod=djemTMB_t
4. http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/121401.pdf
5. http://online.wsj.com/article/SB10001424052748704013604576248421708017378.html?mod=djemTMB_t
6. http://www.ecb.int/press/pressconf/2011/html/is110407.en.html
