Greece. Ireland. And now, it seems, Portugal.
While the circumstances that have driven these debt-ridden members of the eurozone to the brink differ, they share one common characteristic: All three countries aggressively tapped their domestic banking systems for more debt long after they had been shut out of international bond markets.
With its 10-year debt trading near the record high of 7 percent reached last week, Portugal was to try yesterday to sustain what many have come to see as nothing more than a form of bond market charades. It was to try to raise up to 1.25 billion euros (US$1.62 billion) in long-term financing — debt that is expected to come largely from the country’s already depleted banking system.
For Portugal, as it was for Greece and Ireland before their bailouts, borrowing at such high rates from lower-quality lenders may demonstrate its economic sovereignty. But to an increasingly skeptical marketplace, borrowing on such terms reflects nothing more than the country’s unwillingness to accept the harsh reality of its fiscal condition.
As a result, the Portuguese banking system takes on more debt, making it harder to restructure and thus requiring the government in Lisbon to impose more pain on its citizens, a dynamic that is now playing out in Greece.
“Eighty percent of Portugal’s debt stock is held by foreigners,” said Jonathan Tepper, an analyst at Variant Perception, a research firm in London. “But the flow, now, is being financed domestically.”
As its interest rates moved above 6 percent, Greece bowed out of the markets and soon after had to accept a bailout.
Portugal has so far insisted that its financing needs for this year — about 20 billion euros, or 11 percent of its GDP — are manageable, and compared with what Greece owed last year, they are.
But with its gaping current-account and budget deficits, combined with a negligible growth rate, the market consensus is that Portugal must soon accept a bailout from Europe and the IMF.
Analysts said they believed it would involve a package of 50 billion to 70 billion euros, smaller than the Irish or Greek bailouts.
All sides emphasize, however, that nothing can happen until Portugal feels it has no other choice and formally requests aid.
To date, Portugal has vigorously denied that a rescue package is imminent, and Portuguese Prime Minister Jose Socrates reiterated that stance on Tuesday. But the view in the marketplace is that it is just a matter of time before the country throws in the towel.
In fact, some may ask what took so long. A year ago, the IMF published the following in its annual assessment of Portugal’s economy. “The outlook: bleak.”
“The staff’s baseline scenario envisages modest adjustment, weak growth and continuing unsustainable imbalances,” IMF economists wrote.
Like Greece and Ireland, Portugal’s financing needs have become more dire as the foreign investors that once bought its securities stay away. They have been scared off as Europe moves closer to formalizing a new mechanism that could require the holders of bank and sovereign debt to take losses on their positions in a future crisis.
But regardless of what happens to Portugal in the short term, the increased amounts of sovereign debt it is taking on compounds a recurring theme: Domestic banking systems are absorbing higher levels of dubious debt, which not only infects their balance sheets but could end up being restructured.
Consider the situation in Greece. According to research from Goldman Sachs, Greek banks, not those in Germany and France, are the largest holders of risky European debt. Indeed, the bank with the largest single exposure to Greek, Irish or Portuguese sovereign debt is the National Bank of Greece, which owns nearly 20 billion euros of Greek government obligations.
Altogether, Greek banks hold 62 billion euros in sovereign debt.
Such a buildup within a country’s own banking system makes it all the more difficult for a government to propose a debt restructuring, given that the country’s local banks and its many unionized employees will suffer, not just faceless hedge funds abroad.
In Greece, the government is in the middle of a tough restructuring program that focuses on cutting public-sector wages and pensions. The only major line item of the budget that is increasing is debt interest, which, according to the European Commission, will exceed government proceeds from direct taxes by 2014.
Still, government officials and bankers are resolute in insisting that Greece will not restructure its sovereign debt, and that to do so would be unacceptable after having accepted so much money from Europe and the IMF.
“A large part of the Greek debt is hidden on the balance sheets of the Greek banks,” said Theodore Pelagidis, an economist at the University of Piraeus. “So you cannot just say ‘Let’s restructure.’ It is not so easy.”
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