With 10-year Portuguese bond yields above 14% (see Display), the market is suggesting that Portugal will soon need another bailout from its euro-area partners. While we share the market’s skepticism about the sustainability of Portugal’s public sector finances, we doubt that policymakers at this stage will seek to impose losses on private sector creditors, as they did in Greece’s second bailout last year.
Portugal clearly has problems. Adjusting for special factors, we estimate that last year’s budget deficit was close to 8% of gross domestic product (GDP), while outstanding public sector debt is now above 100% of GDP. Even more important, economic growth has been persistently weak for many years—even before the credit crisis.
Portugal’s economy was the slowest growing in the euro area between 2001 and 2007, with an average annual growth rate of just 1.1%. The Organisation for Economic Co-operation and Development estimates that today, Portugal shares with Italy the dubious distinction of having the lowest potential growth rate of any euro-area country.
Even so, Portugal’s position is not as clear-cut as Greece’s. A number of factors suggest that euro-area policymakers may continue to give Portugal the benefit of the doubt—at least for now.
The first is that Portugal’s euro-area partners and the International Monetary Fund (IMF), not the financial markets, will judge Portugal’s debt sustainability—and the latest review of Portugal’s program is favorable. The most recent official projection (made in December) is that Portugal’s debt-to-GDP ratio will peak below 120%. That’s much lower than the 172% peak projected for Greece’s debt-to-GDP ratio last July, when euro-area governments first decided to involve private sector creditors in a rescue package.
Two other factors are also in Portugal’s favor. First, unlike its Greek counterpart, the Portuguese government seems to be successfully implementing the program it agreed to with its euro-area partners and the IMF. Second, imposing losses on Portuguese bondholders at this stage would destroy recent attempts to rebuild market confidence in euro-area sovereign debt by assuring investors that Greece is a unique case.
In our view, it would be more sensible for Europe’s leaders to grant additional aid to Portugal without asking private sector creditors to share the burden. While this would not alleviate the market’s concerns about the sustainability of Portugal’s debt burden, it could help reinforce the point that Greece is not necessarily a template for the rest of the European periphery. In fact, given the relatively low cost of supporting Portugal, this might represent an efficient use of the scarce resources currently available in the euro area’s bailout funds.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Darren Williams is Senior European Economist at AllianceBernstein.