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Wednesday, March 30, 2011
And now, it is Portugal's turn. Last Wednesday, the government in Lisbon was forced to resign when the opposition refused to back a tough economic package designed to tackle the country's fiscal crisis. The result is a political crisis on top of an economic mess, one that threatens — again — to spill over into the European Union. Portuguese and EU officials say the damage can be contained, but developments in Portugal suggest that the time has come for a new approach for dealing with economic crisis.
Portugal has long been one of western Europe's poorest countries. Even during the go-go years of the last decade, its economy struggled: Growth has been below 1.5 percent for all except three years and was negative in 2004 and 2009. Unfortunately, that anemic performance did not slow government outlays. As a result, the country ran up a budget deficit that reached 9.3 percent of its GDP in 2009. (Incredibly, that figure was only fourth largest in the eurozone.)
That shortfall contributed to a total debt that is, by one estimate, a stunning 350 percent of GDP. Foreign indebtedness exceeds 200 percent of GDP. The government has pledged to cut the budget deficit to 4.6 percent of GDP this year, to 3 percent in 2012 and 2 percent in 2013. To do that, the government proposed tough austerity measures that would cut spending, raise taxes on incomes and pensions and up the value-added tax.
While all parties appreciate the need for fiscal discipline, the opposition Social Democrats said enough after four attempts, rejecting the idea of yet more taxes when economists predict another year of negative growth and the unemployment rate is already 11.2 percent.
The political crisis means that there is no plan in place even as Portugal has to service its debt. The government has said that it can meet a 4.5 billion euro ($6.4 billion) bond repayment that is due next month, but it is unclear it if will be able to repay 4.9 billion euro ($6.9 billion) debt that is due in June.
Cognizant of the conditions imposed on other governments that requested financial help, the outgoing government has resisted the idea of going to the EU for a bailout. Prime Minister Jose Socrates explained that "I know what it meant for the Greeks and the Irish, and I don't want that for my country."
But the collapse of the government means that the country is likely to call new elections — all the parties being consulted prefer that option to a unity coalition — putting on hold any economic package. That raises the prospect of a default on debt payments. Consistent with that outlook, yields on Portugal's 10-year benchmark bonds topped 8 percent, hitting a record high; that level is thought to be unsustainable given the amounts that need to be refinanced this summer.
The EU has the money to help Portugal out; it is the terms that are a problem. Portugal is already experiencing national strikes — there was a 24-hour train strike last week — and the squeeze will get even tighter if the EU loans Lisbon funds to service its debt.
Most political observers believe that public unease forced the Social Democrats to reject the government's plan, seeing a collapse as the best way to take power. Opinion polls show the party prevailing if a vote is held.
European publics are increasingly restive over the terms of those bailout packages. To put it plainly, banks and other bondholders are being paid at the expense of ordinary citizens. To many in Europe, that is unfair.
Truly all Europeans should be sharing the pain — no class of citizens should be exempt. The failure of economies that have adopted extreme measures to recover and the scale of the downturns they are experiencing have convinced many politicians that the current approach is unsustainable. Even bond markets seem to share that view: The interest rates on Greek and Irish bonds have been moving upward even after they received help from the EU. That suggests that markets anticipate renegotiations on repayment terms.
Failure to agree on a tougher austerity package could force default and the fear among bankers and European politicians is that it would spread throughout the eurozone. The next potential domino is Spain. Spanish officials believe that their situation has turned the corner and say they are not worried about contagion from Portugal. Spanish banks hold about $100 billion of Portuguese debt, however, and a default would hit them hard. Even if the government does have measures in place to keep the banks solvent, they would be expensive.
European leaders know they have a problem. They had promised to devise a comprehensive solution to the debt crisis at their summit last weekend, but the developments in Portugal, along with elections elsewhere in the EU, forced a delay. Those leaders agreed on terms for funding a European Stability Mechanism that will become operational in two years. Unfortunately, it will take longer to fully fund — five years instead of three. That means doubt will persist about Europe's ability to support economies in trouble. And the threat of default among its members raises concerns about the entire eurozone.