Citi analysts have attempted to explain the Portugal enigma, which they note now has the country’s 10-year bonds trading at some 1,000 basis points above Bunds.
The reason, Jurgen Michels and team say, is simply that the country is not on a sustainable fiscal path:
In earlier assessments of its debt position, we argued that Portugal would not be able to move on to a viable fiscal path without a haircut of 35% by the end of 2012 or in 2013. While we acknowledge that Portugal is in many aspects different from Greece, we now conclude that the size of the haircut will need to be raised to 50%, most likely taking the form of a reduction in the debt held by the private sector. We argue that the size of the haircut will depend on the macroeconomic situation, the amount of arrears that the government will need to settle, and the size of contingent liabilities that will require financing. In any case, assuming that market access cannot be regained before 2016, Portugal would need an extension in its official funding of between €50bn to €65bn.
Unlike Greece, they write, implementation of reforms is not an issue with Portugal. And indeed, the government is expected to meet its 2011 target of a 5.9 per cent deficit.
It’s how it got there that’s the problem:
As it became increasingly obvious that the government would miss its deficit target of 5.9% of GDP for 2011, newly elected PM Coelho pushed through additional revenue raising measures worth 0.6% of GDP. Furthermore, the government used one-off measures, e.g. the transfer of banks’ pension funds to the government’s social security budget, estimated by the IMF to have a net deficit reducing impact of around 1.9% of GDP (see Figure 3 below).
The Portuguese government might be willing to comply with the Troika programme, but various risks remain — the country’s state-owned enterprises could require more help; asset sales could disappoint; and public-private partnerships could prove a bigger liability than expected. That’s just to name a few.
The other hazards are the Troika’s expectations of Portugal’s return to the debt markets, which is expected to raise €65bn in medium- and long-term financing, starting with €9.3bn in 2013. This, says Citi, is impossible, at least at rates that Portugal could afford. An extension of Troika funding is thus inevitable, they say.
We estimate that the funding gap will increase by €25bn if it goes to the end of 2014 and by €65bn for an extension to 2015
And the other big risk is — no prizes for guessing — growth may not quite turn out to be as helpful to revenue as forecast. The Troika’s GDP base case for Portgual is very optimistic, says Citi. So they have modelled variations on those projections, and it does not look great:
So, Citi’s own baseline scenario would see a debt/GDP ratio of about 146 per cent in 2015/2016, even with a second Troika programme:
With such a level of debt, we argue that Portugal even in 2017 would probably not be able to return to markets and issue at affordable rates. However, with a PSI-style debt restructuring, probably enforced through the use of retrospective CACs, which as we have learned in the Greek case are unlikely to include the Eurosystem’s SMP holdings, Portugal might get back on a sustainable fiscal path. If done in 2012, a 50% haircut (worth around €68bn) in the nominal value of government debt held by the private sector would help to cap the peak in the debt-to-GDP ratio at around 113% in 2015. Note that additional capital requirements for Portuguese banks (around €10bn) because of their losses on their sovereign holdings will partly offset the debt reduction.
Oh — but don’t expect it to play out like that. Oh, no:
We do not expect that a PSI will be included initially when the Troika agrees to extend the first program. Indeed, the statements that the Greek PSI is an exception and that such measures will not be repeated in other euro area countries are too recent. Furthermore, unless the Troika changes its outlook on the Portuguese economy significantly, the debt sustainability analysis will probably show a debt-to GDP ratio around 120% in 2020, which by Greek standards is synonymous with debt sustainability