The final rescue
Portugal's request for financial aid should not affect the stability of Spanish debt
The Portuguese government succumbed to the inevitable on Wednesday. José Sócrates, the country's acting prime minister, announced that he was going to request financial assistance from the European Union. The lion's share of that help will come from the European Financial Stability Facility (EFSF). With sufficient advance notice, Brussels had already expressed its willingness to come to Portugal's rescue.
The Portuguese request for help has not surprised anyone. The country's situation in terms of its solvency was unsustainable, but the call for assistance had been delayed for political reasons. In particular, the time lag was due to José Sócrates' desire to withstand the pressure from the markets so that it would be the government formed after the elections that had to formalize the request. But on Wednesday, two devastating facts came to the fore. On the one hand, the Portuguese Treasury managed to sell just over 1 billion euros in six- and 12-month T-bills ? but at a rate of interest that was practically double that seen in the last auction. Subsequently, the big Portuguese banks informed the government that they would cease to buy the country's public debt during the following months. That was the definitive push toward a rescue.
The first calculations put the cost of the Portuguese bailout at around 75 billion euros. Portugal is now facing a paradoxical situation. Financial aid from the EU does not mean that the country's economic problems are over; it does mean that a worse situation in terms of the country's solvency will be avoided- i.e. defaulting on their debt. In exchange for the European rescue, Portugal will have to implement a drastic program of cuts, similar or even more severe than the plan that Sócrates presented to parliament (only to see it rejected). The moral of this rescue is that political maneuvering has not served to avoid the inevitable: a radical cutback in income over the next five years and a string of structural reforms.
The rescue mechanisms are there to be made use of; as such, Sócrates' decision is reasonable. It will avoid the agony of debt tenders with rising yields that the country would not be able to afford. But, on the basis of the rescue request, the European authorities have an urgent task ahead of them: reforming the financing system for the fund, so that the countries which resort to the mechanism don't have to pay high interest rates for the funds they receive. Anything above five percent, as is the case here, limits affected countries' margin for recovery.
The reaction of the debt markets over the coming days will confirm if the domino theory is correct. If it is, the speculative convulsions would now focus on Spanish debt, given that Spanish banks have accumulated Portuguese assets. Against that theory is the fact that Spanish solvency has clearly disassociated itself from the situation in Portugal and Ireland. Spain's plan for fiscal austerity and its economic reforms are already underway- and they are getting results. As such, the most likely outcome is that the European debt crisis will come to an end in Portugal.