Spring cleaning

The EU has today released its spring forecast, which updates last autumn’s economic forecasts for EU (and related) countries.

Despite our (relatively) chirpy title it’s far from happy reading.

The EU now expects Greek debt to reach 157.7% of GDP in 2011 and 166.1% in 2012. We can’t help but think that this backs up our (and many others') claim that the bailout has been a complete failure in Greece (combine this with talk of a second bailout only a year after the first and they’re almost making our point for us).

It’s not just Greece either. Irish debt is expected to reach 112% this year and 117.9% next. While Portugal’s debt is forecast to hit 101.7% by the end of the year and go on to 107.4% in 2012. Only a few months ago Portugal’s debt was expected to be around 82% this year, that’s a whopping 20% increase in only a few months!

All in all the figures and the report make fairly grim reading. Over the past year we have seen these sets of figures continuously revised upwards, yet the EU and the ECB continue to maintain that the adjustment programmes they’ve laid out for these countries are achievable and are having a substantial impact.

We think it’s about time the EU started accepting the reality of its own figures and added a debt restructuring to its tools for cleaning up the eurozone debt crisis this spring.

Rettungspaket zwingt Portugal zu radikalem Kurswechsel
REUTERS DEUTSCHLAND: Lissabon/Berlin (Reuters) - Portugal muss unter der Obhut von Europäischer Union und IWF das Ruder radikal herumreißen.

Die Kreditgeber verlangen im Gegenzug für das 78 Milliarden Euro schwere Hilfspaket ein Anpassungsprogramm, das unter anderem lange verzögerte Reformen am Arbeitsmarkt vorsieht. "Portugal muss viel offener werden gegenüber dem Wettbewerb", sagte IWF-Verhandlungsführer Poul Thomsen am Donnerstag in Lissabon nach Abschluss der Verhandlungen über das Hilfspaket, die von EU, IWF und Europäische Zentralbank geführt wurden.

Bundeskanzlerin Angela Merkel drängt auf realistische Wachstumsannahmen für das Programm. Bundeswirtschaftsminister Rainer Brüderle forderte das Land auf, seine Probleme mit der Wettbewerbsfähigkeit anzupacken. "Entscheidend ist, dass Solidarität keine Einbahnstraße ist", sagte er. EZB-Präsident Jean-Claude Trichet hob hervor, eine breite politische Unterstützung für das Hilfsprogramm sei wichtig.

Mit der Einigung erhält der Euro-Staat nach Griechenland und Irland als drittes Mitgliedsland der Währungsunion Finanzhilfen seiner Partnerländer sowie von EU und IWF. Der Internationale Währungsfonds übernimmt mit 26 Milliarden Euro ein Drittel der Portugal-Hilfen. Wenn sich die Aufteilung der Kredite und Garantien an den bisherigen Schlüsseln orientiert, kommt auf Deutschland insgesamt ein Anteil von ungefähr 15 Milliarden Euro zu. » | Donnerstag, 05. Mai 2011

You call that austerity?

We imagine that will be the response by many in Athens and Dublin to the conditions which have been announced along with the €78bn bailout deal for Portugal. Jose Socrates, the caretaker Portuguese PM, was almost boasting on TV last night about how much more favourable the terms were for Portugal compared to Greece and Ireland. In the cold light of day though, most of the details we’ve seen so far focus on what won’t happen rather than what will, raising the question: Where are the necessary savings actually going to come from? That should be slightly concerning for taxpayers across the EU.

The point that has attracted most attention is the easing of the deficit cutting programme. But in actual fact the targeted cut is higher than before, given the change in the level of the deficit.

Previous 2010 estimate and 2011 target: 7.3% and 4.6% = change of 2.7%

New 2010 estimate and 2011 target: 9.1% and 5.9% = change of 3.2%

Most observers, including us, didn’t expect Portugal to be able to achieve its original level of cuts, let alone a higher level - especially when combined with lower growth prospects. That was before we even found out what was not going to be cut…

According to Socrates the conditions will not include cuts to: minimum wages, public sector pay, education spending and healthcare. In addition, there will be no additional public sector job cuts and the retirement age will not be increased. That is a huge list of things that will be left untouched, especially since savings of 3.2% of GDP are expected.

So, seriously, where is the money coming from?

Well, there are expected to be some, limited, cuts to higher scale state pensions as well as a decrease in the amount and duration of unemployment benefit. There is also a plan to raise VAT on electricity. In terms of increasing revenue, there was talk of privatising €5.3bn in public assets but not Caixa Geral de Depositos, the largest credit institution, which was widely expected to be sold to raise funds. So all in all not exactly an earth-shattering plan for saving 3.2% of GDP.

To be fair, there are more details and plans to be announced but considering what has already been taken off the table we’re not overly optimistic.

Admittedly, too much austerity would definitely be bad for the economy and finding the right balance is a hard line to tread. But for those of us who already believe the bailouts to be a waste of money, since they won’t solve any of the long term problems, these kinds of conditions are almost just adding insult to injury.

Up, up and away…

That’s been the story with Greece’s debt and deficit figures for some time, particularly since it’s become almost customary for the figures to receive at least one upward revision on their original estimates. However, Eurostat’s latest figures suggest the problem (of missing targets) looks to be spreading to other peripheral eurozone countries (not that the spotlight isn’t still firmly on Greece).

Eurostat yesterday released its debt and deficit data for 2010 and it included some interesting revisions – upwards as always. Starting with Greece, we see that the government missed its deficit target by 1.1% of GDP (all % are of GDP from now on), coming in at 10.5% instead of the 9.4% which the Greek government proudly predicted in January. To be fair, this still means the deficit fell by around 5% last year, but the figures show that less than 2% of the decrease came from increased revenue. Things continue to look bad for Greece, as we, amongst others, struggle to see where the government will find the money it needs. The programme of spending cuts is already pushing austerity to its limit and the government just doesn’t seem to be able to increase revenue (tax evasion is still massive but the ongoing recession, which is worsened by the austerity, just makes tackling it all the more difficult).

Meanwhile, Portugal also saw its deficit revised upward for the second time in a matter of months. It now stands at 9.1%, way above the government’s estimate of 7.3%. The government still put the difference down to changes in accounting rules enforced by the EU, although it is strange that it seems to affect Portugal so much more than anyone else…in any case Portugal now needs to cut the deficit by close to 5% to meet its target for 2011. Its debt burden was also increased, putting it at 93% in 2010.

Ireland fortunately didn't see its deficit or debt estimate revised, although with the deficit coming in at a whopping 32.4% this isn't much of a consolation (most of the deficit is down to the bank bailouts, but even excluding them the deficit was around 12% - the highest in the eurozone).

All in all the figures weren’t exactly expected to be encouraging but the continuing string of upward revisions and missed targets doesn’t exactly inspire confidence.

The EU's walls of Jericho moment?

The exact consequences for the eurozone of the True Finns' success in yesterday's Finnish elections remain unclear. The result makes it the third largest party, securing 39 seats in the 200-strong parliament with 19% of the votes, close behind the National Coalition Party (NCP), which received 20.5% of the votes (44 seats in Parliament) and the Social Democrats which won 19.1% of the votes (42 seats). To put this into context, they polled only 4% in the last national elections.

With performance better than the 15 or so percent expected on Friday, a seat within the new coalition government is now a distinct possibility. Finnish television Yle quotes the party secretary of the victorious National Coalition Party saying that a government consisting of the three major parties is a "strong possibility", with the NCP’s Jyrki Katainen as Prime Minister.

Formal coalition negotiations are due to start on 27 April, which could make it very difficult for Finland to sign up to a bail-out package for Portugal, as that requires the approval of Finnish Parliament. True Finns leader Timo Soini has re-stated his opposition to the Portuguese bail-out package following last night’s election results. “I don’t believe that the package that is there will remain”, he told Yle last night. The Social Democrats want Portugal to restructure its debt rather than seek a bail-out, which is an additional factor in all of this. However, let's not also forget as with all politicians, Mr. Soini wants to be in government - he wants powers - so it's possible that he might compromise on the party's tough 'no more bailouts' position. What's clear is that when it comes to the EU Soini and Katainen occupy two different planets.

Regardless, it's clear that a new brand of "triple A" populism has emerged in the creditor eurozone countries, whose voters are voicing strong opposition to the "we'll keep the euro together at any price" doctrine that they have been fed by EU elites up to now. As we've noted before, such anti-euro sentiments are now picked up by nationalist parties from Vienna to Paris, feeding into the mix of anti-incumbency, pro-independence and most often, strong anti-immigration sentiments.

As we also noted before, the "far-right" label is inappropriate as a generalised term to describe the various parties currently occupying this space around Europe - they're all different in their make-up, roots and emphasis with some a lot nastier than others - and the True Finns simply isn't a "far right" party. What's clear though, is that they all push a heavily nationalist agenda, and they all fish in more or less murky, anti-immigration waters.

But in relation to the eurozone specifically, what's so significant about this election is that it's changing the parameters of the debate. In Austria, Netherlands, Germany and France, the established parties have managed to keep strong anti-euro, anti-bail-out forces outside the realm of government. The Dutch government rely on the opposition parties to circumvent Gert Wilders' Freedom Party, for example. If the True Finns make it into government - and chances are that they will - 'triple A populism' will have become part of the mainstream conversation, in a mainstream European country.

The guiding principle of European integration has always been 'build the institutions and the facts of life will follow'. In the realms of eurozone bail-outs, as well as in the contentious domain of immigration, this guiding principle is now being tested to its limits.

As Gideon Rachman points out on his blog today, the EU is in "deep trouble". Someone (a certain Mr T. Blair), in a speech to the European Parliament, said in 2005:

"It is time to give ourselves a reality check. To receive the wake-up call. The people are blowing the trumpets round the city walls. Are we listening? Have we the political will to go out and meet them so that they regard our leadership as part of the solution not the problem?"

That was six years ago. It's a most unfortunate irony that EU leaders, in their misguided efforts to stamp out 'nationalism' via over-building institutions and attempting to superimpose an artificial identity from above, are now contributing to the rise of the very currents they were professing to fight.

Why is Portugal in trouble?

Solving the problem should undoubtedly be the priority now, but looking at how Portugal got into this mess might help to formulate a solution.

Clearly there were many factors which helped to precipitate the current crisis, including numerous domestic political and policy mistakes. However, being a member of the single currency definitely seems to have played a part.

According to an interesting paper published by European Commission officials, joining the euro had the following consequences:

"The Portuguese economy went from a boom led by in the second half of the nineties to a marked slowdown in this decade (Chart 1). A major impulse for the expansion was the considerable fall in interest rates when the prospect of accession to EMU became increasingly self-validating. Nominal short-term interest rates fully converged to those at the common low level set by the ECB (Chart 2)."

The paper suggests that the "substantial fall in interest rates, [was] the main trigger for the boom", which later resulted in a bust. The interesting difference with Portugal, compared to Spain, Ireland and Greece, is that it experienced the infamous boom - bust dynamics before it entered the eurozone, but still because of the "prospect of accession to EMU", as the officials put it.

The eurozone's "sleeping pill" dynamics (as Herman Van Rompuy puts it) have prevented investors from forcing the country into unpopular, but necessary, reforms to boost competitiveness, resulting in Portugal becoming 21% less competitive relative to Germany over the past decade (this looks to be true of the past and current crisis).

So when Portugal experienced its bust, long before Spain and Ireland experienced theirs, there wasn't a currency which could come under strain and thereby discipline the politicians. This was surely one of the reasons for the consistently sluggish growth in Portugal following its bust.

There is, obviously, more to it though. Thanks to the ECB's artificially low interest rates, which were designed for a slow growing Germany, the country started accumulating very high levels of private debt, up to more than 200 percent of GDP (just like in Spain and Ireland, however, they managed to grow at the same time ).

On top of all of this, the Portuguese government hasn't exactly been a shining example of sound budgetary management. It has run large budget deficits for many years and has accumulated a significant level of debt for an economy the size of Portugal's (both the debt and deficit figures for last year were recently revised upwards as well).

Fundamentally however, an overvalued currency which prevented growth (the Escudo would have decreased in value following the original bust), combined with interest rates which were an ongoing stimulus to take on new debt, left Portugal with a decade of low growth. The resulting fall in relative living standards, compared to the rest of the EU, and the fall in tax receipts further fuelled the build up of both private and pubic debt.

Interestingly, Portugal's problems can provide some hint at what the future may hold for Greece, Ireland and possibly Spain. Even loose monetary policy and boosts in liquidity (admittedly in debt form) didn't solve Portugal's underlying competitiveness and currency problems, in fact they may have made things worse.

These lessons from Portugal's past should be heeded by those in charge. Tackling the root causes of this crisis - eurozone imbalances, competitiveness problems and the banking crisis - is of paramount importance, as is providing for all eventualities, including a restructuring and possibly even a change in eurozone membership.

A dog eat dog world

This placard seems to capture how a lot of Portuguese are today feeling about their economic future - Socrates is the poodle in Merkel's arms. (hat-tip FTD)

Another one bites the dust…

Portugal’s announcement that it too will tap the EU/IMF bail-out fund comes as no surprise. As we’ve argued many times before, it was merely a question of time. The announcement has however send eurozone hawks into a tailspin as questions over the amount, timing and conditions remain to be answered. Here’s some leaks picked up from the Portuguese press and elsewhere.

The size of the bail-out is expected to fall between €70bn to €90bn. Jornal de Negócios today reports that Jean-Claude Juncker says €75bn could be “appropriate”. Similar figures have been flying around for some time though. The Portuguese papers are somewhat less conservative, with many papers citing Diário Económico's estimate that the figure could rise to €90bn.

Público report that Guy Schuller, a Spokesperson for Jean-Claude Juncker says that technically there is no reason why some of the bail-out cannot arrive before the elections. This is also backed up by a European source close to tomorrow’s ECOFIN meeting who is cited in Dow Jones saying, “It will be difficult to concede a total package to a caretaker government” but “part of the resources could arrive before the elections”. “The preliminary technical work for the case of Portugal has already been done”, making it possible to issue the resources with “great speed”, claims the source.

The bail-out news has received a mixed response within Portugal, President Anibal Cavaco welcomed the move, announcing his support for caretaker PM José Sócrates and calling for “an attitude of responsible cooperation from the opposition parties”.

Opposition leader Pedro Passos said he supports the move, claiming it’s a way “to guarantee the national security and to preserve the reputation of Portugal abroad”. However, Reuters quotes a senior EU official who said that “the conditions demanded by Brussels are going to be very similar to the measures of the PEC, rejected in March by Parliament”. The same conditions which Passos so vehemently opposed just two weeks ago.

A Portuguese government source confirmed today that a bail-out will only be arranged with the support of the opposition. The National Federation of Trade Unions for the public sector will hold a strike on 6 May under the guise of getting “the IMF out of Portugal”, reports Diário Económico.

Meanwhile, the President of the Portuguese Banking Association has said that the ECB gave “clear instructions” to the banks to reduce their exposure to the government and other public sector bodies.

Some straight talking from Borg

Anders Borg, the Finance Minister of non-euro member Sweden, today had some strong things to say about how the Portuguese government has handled itself. He told Swedish Radio:

"We have reason to be very critical of the Portuguese government. This is a decision that should have been made in November, December. It’s been obvious for a long time that this country can’t stand on its own two feet.

There have been very frank discussions but the discussions have got stuck in internal political discussions instead of the necessary decisions are being made.

The Portuguese government has made the situation worse for itself and has contributed to an uncertain situation which has cost jobs and wealth in other countries. So we have reason to be strongly critical of them."

On the question on whether Sweden will contribute to a bail-out,

“It’s so complicated so we need to wait until some pieces fall into place.”

Pretty tough talk.

Portugal Asks for Bail-out Which Could Cost Britain £4.4 Billion
THE DAILY TELEGRAPH: Portugal last night became the third European Union country after Greece and Ireland to formally request an emergency bail–out which could cost Britain £4.4 billion.


The country's caretaker prime minister José Sócrates said the measure had been taken after the stricken nation had run out of options.
Economists last night put the UK's involvement in a Portuguese bail–out at up to a potential £4.4billion.

After months of resisting having to apply for a bail–out from the EU and the International Monetary Fund, Portugal's cost of borrowing has reached unsustainable levels.

Addressing the nation last night Mr Sócrates, said: "I have always said that asking for aid would be the final way to go, but we have reached the moment."

It is understood that the rescue fund could be as high as £70 billion, or €80 billion.

Sources close to the Treasury said last night that Britain would take part in any Portugal–related discussions involving the EU's 27 member states. However, the type of bail–out is yet to be discussed and therefore the extent of the UK's exposure was impossible to gauge, the sources said. » | James Hall | Thursday, April 07, 2011

THE DAILY TELEGRAPH: Spain 'won't follow Portugal' with bail-out: Spain said it will not follow ailing neighbour Portugal in seeking a European bail-out. » | James Hall | Thursday, April 07, 2011

Portugal: so what are the options?

Despite Portugal asking for a bailout there is still massive uncertainty over what form a bailout would take and how large it would need to be. Below we have broken down the potential size of the bailouts and what funding needs they could cover in Portugal. We have also looked at what amount the UK would be liable for in each (as outlined in our briefing on the Portugal bail-out published the other week):

Total cost of a Portuguese bail-out: €60bn
Debt maturing this year = €12.3bn (Short and Long term from June onwards)
Debt maturing in 2012 and 2013 = €17.25bn (Long term only)
Deficit for the next three years = €28.3bn (2011 - 2013)
(This leaves €2.15bn leftover, which could be used to aid the banking sector, or simply to allow some room for manoeuvre within the bail-out)

This is likely the lowest viable level for a bail-out package since it only just manages to cover Portugal up to the end of 2013. Any lower and the money would not be sufficient to cover Portugal’s costs for a reasonable amount of time.

Total cost of a Portuguese bail-out: €70bn
Debt maturing this year = €16.8bn (Short and Long term from April onwards)
Debt maturing in the next three years = €23.8bn (Long term only)
Deficit for the next three years = €24.74bn (Apr 2011 – mid 2014)
Banking sector aid = €5bn

At this level Portugal could be taken off the markets from now until mid 2014, we expect a full bailout of Portugal to be of this magnitude (possibly up to €75bn)

Total amount of a Portuguese bail-out: €80bn
Debt maturing this year = €16.8bn (Short and Long term from April onwards)
Debt maturing up to the end of 2014= €30.4bn (Long term only)
Deficit for the next three years = €27.1bn (Apr 2011 – end 2014)
Banking Sector Aid = €5.7bn

An €80bn bail-out package could take Portugal off the market until the end of 2014. This includes covering the debt as well as the deficit from now until the end of 2014. There would also be scope to provide the banking sector with €5.7bn to aid recapitalisation or to encourage lending to households and SMEs. This will be a harder sell to some of the Triple A rated countries, especially if they believe Portugal could make do with less.

Total amount of a Portuguese bail-out: €90bn
Debt maturing this year = €16.8bn (Short and Long term from April onwards)
Debt maturing up to the end of 2014= €30.4bn (Long term only)
Deficit for the next three years = €27.1bn (Apr 2011 – end 2014)
Banking Sector Aid = €15.7bn

The extra funding here could be put towards covering or reducing some of the short term debt which may still be required for unforeseen funding costs over the three years. This amount could be floated as a way to make sure there are no renegotiations or shortage of funding as seen in Greece and Ireland.

Obviously, the amount that the UK would be liable for increases with the level of the bail-outs, however, there is still a very large range given the various structures which the bail-out could take:


It is important to note that any bail-out would not impose direct costs onto the UK, other than the cash contributions which the UK makes to the IMF. However, a bailout is still significant for UK taxpayers, as it effectively requires them to underwrite the debt of peripheral eurozone economies. The liabilities also significantly increase the level of UK exposure to these economies. In any case, if a firm took on large liabilities they would need to be declared in its accounting procedures and would be taken account of by anyone who assessed the financial state of the company. The same should definitely be true of governments.

There has also been talk of bridge loans, see our previous post for a discussion of that issue.

Le Portugal demande l’aide financière de la Commission européenne
TRIBUNE DE GENÈVE: Le Portugal a demandé mercredi à bénéficier d’une assistance financière de l’Union européenne, a annoncé le président de la Commission européenne José Manuel Barroso dans un communiqué.

"Le Premier ministre du Portugal José Socrates a informé ce jour (mercredi) le président de la Commission européenne José Manuel Barroso de son intention de demander l’activation des mécanismes de soutien financier" de l’UE, a précisé la Commission.

"Le président de la Commission a assuré que cette demande serait examinée le plus rapidement possible (...) et s’est dit confiant dans les capacités du Portugal de surmonter ses difficultés actuelles avec la solidarité de ses partenaires", a ajouté la commission. Peu auparavant, le Premier ministre portugais José Socrates avait annoncé lors d’une allocution télévisée que le gouvernement portugais avait "décidé aujourd’hui même d’adresser une demande d’assistance financière à la Commission européenne". » | AFP | Mercredi 06 Avril 2011

A bridge to nowhere

There’s been a lot of talk over the last couple of days about Portugal getting bridge loans from somewhere (the European Commission, bilateral loans, the ECB) to hold them over until a new government comes to power.

If the objective is to deal with the sovereign debt crisis, such a solution would really be the worst of both worlds.

Not only would this small bailout have to be condition-free (since there is no government to enact or negotiate the conditions) but it would be nothing more than a precursor to a larger bailout to be negotiated with the new government. Neither of these bailouts will solve anything (as we pointed out in our Portugal paper); the country is basically insolvent and uncompetitive within the eurozone and beyond.

Regardless, no one seems to have any idea where a condition free loan would actually come from. As FT Alphaville points out, EFSM, IMF and even bilateral loans come with conditions (although we agree that the latter is currently the most likely option). The ECB has been eerily silent during the back and forth on this issue, suggesting that it is strongly opposed to expanding its government bond buying to fund Portugal (although we already knew that).

Oh, and just for good measure the caretaker government continues its line of denying that any talks with the EU over short term loans, or otherwise, exist.

Meanwhile, back at the fort, Portugal held another short term bond auction, which raised €1bn but at 5.9% for a one year loan (at that interest rate you could get a €70bn bailout from the EU/IMF). To add insult to injury Portuguese banks announced they would stop buying Portuguese government bonds (because even they have accepted that the debt will be restructured). In case you were wondering, it looks like the Portuguese social security fund bought most of the debt on offer today, meaning that when it gets restructured a large chunk of the populations’ retirement capital will be wiped out.

Clearly, a bridge doesn’t help if you’ve already sunk.

Portugal and Greece Downgraded on Debt Worries
BBC: Ratings agency Standard & Poor's has downgraded struggling Greece and Portugal on further debt worries.

S&P says investors in their bonds could lose out under the terms of a new eurozone bail-out package.

The move pushed up the countries' borrowing costs as lenders demanded a higher rate of return for buying government bonds.

The downgrades left Portugal one notch above junk rating and Greece's creditworthiness below that of Egypt. » | Tuesday, March 29, 2011

Permanent euro bail-out fund failing before starting?

Standard & Poor’s yesterday downgraded both Greek and Portuguese debt by one notch and kept them on negative outlooks. That hints at further downgrades in the near future, although given the extent of the problems in both countries that could be as soon as next week.

More interesting to us, is the reasoning behind the downgrade. S&P directly puts its decision down to the agreement which was reached on the permanent bailout fund (ESM) at last week’s EU summit. In particular, the fact that, as expected, ESM debt will be senior to all private debt and taking loans from the ESM may be conditional on restructuring debt. S&P suggests this could be “detrimental to commercial creditors”.

Investors feared ESM uncertainty, but if there’s one thing markets hate more than uncertainty, it’s having their fears crystallised by government policy. The ESM undoubtedly makes peripheral government bonds more risky to hold and was always going to be met with a downgrade and higher borrowing costs. The real questions remain: Why did EU leaders decide to announce this two years in advance, thereby massively prolonging and increasing the pain of peripheral economies? And at the same time why did they put off dealing with the temporary bail-out fund, the EFSF?

There's still no agreement on how to top up the EFSF, which in turn makes investors doubt the EU's capability to deal with future bail-outs. Sorting out the EFSF might have helped limit the fallout from the ESM decisions; in any case it makes no sense to delay the more pressing of the two issues. Flagging up the fact that debt restructuring may be possible down the line somehow manages to simultaneously ignore the fact that it should be done sooner while also increasing the need for it.

Eurozone countries continue to complain about rating agencies' actions – which are admittedly far from perfect – but maybe they should stop throwing fuel on the fire.

While the principle behind it is very much welcome - putting the burden on taxpayers rather than investors - due to poor sequencing and timing, the ESM has managed to fail before it even came close to starting. That’s impressive even for an EU policy.

How much longer can the eurozone live an alternate reality?

This week's fun and games are over, with EU leaders concluding their Brussels summit earlier this afternoon.

Once again, this summit is unlikely to be remembered for anything EU leaders could agree on but, rather, for what eurozone leaders, in particular, were unwilling to even discuss. Namely, getting to the root of sorting out the eurozone's short-to-medium-term future.

As the BBC's Paul Mason asks on his blog:

Why, within the space of 12 days, do we get a "grand bargain" to create a Euro Stability Mechanism (11 March), which is then (a) knocked back by Finland (b) defied by Portugal (c) renegotiated at the behest of Germany's FDP coalition partner so they can do a tax giveaway in the coming elections; and (d) excludes Ireland anyway?

Chancellor Angela Merkel's, and by extension Germany's, focus on what are, in the grand scheme of things, minor details is starting to betray a worrying resemblance to an obsessive-compulsive's inability to recognise the bigger and far more important realities in life. Merkel's two 'victories' from this summit appear to be the fact that Germany will now pay in its share of capital to the permanent post-2013 eurozone bailout fund over five years rather than four and an EU commitment to "stress test" nuclear power stations. These are both pretty obvious bones thrown to the domestic German audience - the SPD and Greens are breathing down the neck of Merkel's CDU party in important regional elections - but will do little to reassure people that the eurozone is serious about tackling its problems. Not for the first time, domestic politics is pitted against eurozone imperatives.

True, the proposals on economic governance and tighter fiscal discipline were broadly endorsed, but earlier German proposals have been watered down and there's still much to play for in regards to how much of the package will be credibly enforceable. How will Italy and Greece cope with demands to get their debt-to-GDP below the 60% threshold?

Partly also due to Finnish resistance, eurozone leaders were unable to reach agreement on how to top up the existing temporary bailout fund, which, with Portugal more or less in a state of political and economic crisis seems a little complacent to say the least. We're told that all will be settled at the next summit in June - but haven't we heard this before; "It will all be sorted next time, no need to worry".

Maybe Merkel and the rest of the eurozone's leaders just prefer working under pressure. June really will be cutting it fine: Portuguese elections are expected to have been held only a week or so before and the new attempt at credible stress tests for Europe's banks are due to be published.

How much longer can the eurozone live an alternate reality?

Splitting the difference between the BBC and the tabloids

There have been lots of numbers floating around on what a bailout of Portugal would mean for the UK. The tabloids today reported a figure of €6.8 billion, while on the BBC Today programme, Robert Peston argued that Britain would only contribute through the IMF, and possibly nothing at all.

Please bear with us as we're trying to break down what's going on here.

First, any bailout would NOT be a direct cost imposed on the UK, apart from the cash contributions the country is making to the IMF. The UK would be liable for a possible bail-out under the the so-called European Financial Stabilisation Mechanism, which the Labour government signed up to in the dying hours of its administration. The mechanism involves the European Commission borrowing money on the markets and then lending it to struggling eurozone countries, using the EU budget as collateral. So far, only Ireland has tapped this fund (Greece only recieved money from the IMF and the bail-out fund that only eurozone members contribute to, the EFSF). Since the UK contributes to the EU budget, it guarantees a certain portion of the loans given to any bailout recipient under the EFSM (the UK's share is around 13.6%). However, this is still significant for UK taxpayers, as it effectively requires them to underwrite the debt of peripheral eurozone economies. It's a bit like if you were to underwrite the mortgage of your neighbours house.

Secondly, in terms of the size of these liabilities, we expect a bailout of Portugal to be in the region of 60-€70bn - though we've seen figures of up to €100bn floating around(clearly its a moving target which makes it difficult to predict). If Portugal needs a €70bn bail-out and the rescue operation is structured in the same way as the loans to Ireland were - one third each from the EFSM, EFSF and IMF - the UK’s liabilities would be €3.2bn (13.6% of the total) under the EFSM and €1.05bn under the IMF. This gives a total UK liability of €4.25bn (if the bail-out is restricted to €60bn, then the UK's liabilities will be in the region of €3.7bn).

Are you with us? Pardon all the acronyms - but this is EU policy, remember.

Thirdly, this is assuming that the EFSM - which, again, the UK is partially underwriting - is in fact activated and used. If EU leaders decide to only look to the IMF and the EFSF, we're looking at a different scenario.

So, the question is, will the EFSM be used in a Portuguese bail-out? The BBC's Robert Peston gave no explanation on the Today programme for his assertion that the UK wouldn't be implicated in a rescue operation on the Iberian peninsula. However, on his blog, he seems to suggest that the EFSM will only be used once the eurozone-only fund, the EFSF, has been exhausted (which it won't be in the case of Portugal).

This is a possible scenario (as we explain in our Portugal briefing) - which will clearly limit the UK's liabilities - but it involves some pretty heroic assumptions. EU leaders are currently bogged down in hugely complicated talks over how to boost the fire power of the EFSF (the fund is currently worth €440bn on paper, but a lot less in reality) in order to convince markets that the eurozone has what it takes to save the euro. A deal is currently being blocked by Finland, due to domestic opposition to underwrite the debt liabilities of other countries, with Finnish national elections looming.

Only involving the EFSF and IMF in a bail-out would leave the EFSF almost completely tapped out. And if markets suspect that the EFSF is runing dry, the euro might be in for an even bumpier ride. Therefore, there will be many EU leaders out there who will want to use a large chunk from the EU-wide EFSM (which still have €37.5bn in it).

In addition, the EFSM is much faster to get off the ground as, unlike the EFSF, it's decided by majority voting. The case of Finland (and also Slovakia which refused to take part in the Greek bail-out), shows why this matters. Ergo, there is a very strong case for suspecting that the EFSM will be used, and therefore, that the UK will become indirectly liable.

That Peston seems to be omitting this discussion - which touches on so many important aspects of the ongoing eurozone crisis - is surprising.

Fourthly, the UK tabloids today featured pieces on what would happen if the EFSM was tapped completely (i.e. if it used all the remaining funds). Well, there is currently €37.5bn left, of which the UK is liable for €5.17bn. However, it's very unlikely that this entire amount will used in a Portugal bailout, since the cost will be shared with first, the IMF and most likely also the EFSF. Our estimates that we set out above are far more likely.

So still lots of uncertainty. Time will tell.

Don't fear the R-word

The Portuguese Prime Minister Jose Socrates resigned last night, after failing to get his new austerity measures through the Portuguese Parliament. This has pushed Portugal into a political crisis, and forced them to the brink of asking for a bailout.

As our new briefing on Portugal’s economic situation shows, a bailout could amount to €60bn - €70bn. Based on the structures of previous bailouts, the UK’s contribution could amount to as much as €4.26bn in liabilities (in the form of loan guarantees). That’s a big liability for taxpayers.

That’s why we argue for a combination of a restructuring and bailout. This would shift some of the burden onto investors; it would also help put Portugal on the road to debt sustainability rather than just recycling more debt around the EU.

For you restructuring-phobes out there, we are aware of the risk of contagion, but we believe there are many factors in this instance which make this a viable course of action:

- The bailouts of Greece and Ireland have solved little, they still have no market access to fund themselves and face ever increasing debt burdens.
- Markets are already boycotting peripheral eurozone debt, how much worse can things get (if it wasn't for the ECB, Portugal would have gone bust long ago)!
- Portugal’s debt burden, although large in GDP terms, is relatively small in nominal terms (given the size of other EU countries and banks).
- Exposure to this debt is spread around the EU and does not fall heavily on peripheral economies; the European banking sector will withstand the losses it may incur (although if it coincides with other negative banks may start to wobble - but that's an argument in favour of sorting out the banks!)
- The ‘Portugal goes, Spain goes’ assumption looks to be overstated (see positive market response to Spain despite Portuguese problems). In any case a limited bailout fund should help halt the spread of contagion from Portugal.
- Unfortunately, we’re in a crisis; difficult decisions need to be taken. A restructuring now is preferable to a more costly one later. The alternative is ongoing transfers of wealth to struggling eurozone economies - the sudden rise of the "True Finns" in Finland shows why this is politically very unlikely.

The question that now needs to be answered is when can or will any of this take place? That depends on what powers a caretaker Portuguese government has, but, in our view, the sooner the better. (The double standards displayed by the opposition in bringing down the government over austerity measures, then pledging to do a better job of managing the debt and deficit levels, doesn’t fill us with confidence though).

You can read our briefing here.

Portugal in Crisis after Prime Minister Resigns over Austerity Measures
THE GUARDIAN: • EU bailout closer after José Sócrates loses crucial vote • Political limbo will put pressure on Portuguese bonds

Portuguese prime minister José Sócrates has said he has submitted his resignation to the president after parliament rejected his minority Socialist government's latest austerity measures.

The loss of the vote "has taken away from the government all conditions to govern," Sócrates said. It brings the country closer to needing a bailout.

Sócrates is said he tendered his resignation to President Aníbal Cavaco Silva tonight, leaving the country in a political limbo that would place further pressure on Portugal's record-level bond yields.

Sócrates had said before the vote that he would resign if the measures to cut spending and increase taxes – designed to see off a bailout similar to those taken by Greece and Ireland – were rejected.

The measures had aroused the fury of trade unions, and railway engineers walked off the job in the morning, causing widespread travel disruption. » | Giles Tremlett in Madrid | Wednesday, March 23, 2011

THE GUARDIAN: Portugal bailout 'could cost UK £3bn': Bailout request seen as 'inevitable' following prime minister's resignation in wake of failure to push through austerity measures » | Graeme Wearden | Thursday, March 24, 2011

Portugal Braces for Government Collapse
THE WALL STREET JOURNAL: LISBON, Portugal—Portugal's government could collapse Wednesday after opposition parties withdrew their support for another round of austerity policies aimed at averting a financial bailout.

The expected defeat of the minority government's latest spending plans in a parliamentary vote will likely force its resignation and could stall national and European efforts to deal with the continent's protracted debt crisis.

The vote comes on the eve of a two-day European Union summit where policy makers are hoping to take new steps to restore investor faith in the fiscal soundness of the 17-nation euro zone, including Portugal.

Last year, both Greece and Ireland had to accept massive rescue packages after markets lost faith in their governments' efforts to deal with their debt burdens.

The political tension fueled a rise in Portugal's borrowing rates, just as it is trying to cut spending. The yield on the country's 10-year bond, for example, was up to 7.57%Tuesday—just shy of its euro-era record level. The interest rate has been above 7% for several weeks despite the government's earlier austerity measures that, its political rivals say, failed to quell investor fears.

As in Greece, the austerity policies—including tax hikes and pay cuts—have prompted an outcry from trade unions and numerous demonstrations and strikes. Train engineers walked off the job during the morning commute Wednesday, causing widespread travel disruption.

By most measures, Portugal is one of the euro zone's smallest and feeblest economies but its financial collapse would likely trigger a fresh bout of nerves over other debt-heavy—and bigger—euro countries such as Spain, Belgium and Italy.

"Portugal seems very likely to become the third … eurozone country to need a bailout," Emilie Gay, European economist at Capital Economics, said. » | Associated Press | Wednesday, March 23, 2011