Here we go again. Just two weeks into the new year and pressure is mounting on Portugal to secure additional funding now before it is forced to accept an emergency bail-out. For its part, Portugal denies that it needs any outside help and is attempting to raise funds through the sale of government bonds.
Unfortunately, buyers are demanding higher returns in exchange for the increased risk and Portugal has been forced to increase the yield on ten-year notes to more than seven percent in order to attract buyers. This represents a premium of roughly 380 basis points over ten-years bonds issued by Germany and is simply not sustainable.
We have, of course, seen this movie before. First it was Greece and then – less than three months ago – it was Ireland telling everyone that would listen that everything was fine and that there was no crisis. The government kept repeating the line right up until late November when it agreed to take nearly $90 billion in an emergency bailout. As part of the deal, it also promised to slash spending and raise taxes to bring the country’s deficit back to Eurozone guidelines of three percent of GDP.
Those calling for Portugal to arrange for loans through the EU and the IMF now want the deal done before Portugal slides further towards insolvency. There is a fine line between a preventative action and an act of desperation, but the difference in perception between the two is immense. Either way, the euro will weaken and the longer action is delayed, the greater the potential impact on the euro.
Containing negative fallout from Portugal is also seen as critical for preventing the debt contagion from spreading to other countries. Already, Spain is being touted as the next victim casting a chill over the entire region as Spain makes up about 10 percent of the Eurozone economy. Greece, Ireland, and Portugal combined make up only about 6 percent.
Some analysts have even suggested that while Europe can provide sufficient funds to prevent Portugal from collapsing, Spain’s economy is beyond the EU’s capacity to re-inflate. What happens should that occur is anybody’s guess, but it does bring into question the ability of the euro to continue as a viable currency.
