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Warning bells as Portugal urged to exit bailout without buffer

With Portugal’s 78-billion-euro IMF-EU aid programme about to come to an end, its creditors are not only expecting the country to exit its massive bailout on May 17, but urging it to do so without a safety net.

Analysts however warned that it is too soon for Portugal, which only shook off a 2.5-years-long recession in the second quarter of 2013, to raise its own funds on the open markets without any recourse to credit as back-up.

Portugal sought the rescue package to avert default, after decades of ballooning wages and state spending led to a massive build-up of public debt.

International creditors granted the bailout in May 2011, but set strict conditions including severe sweeping job, pay and pension cuts.

The painful austerity has pushed tens of thousands onto the streets, but Lisbon’s stubborn adherence to the bailout conditions allowed it to pass successive reviews carried out by the international creditors, thereby securing a continuous flow of aid funds.

In fact, it has been so faithfully sticking to the rules that creditors now believe that it is ready to stand on its own.

Steffen Kampeter, a top official at the German Finance Ministry said: “Portugal is close to the end of the troika mission and it would be a good occasion to exit the aid programme without a safety net.”

During a visit last week to Portugal, where he met Deputy Prime Minister Paulo Portas and Finance Minister Maria Luis Albuquerque, Kampeter took care to point out that the final decision rests with the Portuguese government.

But European Commission President Jose Manuel Barroso also pressed the same case, even though in January he had said he preferred to leave a line of credit open for Portugal in case it needed it.

“It is clear that a precautionary programme would provide more guarantees and security,” Barroso told Portuguese journalists in Brussels.

“But if Portugal is a position to go without, it would be best for everyone,” said the former Portuguese prime minister.

Germany and the EU’s stance have left analysts perplexed, as the economists believe that such an exit without any safeguards — unthinkable just months back — would be too risky.

“Brussels and Berlin are washing their hands and have closed the door to a credit line, hoping that the problem would be fixed on its own because markets are calmer,” said Manuel Cadeira Cabral, an economist at the University of Minho.

But Portugal’s economy is still fragile, with the government forecasting a 1.2 percent growth for 2014. It emerged from recession in the second quarter of 2013, but for the full year, the economy contracted 1.4 percent.

In addition, the difference between the bond yields for Portugal and Ireland — which exited its bailout programme in December — remains wide.

While Dublin raised over 3 billion euros for 10 years at a rate of 3.5 percent from the markets, Lisbon had to pay 5.1 percent to do the same.

Unemployment has fallen from its peak but remains stubbornly high, at a rate of 15.3 percent in the last three months of 2013.

“An exit without a safety net would be tough for Portugal and the probability of a failure would be higher,” said Joao Cesar das Neves, an economist at the Catholic University of Lisbon.

He believes that the German government, which would have to seek parliamentary approval for any credit line just on the eve of European elections, “is simply tired of helping peripheral countries of the eurozone”.

Portugal also needs to have political consensus to stay on the course of austerity if it is to keep its finances stable and convince markets of its credibility.

But the Socialist party, the main opposition, is unwilling to do any deals with centre-right government.

“A consensus does not seem possible currently, because the Socialist party is looking to capitalise on the Portuguese people’s discontent,” das Neves said.

With no consensus, “Portugal’s image would suffer before the markets, leading to a serious problem of financing eventually,” said Joao Duque, a professor at the Lisbon School of Economics and Management.

“And it would be the people who would have to bear the cost,” he warned.

A credit line from the EU’s new bailout fund, the European Stability Mechanism, would come with conditions attached, helping reassure markets that the government will keep working to repair public finances.

In addition to any funds available from the ESM, the credit line would also open the door to possible purchases of Portuguese government bonds by the European Central Bank under an as yet untested part of its crisis policy.

The possibility that the ECB would step in to purchase Portuguese bonds would likely help the government borrow at lower rates.