Portugal, Spain become market target after Ireland

By BARRY HATTON and ALAN CLENDENNING, Associated Press, Tuesday, November 23, 2010 at 4:01 a.m.

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Brokers look at the main screen at the Stock Exchange in Madrid Tuesday Nov. 23, 2010. Spain's borrowing costs have soared in a sale of 3- and 6-month bills amid fears the country could be affected by contagion from Ireland's debt crisis.The central bank says the treasury was obliged to pay 1.7 percent in average interest to sell euro2.1 billion ($2.87 billion) in 3-month bills, nearly double the 0.95 percent rate paid in the last such auction Oct. 26. The auction Tuesday came as Madrid's Ibex 35 bourse dipped for the second day in a row amid concerns over Spain's ability to handle its debt in the wake of European Union's bailout of Ireland. Spain's economy is struggling to emerge from nearly two years of recession. (AP Photo/Paul White)

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People walk past a poster with the words "General Strike it's not one right. It's many." Tuesday, Nov. 23 2010, in Lisbon. Workers' unions have united in a call for a general strike for Nov. 24 protesting the government's package of austerity measures aimed at controlling the country's current financial crisis. (AP Photo/Armando Franca)

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A banner reading: "General strike" and "Against injustices, change policy" hangs from a fence as a ferry bringing commuters across the Tagus river approaches Lisbon Tuesday, Nov. 23 2010. Workers' unions have united in a call for a general strike for Nov. 24 protesting the government's package of austerity measures aimed at controlling the country's current financial crisis. (AP Photo/Armando Franca)

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Commuters arrive in Lisbon from across the Tagus river Tuesday, Nov. 23 2010. Workers' unions have united in a call for a general strike for Nov. 24 that is expected to bring public transport to a halt. As the government struggles to cope with the current international financial crisis discontent with its austerity measures is on the rise among the Portuguese. (AP Photo/Armando Franca)

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A homeless sleeps in front of a pawn shop on Monday, Nov. 22, 2010 in downtown Lisbon. Portugal is widely viewed as the eurozone's weakest member after Ireland and Greece as its high debt burden suggests growth will be weak for years. As Ireland prepares to receive a bailout, the Portuguese are preparing for the market spotlight to focus on them but Prime Minister Jose Socrates told reporters Monday that Portugal "doesn't need anybody's help." (AP Photo/ Francisco Seco)

LISBON, Portugal — Europe's efforts to contain its debt crisis came under increasing strain Tuesday as bond market jitters shook Portugal and Spain, seen as the 16-nation eurozone's next weakest links now that Ireland has followed Greece by accepting a massive international rescue.

The nations' borrowing costs rose, suggesting investors are more worried about default, while Spain limited the size of a bond sale because traders demanded sharply higher premiums.

Stock traders panicked and dumped shares across all sectors, sending Portugal's benchmark stock index down 2.2 percent by the close, while Spain's sank 3.1 percent to a level not seen since July. The euro slid below $1.34 for the first time in two months.

Spooked by the scale of Greece's bailout requirements in May and Ireland's banking failures, international investors are looking much closer at the public finances of eurozone countries and they don't like what they're seeing, particularly in Portugal.

Traders are "looking for their next target" and Portugal fits the bill, said Emilie Gay, an analyst at Capital Economics in London. She predicts Portugal will have to ask for help by early next year, when it has to begin refinancing billions of euros (dollars) in government bonds. A bailout for Portugal would cost at least euro50 billion, according to Capital Economics.

European Union President Herman Van Rompuy insisted Portugal's finances are sound because the country's banks are well capitalized, they haven't had to cope with a severe housing market bubble, and the government has a strong program to bring the deficit down.

Asked during a visit to Stockholm whether the Irish bailout package was big enough and whether it can prevent the crisis spreading, Van Rompuy said "there is no need for help in Portugal and of course the safety net is big enough to support Ireland."

Portugal accounts for less than 2 percent of the eurozone's total economy but a potential bailout would crank up pressure on Spain, the European Union's fourth-largest economy, and entail possibly dramatic repercussions for the entire bloc.

Analysts at Capital Economics described the risk of a Spanish bailout as "fairly low" but warned that "the cost would be devastatingly high."

"This threat is therefore closely linked to the risk of some form of eurozone breakup, stemming either from Spain being forced to leave and default or perhaps even from Germany jumping ship," the analysts said in a report to investors Tuesday.

Ireland's decision to accept a loan to prop up its banks, which may reach euro100 billion ($136 billion), and make sharp budget cuts has come just six months after the EU and IMF provided a similar sum for Greece.

Greece, meanwhile, is still grappling with its promised reforms and must make an extra effort to meet next year's deficit targets, its international donors said Tuesday.

The establishment of a euro750 billion ($1.05 trillion) safety net, following Greece's bailout, for any other eurozone members facing the risk of imminent loan defaults has done little to quell market fears.

Portugal's recent public finance figures have sharpened concerns' about its ability to handle its debt load. Public spending rose 2.8 percent in the first 10 months of the year compared with a year earlier. Crucially, higher interest payments on its loans outweighed an increase in tax revenue, suggesting the weight of existing debt may be unsustainable as it offsets any progress in public finances.

The interest rate on 10-year Portuguese bonds rose to 6.9 percent Tuesday from 6.8 percent the previous day. That was close to the record 7 percent breached earlier this month.

Ever since Greece's bailout, Portugal was considered a risk because of its meager economic growth and high debt. It has borrowed huge amounts to finance sacred welfare entitlements and private spending - while protecting jobs through outdated labor laws that make it difficult to hire and fire workers. Its industry has also broadly failed to move with the times.

Spain, though much larger than Portugal, is also feeling the heat of the market spotlight. Its borrowing costs soared Tuesday in a sale of 3- and 6-month bills and the government declined to sell as much of the debt as initially planned because of the higher rate.

The central bank says the treasury was obliged to pay 1.7 percent in average interest to sell euro2.1 billion ($2.87 billion) in 3-month bills, nearly double the 0.95 percent rate paid in the last such auction in October. The rate for the sale of euro1.2 billion in 6-month bills jumped to 2.1 percent from 1.3 percent.

The difference between 10-year Spanish bonds and the equivalent benchmark German bund rose nearly 15 basis points to around 2.32 percentage points in midafternoon trading. That equals a record set in June, right before the results of stress tests on European banks were released.

Spanish Central Bank governor Miguel Angel Fernandez Ordonez said the effects of the Irish crisis had "spread rapidly to periphery" countries.

He said Spain's fiscal consolidation program "is not without risks" and warned the government against straying off course.

Spain is struggling to emerge from nearly two years of recession. Third-quarter growth was flat, after two quarters of timid expansion and unemployment is at a eurozone high of 19.8 percent.

The government has enforced austerity measures including a freeze on pensions and a cut in civil service wages by an average of five percent.

The 2011 budget foresees cutting the deficit from an expected 9.3 percent of GDP this year to 6.0 percent in 2011. Last year it stood at 11.2 percent of GDP.

Portugal, which last year had the fourth-highest deficit in the eurozone after Greece, Ireland and Spain, is also readying an austerity package, featuring tax hikes and pay cuts, for introduction Jan. 1. Parliament is due to approve the measures on Friday.

However Portugal, like other European countries, is facing a popular backlash against its cuts. A national 24-hour strike Wednesday is expected to bring the biggest shutdown in public services in over 20 years.

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Alan Clendenning reported from Madrid. Daniel Woolls and Ciaran Giles contributed from Madrid, Elena Becatoros from Athens, Shawn Pogatchnik from Dublin, and Louise Nordstrom from Stockholm.

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Portugal, Spain become market target after Ireland

LISBON, Portugal (AP) - Nervous bond markets pressed Portugal and Spain on Tuesday amid concerns they are the next weak links in Europe's debt crisis now that Ireland has accepted a massive loan to prop up its banks.

Both countries' borrowing costs rose and Spain limited the size of a bond sale because traders demanded high premiums to hold its debt. Stock markets, meanwhile, fell -- Portugal's benchmark PIS exchange slumped 1.2 percent, falling for the second consecutive day. Spain's IBEX was down 1.5 percent.

Spooked by the scale of Greece's bailout requirements in May and Ireland's banking failures, international investors are taking a closer look at the finances of eurozone countries and they don't like the look of Portugal's accounts. Neighboring Spain looms as the next, much larger, domino to topple.

Portugal is considered a risk because of its meager economic growth and its high debt levels. It has borrowed huge amounts to finance sacred welfare entitlements and private spending -- while protecting jobs through outdated labor laws that ignored changes in market conditions.

Investors are "looking for their next target" and Portugal fits the bill, said Emilie Gay, an analyst at Capital Economics in London.

She predicts Portugal will have to ask for help by early next year, when it has to begin refinancing billions of euros (dollars) in government bonds.

Others predict the crunch may come sooner, especially after figures released late Monday showed Portugal's public spending rose 2.8 percent in the first 10 months of this year compared to the same period last year as higher interest payments outweighed a 4.6 percent increase in tax revenue.

Spain's borrowing costs also soared Tuesday in a sale of 3- and 6-month bills amid fears the country could be affected. The government declined to sell as much debt as initially planned because of the higher rate.

While experts stress that Spain's large banks are in much better condition than Ireland's, the sharp rise in Spanish borrowing costs was an ominous sign of the risk that a bailout of Europe's fourth largest economy would pose to Europe.

"The reality is that Spain is a huge bailout," said Stephen Matlin managing director of the Matlin Associates investment banking firm in Madrid. "Spain is bigger than the bailout fund, so we would get into an enormous situation if they have to bail out Portugal and Spain."

Portugal is the more immediate problem. Its budget deficit -- how much more the government spent than it received -- reached 9.3 percent of gross domestic product last year. That was far above the 3 percent limit for countries using the euro currency, a rule repeatedly broken even by the biggest economies, and the fourth-highest deficit in the eurozone after Greece, Ireland and Spain.

The jump in deficits during the crisis, however, is not the whole story. Portugal's debt load, amassed over years of overspending, is high and increasingly costly to sustain as borrowing rates have risen during the recent months' debt crisis.

Pedro Passos Coelho, leader of the center-right Social Democratic Party, the main opposition party, has accused the center-left Socialist government of shifting debt off the books. He said "a good portion of our (official) figures is fiction" and estimated public debt at 112 percent of GDP and the deficit at 9.5 percent. The government, by contrast, puts it at 86 percent of GDP this year.

Allegations of data mishandling are serious because they echo what happened in Greece, where the revelation that it had hidden the size of its debts caused markets to rapidly lose confidence in the government and triggered a funding crisis.

Over the longer term, Portugal's core problem is how to generate wealth that might pay for its lifestyle -- part of a malaise hurting western Europe as countries cope with an aging population and competition from Asia and other regions.

When Ford and Volkswagen spent almost euro2 billion to set up a huge new manufacturing plant near Lisbon in the early 1990s, it appeared to be the prelude for a mass arrival of high-grade industry that would power Portugal forward. It also looked like an endorsement of Portugal's ambition to become a modern western European nation after languishing under four decades of dictatorship and political turmoil following the 1974 Carnation Revolution.

But in many ways it was a false dawn.

Portugal didn't shed the post-revolution labor laws which made it hard to fire workers as trade unions stood in the way of attempts to modernize. Laying off workers is a bureaucratic entanglement, and entails hefty compensation payments, and workers can refuse proposed changes to their working hours.

That turned foreign investors off Portugal.

Civil servants, meanwhile, cannot be fired except in cases of extreme misconduct, leaving the public sector bloated.

Education levels among Europe's lowest and a cultural reluctance to taking risks on new work methods have kept productivity low -- it stands at around two-thirds of that in neighboring Spain.

Portugal stuck too long with traditional industries such as textiles and footwear which have been unable to compete with Asian imports. And, being locked into the euro, Portugal can't devalue its currency to make its exports cheaper.

State-owned companies are among the most inefficient, and their total debts are estimated at more than euro15 billion. Part of the reason is political -- in a country where the average monthly wage is around euro800 a month, and where hundreds of thousands earn the minimum wage of euro475 a month, the government forces public transport companies to keep ticket prices artificially low and pays them compensation for their losses.

Those low earners, meanwhile, have used the cheap loans that came with euro membership to finance purchases of cars and houses.

Portugal, a country of 10.6 million people, remains one of western Europe's poorest nations, and the outlook is gloomy.
The Bank of Portugal predicts growth of 0.9 percent this year, after a contraction of 2.7 percent last year, and many analysts predict another recession in 2011 due to a government austerity program devised to drive down the country's debt.

Some Portuguese are despairing of their country ever attaining average European standards of income.

Emigration to Portuguese-speaking countries such as Angola and Brazil, whose economies are flourishing, has soared in recent times.

Alvaro Santos Pereira, a researcher at Canada's Simon Fraser University, estimated in a recent study that between 1998 and 2008 some 700,000 Portuguese left their country. From 2008 to 2009, he said, Portuguese visas issued for Angola more than doubled to 46,000.

Vasco Costa, a 48-year-old father of three who owns a chain of shops in Portugal, says he's seriously considering moving his family to Brazil, where economic growth is expected to reach 7.5 percent this year.

"We're going backwards while Brazil is growing more than 7 percent a year," he said as he waited to catch a Lisbon subway train. "I only see a brutal period of stagnation here."

(Copyright 2010 by The Associated Press. All Rights Reserved.)

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