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Portugal: Precautionary Program
by Nuno Teles
9 December 2013

They call it “insurance”, “precautionary program”, “return to the markets” , “post- troika” , etc... The idea is simple. The European Union has set up a fund of 500 billion euros, the European Stability Mechanism (ESM ), through which future bailouts will be funded.

Additionally, this fund is available to support eventual access to the markets of European States through direct purchases in the secondary market of debt securities. The idea behind this support mechanism is to secure public funding through the market at interest rates considered reasonable. An investor in European sovereign debt demanding high interest rates will be “disciplined” by the ESM action as a lender-of-last-resort at lower rates. In fact, this is a form of debt mutualisation at the European level. However, this has several problems. The first is the conditionality imposed on States asking for help. European states will only have access to such financial support in return of a new memorandum through which conditionality and austerity is again to be imposed. This is already the case of Spain, where bank recapitalization was funded by the ESM. In Portugal, we already know too well what this means: recession, unemployment and general degradation of public services. Within such a program the recovery of our fiscal sovereignty amounts to plain delusion.

Nonetheless, this new form of “bail-out” would leave the IMF out of the current troika of official lender, meaning that less austerity should thus be expected, right? No. According to ESM itself, the IMF assistance will always be sought in the policy design of these memorandums. Moreover, it is well known that within the troika , the IMF has been playing the “good cop” role in the troika, more concerned with the national balance of payments than with the fiscal deficit and public debt . Is there any relationship between the ESM and the announced, but not yet put into practice, program of unlimited ECB debt purchases in the secondary market (the famous Outright Monetary Transactions )? One has to bear in mind of that the ESM does not have the financial strength to cope with a crisis in large economies such as Spain or Italy, whose sovereign debt easily deplete the funds needed . The announced ECB intervention thus served to appease market jittery towards these two countries and not in relation to Portugal, Greece or Ireland. It remains to be seen whether these countries can apply for such financial support.

Since there is a ready mechanism to fund us and being Portugal totally compliant with what has been asked by the UE, why so much discussion around a potential of a second bailout program and the so-called precautionary program? Here, things get a bit more complex. Due to weak financial strength of the ESM, European states will have to demonstrate that they have secured funding through open

markets, not depending exclusively on the fund. In the cases of Portugal and Ireland, this will necessarily happen at interest rates higher than those now charged by the troika loans. In the case of Ireland, with a public debt profile more sustainable than ours, such higher interest rates do not immediately imply an unsustainable trajectory.
In Portugal, the case is far from clear. The intervention of the ESM may reduce interest rates now prevailing in the debt secondary market, but these rates will always higher than what is now charged by troika loans around (3,4%). Living in a current context of international interest rates historically low, any reversal of monetary policy, as it recently happened in the U.S., is immediately reflected in a general increase of interest rates. Hence, the interest that the ESM has to pay to fund itself will tend to rise, reducing the margin that the mechanism has to hold Portuguese interest rates down in the market. With a public debt reaching 130% of GDP, Portugal can only service its debt in short term through very low interest rates. That makes the hypothesis of a second bailout not be off the table. In this case, judging by the Greek example, austerity will be exacerbated and may be accompanied by some sort of creditor-led debt restructuring.

Anyway, what is important to stress is that all this does not depend on the markets. The current policy dilemmas all result from European policy decisions. The imposition of austerity, the hands-off approach of the ECB, the conditional now proposed for a recently created ESM, lacking financial firepower, were all policy decisions with the same objective: the fiscal control exerted by the European core in order to safeguard creditor interest. In the present European context the Portuguese people is thus faced with only different versions of permanent austerity. Open confrontation with the current European establishment rests has the only option in order to grant some hope to our country and the rest of Europe .

Nuno Teles