Portugal: Precautionary Program

9 December 2013 by Nuno Teles

Stop ESM / CC - Edwin IJsman

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 Secondary market The market where institutional investors resell and purchase financial assets. Thus the secondary market is the market where already existing financial assets are traded. of debt securities. The idea behind this support mechanism is to secure public funding through the market at interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
considered reasonable. An investor in European sovereign debt Sovereign debt Government debts or debts guaranteed by the government. demanding high interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rates will be “disciplined” by the ESM ESM
European Stability Mechanism
The European Stability Mechanism is a European entity for managing the financial crisis in the Eurozone. In 2012, it replaced the European Financial Stability Facility and the European Financial Stabilisation Mechanism, which had been implemented in response to the public-debt crisis in the Eurozone. It concerns only EU member States that are part of the Eurozone. If there is a threat to the stability of the Eurozone, this European financial institution is supposed to grant financial ‘assistance’ (loans) to a country or countries in difficulty. There are strict conditions to this assistance.

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 Recapitalization Reconstituting or increasing a company’s share capital to reinforce its equity after losses. When the banks were bailed out by the European States, they were most often recapitalized with no conditions attached and without the States having the decision-making power their participation in the banks’ capital should have given them. 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 IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

out of the current troika Troika Troika: IMF, European Commission and European Central Bank, which together impose austerity measures through the conditions tied to loans to countries in difficulty.

IMF : https://www.ecb.europa.eu/home/html/index.en.html
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 Balance of payments A country’s balance of current payments is the result of its commercial transactions (i.e. imported and exported goods and services) and its financial exchanges with foreign countries. The balance of payments is a measure of the financial position of a country vis-à-vis the rest of the world. A country with a surplus in its current payments is a lending country for the rest of the world. On the other hand, if a country’s balance is in the red, that country will have to turn to the international lenders to meet its funding needs. 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 ECB
European Central Bank
The European Central Bank is a European institution based in Frankfurt, founded in 1998, to which the countries of the Eurozone have transferred their monetary powers. Its official role is to ensure price stability by combating inflation within that Zone. Its three decision-making organs (the Executive Board, the Governing Council and the General Council) are composed of governors of the central banks of the member states and/or recognized specialists. According to its statutes, it is politically ‘independent’ but it is directly influenced by the world of finance.

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 GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
, 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 .



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