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Portugal & The European
Sovereign Debt Crisis
Colgate Finance Club
10 April 2011
Charles Onis ‘14
What’s been happening in
Europe?
 Since May 2010, a sovereign debt crisis has arisen in
many European states.
 A sovereign debt crisis arises when the government of a
sovereign state fails to pay back its debt in full. The
fear that a government will fail to honor its debts result
in a dramatic rise in the interest rate.
 In 2010, concern about rising deficits and debt levels
across the world, along with a wave of downgrading of
European government debt created alarm in financial
markets.
Greece
 For most of 2010, such a debt crisis was focused on Greece,
where there was concern about the rising cost of financing
government debt.
 The initial currency devaluation that Greece faced with the
introduction of the Euro in 2001 helped to finance the
borrowing, as Greece was able to borrow due to lower
interest rates their government bond could command.
 The 2008 global financial crisis had a particularly large effect
on Greece. Two of the countries biggest industries are tourism
and shipping, revenues from which fell roughly 15% in 2009.
Greece (cont.)
 To keep within the monetary union guidelines of the EU, the
government of Greece consistently and deliberately
misreported the country’s official economic statistics.
 It was found that Greece has paid Goldman Sachs and other
banks hundreds of millions of dollars in fees since 2001 in
order to arrange transactions that hid the actual level of
borrowing.
 This allowed Greece to spend beyond its means while hiding
the actual deficit from EU overseers.
 In 2009, under the government of George Papandreou, Greece
revised its deficit from an estimated 6% to 12.7%. This rose in
2010 to 13.6%, one of the highest in the world relative to GDP.
What’s been happening in
Europe?
(cont.)
 Concern over the crisis in Greece reduced confidence in other
European economies.
 European states with already high deficits such as Ireland
(14.3%), Spain (11.2%), and Portugal (9.4%) suffered more as a
result. (This led to these countries, plus Greece, receiving the
offensive acronym PIGS)
 Normally sovereign states escape from such a “debt trap”
through monetary policy such as lowering interest rates or
increasing the money supply.
 But countries that use the Euro as their common currency cannot
devalue their currency, and the countries in question refused to
consider some sort of bankruptcy process, nor do they display
the strong economic needed to escape from the trap.
What’s been happening in
Europe?
(cont.)
 In April 2010 the EU ministers agreed to Greece’s bailout
terms.
 In May of 2010, the 27 member states of the EU agreed to
create the European Financial Stability Facility (EFSF), a legal
instrument aimed at preserving financial stability by providing
financial assistance to Eurozone states in crisis.
 The EFSF would reach these goals by selling bonds and using
the money raised to make loans from a pool of €440 Billion
for use by any Eurozone Nations in need.
 Such bonds would be backed by guarantees given by the
European Commission, the Eurozone member states, and the
IMF.
What’s been happening in
Europe?
(cont.)
 In April 2010 the EU ministers agreed to Greece’s bailout
terms.
 The EU’s emergency measures suspended fears that the Greek
debt crisis would spread directly to other countries, but it
was mostly too late for countries with already high deficits.
 While Greece’s debt crisis was caused by its deliberate
misreporting of statistics, Ireland’s was caused by its decision
to guarantee the enormous debts of its reckless banking
sector during the 2008 financial crisis.
 Ongoing financial problems in The Republic of Ireland resulted
in the government being forced to request a bailout EU in
November 2010.
Portugal
 Last Thursday, Portugal became the third EU nation to request a bailout.
 On Friday, European finance ministers began negotiations, along with the IMF for a
roughly €80 billion rescue package for Portugal.
 Portugal’s mishandling of its finances, and thus the cause its debts, has its roots in
faulty government spending methods as far back as 1974.
 These include:







Encouraging over expenditure and investment bubbles through unclear public-private
partnerships.
Funding numerous ineffective and unnecessary external consultancy and advising
committees and firms.
Allowing considerable slippage in state-managed public works.
Inflating top management and head officers’ bonuses and wages.
Persistent and lasting recruitment policy that boosts the number of redundant public
servants.
Risky credit and public debt creation.
Mismanaged European structural and cohesion funds.
Portugal (cont.)
 Such practices were so engrained in Portugal’s government
that it was incapable of forecasting or preventing the deficit
until 2005.
 Later, it proved incapable of doing anything to rectify the
situation even when the country was on the verge of
bankruptcy in 2010.
 “The government had a cash problem, but was just kicking
the can down the road,” - Ricardo Costa, deputy editor of the
weekly newspaper Expresso.
 Portugal has benefitted from last year’s planning by the EU,
particularly given the widespread assumption that it would
need to ask for a bailout, as the European Central Bank (ECB)
had already set aside a fund for Portugal.
Portugal (cont.)
 Portugal’s next steps will likely be fighting off the political and economic costs of
austerity.
 Both Portugal’s opposition party and its bankers have made it clear that they
would no longer support the government’s decision to unload government debt,
even if they could just offload it to the ECB, as government bonds were
approaching junk status.
 While Portugal’s prime minister Jose Socrates has made it clear that he intends to
fight for as low an interest rate as possible, Portugal is in no position to bargain.
 Antonio Nogueira Leite, former Portuguese secretary of treasury and advisor to
Portugal’s opposition party, said that the main issue is that, as Greece and Ireland
have shown, bailout packages “don’t really take into account the arithmetic of
the debt. Once austerity sets in, the country does’t generate the means to be able
to pay for the already incurred debt.”
 The main problem isn’t that not only is Portugal not growing enough, they’re not
growing at all, and if the economy doesn’t grow, Portugal won’t emerge from this
problem in the next decade.
Effect on the Market
 While the markets dropped when both Greece and Ireland applied for
bailouts last year, Portugal’s announcement barely troubled investors.
 The Euro rose, Italian and Spanish bond yields remained close to 12month lows, and bank stocks rose.
 This is attributed to the fact that Portugal’s bailout has long been
expected, but also due to the perception that Spain has been able to
break from its status as one of the countries brought down by the
sovereign debt crisis.
 Spain’s bond’s yields for month’s ago were 5.45% (6% is where a bailout
becomes plausible). This week they had dropped to 5.06%
 Despite this good news, Spain’s recovery prospects depend on banks
being able to borrow at low rates, given how quickly the market can
turn, especially given the market sentiment and political risks across
Europe, Spain’s position could change for the worse any day.
Sources
 NYTimes - In Portugal Crisis, Worries on Europe’s ‘Debt Trap’ http://www.nytimes.com/2011/04/09/world/europe/09portugal.html?pagew
anted=1&_r=2&ref=business
 Wall Street Journal - No Time for Euro Complacency http://online.wsj.com/article/SB1000142405274870410160457624850159089
7730.html
 The Economist - Portugal seeks help, And then there were thre http://www.economist.com/node/18530601
 Diario de Noticias - Meet the real weight of the state http://www.dn.pt/inicio/tv/interior.aspx?content_id=1750097&seccao=Media
)
 Wikipedia – 2010 European sovereign debt crisis http://en.wikipedia.org/wiki/European_sovereign_debt_crisis_(2010–
present)#cite_note-86
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