Recent political turmoil has cast doubt on the ability of Portugal to emerge from its economic crisis. This contrasts with the perception prevalent up to only a couple of months ago, when the country was being considered a “good student” along with Ireland. Investor sentiment has reflected this trend. During the past three months, Portuguese debt has been the worst performer among 30 sovereign markets tracked by Bloomberg indices.
Portugal was bailed out in 2011 through a €78 billion programme. The country is scheduled to exit the programme in mid-2014. There have been signs that the economy is improving, particularly through exports. Portugal has shown discipline in implementing bail-out. Also, compared to other countries the political system is considered relatively stable. In May, Portugal even managed to successfully issue a bond due in 2024 yielding 5.67 per cent, its first such longer-term maturity in more than two years. However, a political crisis triggered earlier this month has reignited fears that Portugal will need more aid.
On July 1, Finance Minister Gaspar surprisingly resigned over reduced support for the austerity strategy he was managing. The following day, Foreign Minister Portas, who is also the head of the junior coalition partner in the centre-right coalition government, quit his role in protest that the Government seemed intent on pursuing further austerity.
In a bid to avoid fresh elections, Prime Minister Coelho reacted by trying to reshuffle the Cabinet, while the Socialist opposition raised the anti-austerity rhetoric. There was also a no-confidence motion by a minor party, which the Government survived.
The President pushed for a “national salvation” agreement to be reached by last weekend. Even though no official deal was actually reached, the country will avoid elections for now as demanded by the President. Meanwhile, a review by the EU and IMF of the country’s bail-out progress scheduled for mid-July was postponed until late summer.
A major issue from the financing point of view is that Portugal needs to return to funding in capital markets in order to refinance upcoming maturities and to be able to exit the bail-out programme
Amid this chaos, Portuguese debt markets have been very volatile and borrowing costs have soared. Significantly, the 10-year yield on the country’s sovereign debt rose above 8 per cent, the highest since November 2012, even though it has now retreated to around 6.3 per cent. The weaker sentiment towards Portuguese sovereign debt is evident when compared to Ireland, which is aiming to exit its bail-out programme this year. The spread between 10-year borrowing costs for Portugal and those for Ireland rose to above 320bps in recent weeks, compared to 200bps back in April this year (100bps = 1%).
The deterioration in credit risk can also be noted in the spread between Portugal’s own two-year and 10-year borrowing costs. This difference between two-year and 10-year rates is currently around 200bps compared to more than 340bps in April.
There seems to have been a bear flattening (a situation wherein the yield curve shape becomes flatter because short-term interest rates are rising at a faster rate than long-term interest rates), with two-year bonds selling off more rapidly than the longer-term bonds. This reflects the fact that investors’ prime concern has become the more immediate creditworthiness of the country.
A major issue from the financing point of view is that Portugal needs to return to funding in capital markets, in order to refinance upcoming maturities and to be able to exit the bail-out programme.
As is often the case in such “vicious cycle” situations, the prohibitive borrowing costs caused by elevated anxiety is in turn making it more likely that further official financing will be required. Some investors could also be of the view that in an extreme scenario, institutional creditors will impose losses on private bondholders rather than extend another bail-out.
On the other hand, it is encouraging that even though there is “austerity fatigue” the major parties remain in favour of the euro and there seems to be awareness of the disruptive effect early elections may have.
The EU could possibly allow some adjustments to the bail-out conditions, such as the granting of additional time. This could be relevant within the context of looming German elections, whereby a new bail-out or a failure in Portugal could have a serious impact.
Therefore, going forward it is also possible that Portugal will manage to achieve sufficient political stability to reassure investors and facilitate an exit from the bail-out next year. Even so, the restless summer in Portugal is a stark reminder to investors that event risk in the eurozone is still very much a factor to keep in mind.
This article is the objective and independent opinion of the author. The information contained in the article is based on public information. Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.
Karl Falzon is a credit analyst at Curmi and Partners Ltd.