Portuguese crash damages hopes for better deal on rates

PORTUGAL BAILOUT ANALYSIS: Draining confidence has seen Portugal inevitably suffer the same fate as Ireland and Greece

THREE DOWN. Portugal went over the edge last night. The Iberian nation of just over 10 million people is to join Ireland and Greece in the bailout zone. With the prime minister throwing in the towel last night on Portuguese TV, yet another weak peripheral euro zone economy will dangle on a lifeline provided by the other 14.

Just as international confidence drained from Ireland from last summer, Portugal has suffered much the same fate, albeit over a longer time period. For most of last year, yields on Irish and Portuguese debt were almost identical, but in the autumn they decoupled. Ireland’s slide gathered pace and the end came – somewhat prematurely – in November when the European Central Bank decided on a pre-emptive bailout.

The absence of a first-order banking crisis in Portugal bought the country time and lessened the pressure from the ECB as Frankfurt is not as exposed to that country’s banks as it is to those of Ireland. But Portugal has had serious problems since long before the financial crisis started.

Unlike Ireland and Greece, which enjoyed artificial booms, Portugal’s anaemic economy has shown no signs of life for more than a decade, managing only the feeblest of growth.

Not even joining the euro, which saw interest rates fall sharply, could shake the economy out of its funk.

Very little growth, an already high public debt level and the failure of successive governments to cut deficits left Portugal in a vulnerable position. Although the economy did not have the same sort of domestic imbalances as Ireland and Spain, once the bond market started doing what it should have been doing throughout the euro era – differentiating between the sovereign bonds of the bloc’s members – Portugal was in trouble. As the financial crisis spread to become a euro zone sovereign debt crisis, it was only a matter of time before the smaller of the two Iberian nations would be forced to resort to a bailout.

But no matter how inevitable this outcome – and it has been inevitable – it comes as another blow to the entire euro edifice and can only lessen Ireland’s chances of securing better terms for its EU-IMF bailout.

The most immediate risk comes from contagion, as it has through this crisis. If last night’s news sparks a fresh wave of panic in financial markets, the next weakest country in the euro zone will slide closer to the edge.

And that is cause for real concern because that country is Portugal’s neighbour. As Spain’s economy and public debts exceed those of Ireland, Greece and Portugal combined, having it join the other three on the end of a lifeline would push the entire euro project to its very limits.

But the inevitability of last night’s news lessens the chances of knock-on effects for Spain – markets may have already priced in the impact of a third euro-zone rescue. And, having become inured to crisis in the euro zone given that it has been going on for more than a year, they might just keep the faith in Spain.

But even if they do, as the news of Portugal going cap in hand to the bailout fund sinks in throughout Europe, the leeway leaders in solid countries have to help the profligate peripherals will narrow further.