Portugal clears bond hurdle but outlook still dark

Published 8:23 pm Wednesday, January 12, 2011

Tensions over Europe’s simmering debt crisis eased slightly on Wednesday as ailing Portugal, viewed as the next candidate for a bailout after Greece and Ireland, showed it can still raise money on international markets and the EU proposed to boost the size and powers of its rescue fund.

But the relatively high interest rate demanded by investors to lend Portugal Ç1.25 billion ($1.62 billion) shows the country — and the wider region — still face an uncertain outlook.

“This is one hurdle that has been overcome but it’s not the end of the problems for Portugal and the eurozone,” said Ian Stannard, an analyst at BNP Paribas. “This auction is not going to make the problems go away.”

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EU officials seemed to accept the fact that the debt crisis is far from over and might even turn nastier if debt speculators target larger economies like Spain.

The European Union’s top monetary official Olli Rehn said he wanted a precautionary increase in the Ç440 billion ($570 billion) bailout fund for debt-stressed eurozone countries. Though Germany, the bloc’s chief financier, has not yet committed to such a move, he said discussions with the 17 eurozone governments are making progress.

Markets are worried the existing fund might be too small and the euro currency become endangered if a bigger economy like Spain, which makes up over 10 percent of the eurozone economy, runs into financial trouble.

There were fears that Portugal’s first bond auction of the year might compound the eurozone’s problems, with speculation that interest rates could be punishingly high or that investors might even stay away from the auction due to concerns about the debt-laden country’s fiscal health.

However, Portugal was relieved to pay a far lower rate for its longer-term debt than previously. The government debt agency said it sold Ç650 million in bonds with a 2014 maturity and Ç599 million in 2020 bonds. Demand for both was more than twice the amount on offer.

The major source of encouragement came from the fact that the yield on the 2020 bond dipped to 6.716 percent from 6.806 percent the last time Portugal tapped investors in November.

“This expression of confidence in Portugal is of the greatest importance. It’s our first result” in the battle to restore market faith in the country, Portuguese Prime Minister Jose Socrates told reporters during a visit to a trade fair in Frankfurt, Germany.

Portugal reduced its budget deficit to at least 7.3 percent of gross domestic product last year, from 9.3 percent in 2009, according to the government. It is aiming for 4.6 percent, roughly the eurozone average, this year.

“The market reaction is fundamentally due to Portugal’s good conduct in bringing about the government’s goals — reducing the deficit and bringing the public accounts back into order,” Socrates said.

The good news was dampened, however, by the much higher rate of 5.4 percent for the shorter-term bond compared with the 4.041 percent yield in October.

Finance Minister Fernando Teixeira dos Santos, who has expressed frustration at what he sees as a lack of help from fellow European nations to keep Portugal from resorting to a rescue, said the auction was “a relative success, given the circumstances” and showed that a financial rescue is not needed.

A bailout, as well as politically embarrassing, largely hands the government’s control over its fiscal policies to foreign aid monitors.

Teixeira dos Santos said he expected market confidence in Portugal to improve, bringing lower interest rates, as the government’s austerity program of tax hikes and pay cuts begins to show results.

The fear is that those improvements will take time to materialize. The Bank of Portugal forecasts the economy will slip back into recession this year, weighing on public finances, as will a string of painful austerity measures.

The budget cuts won praise from German Chancellor Angela Merkel. “We are both of the opinion that these measures are really impressive,” she said after meeting Italian Premier Silvio Berlusconi on Wednesday.

Still, some analysts think Portugal should accept the inevitable and agree a package from its partners in the EU and the International Monetary Fund instead of constantly fire-fighting in the bond markets.

Teixeira dos Santos said Portugal can cope with the current interest rates because the average yield on its total debt is 3.5 percent.

He also revealed that Portugal carried out a private placement last week, selling securities directly to clients in a confidential debt operation, but he gave no details.

To keep the market jitters from spreading beyond Portugal, EU officials are asking heavily-indebted countries — that is, most of the eurozone — to cut public spending and roll back benefits such as employers’ contributions to social security to make their economies more competitive.

Policymakers and experts have been critical of the eurozone’s handling of the debt crisis, specifically a lack of leadership, timely decision making and guiding rules, and Rehn’s comments appeared to address that criticism.