What's the Fuel Price Breaking Point Part II
Wednesday, March 9, 2011
Portugal's Bonds are a Free Lunch
By GRANT DE GRAF
"Greece, Ireland and Portugal may revert to a domestic currency."
What has become very clear, is that the appetite for Portuguese bonds remains solid. Portugal’s Prime Minister Jose Socrates continues to support the country's commitment to access finance through the open market. Seemingly, policymakers wish to demonstrate the absence of an emergency situation. This may in deed reflect the economic dynamics that prevail in Portugal: that the challenges are surmountable.
Investor's are the winners at these bond auctions, as the risk premium that the market is dictating appears somewhat of a free lunch. Given the potential support that Portugal enjoys from the EU and the lack of any hidden debt exposure that was evident in the Greek and Irish bailouts, it is surprising that the market has priced in a premium that appears overly aggressive. The extent of the Irish and Greek bailouts in numerical terms, and the possibility that the European Central Bank may cut the chord are risk factors that investors have discounted in those specific instances. Portugal is different. The country's total debt exposure is relatively small, and the ECB could comfortably cover Portugal's total exposure, made available through a traditional credit line. Even Spain, a significant trading partner remains a creditor, and it is difficult to envisage the impact that a Spanish SOS would have on Portugal.
A more relevant enigma is the uncertainty of the plan [if any] that will emerge to implement a Portuguese recovery. It is unclear whether austerity alone will satisfy concern from investors. Securing a non-emergency long-term loan facility from the ECB to cover its debt exposure with favorable terms, would be a good start. This is not a free lunch, as Portugal is paying a price for being a hand-holder to a big brother. It needs to conform with EU austerity and policy, irrespective of suitability, or it walks.
Comments by Frank Oland Hansen, a senior economist at Danske Bank in Copenhagen, miss the point. “The recent economic performance hasn’t been sufficiently convincing and we expect that Portugal will need help soon,” he said. Other analysts suggest that the ability for Portugal to service high interest rate bonds is not sustainable and that a Portuguese emergency bailout is inevitable. It is important to distinguish between a bailout and a debt restructuring program. Further, the comments fail to grasp the fundamental issues that relate directly to Portugal's challenges. That would be the need for policymakers to formulate a blueprint, which will enhance long-term economic conditions for a solid recovery.
Another catalyst for recovery would be for Portugal to voluntarily revert to a domestic currency, while still retaining its economic ties with the EU. This way it would enjoy a competitive advantage for goods and services that it exports. Realistically, a reversion to a domestic currency appears the way that both Ireland and Greece will ultimately go. The tenacious buoyancy of the Euro in recent weeks, may be a reflection of this hypothesis. Traders are predicting that troubled countries will reject the Euro as their currency. In the long term, this approach would preserve a more bullish approach to the Euro, than may have been anticipated.
Sources:
Grant de Graf is a writer and economist who covers issues that relate to the credit crunch, business cycles, asset correlations, and the sovereign debt crisis. He is also a former trader on Wall Street, where he specialized in options and equity arbitrage. De Graf publishes his posts on his blogs, Grant de Graf and Understanding the Credit Crunch.
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