Portugal Remains Under Pressure As Contagion Intensifies
by Win Thin
With reports of Ireland trying to finalize an IMF/EU deal over the weekend, all eyes are on Portugal. Press report that Portugal is being pushed to request an aid program have been denied by officials, but the way things are going, it seems like it’s only a matter of time before Portugal succumbs to the contagion. As seen in EM crises of the past, we simply cannot ignore the fact that contagion remains a very strong force and so we see little chance that Portugal can avoid it. Parliament gave final approval to the 2011 budget, which contains harsh austerity measures. However, harsh budget measures have not taken any pressure off of Greece or Ireland.
As we pointed out earlier this week, “We remain wary of rosy economic assumptions given the extent of fiscal tightening that’s planned, not just in Ireland but the rest of peripheral euro zone as well. Indeed, we believe slow growth will end up dooming most of the fiscal adjustment measures planned by the periphery. The best thing for improving debt dynamics is stronger growth, but that will be almost impossible for peripheral euro zone to achieve. At least with an EM debt crisis, many of those EM countries can count on a weaker currency and a return to EM-type growth rates in excess of 5-6%. For a mature developed economy, that is highly unlikely and even less so given that the euro zone prevents any sort of competitive devaluation for countries like Greece and Ireland.”
Given the strong linkages and exposure between Portugal and Spain, we believe that Spain will come under even greater pressure in the coming weeks. Indeed, we suspect that’s why Bundesbank’s Weber said earlier this week that the EFSF could be increased if needed, as Spain is twice the size of Greece, Ireland, and Portugal combined. However, increasing the EFSF isn’t all that simple, not when it’s clear that funding it will be very, very difficult given the growing bail out fatigue in Germany and others in the core euro zone. No surprise, but Spanish Prime Minister Zapatero said today that his country does not need any rescue. At this point in this crisis, official denials no longer hold any meaning.
The euro remains soft, and today broke the up trendline dating back to June around 1.3255 as well as a retracement level around 1.3270. Levels to look for ahead are 1.3130 (200-day moving average), 1.3080 (50% retracement of the big June-October rise), and then the psychological 1.30 level. EM currencies continue to suffer from the risk off trading emanating from Europe, and we continue to believe that a significant EM recovery won’t be seen until 2011. EMEA currencies are the worst performers vs. USD on the way, along with KRW as tensions remain high on the Korean peninsula.
Source: Bloomberg
I think that Portugal is the next link in the chain. Only a matter of time. Spain will inevitably follow, but attempts to bail it out might cause further rebellion in Germany. It might be the final straw for german taxpayers. The problem is that german banks have massive involvements in all of the peripheral countries that have experienced problems, and as soon as the bail outs stop some countries will have no option but to default. Though default might actually be the best option. The alternatives are far more public debts which will mean an ever greater burden for the taxpayer in every country, with less opportunities to recover those through taxes as the banks will have tax losses that could exclude them from paying taxes for many years. Better to eliminate that burden on the state by allowing the banks to collapse and then nationalising the assets and wiping out the creditors except the insured depositors. Then create smaller more specialised banks with bans on commercial banks speculating in capital markets and a version of Glass-Steagall in place.
With the fact that Germany is exposed to huge losses in Greece, Ireland, Portugal, Spain, Italy and Belgium means that a series of defaults which are very probable will mean bankruptcy of the entire German banking system and significant problems for the German government.
Would be possible to include next week Belgium in the charts? Thanks.