Portugal Bond-Market Rout Overstates Greek Likeness: Euro Credit

Portugal Bond-Market Rout Overstates Greek Likeness
Portugal followed Greece and Ireland in seeking an international bailout last year as the euro-region crisis intensified. Photographer: Mario Proenca/Bloomberg

Portugal’s bond-market rout suggests investors aren’t rewarding the nation’s austerity efforts and are concerned about a Greek-style reduction in debt repayments.

Portuguese bonds handed investors a loss of 6.9 percent so far this year, the worst performance among 26 sovereign-debt markets tracked by Bloomberg and the European Federation of Financial Analysts Societies. The slump that drove its yields to euro-era records this week overstates the risk of investor losses, known as haircuts, according to analysts at Deutsche Bank AG, BNP Paribas SA and ING Groep NV. Portugal has a lower funding gap than Greece and its progress in cutting its deficit will allow it to better weather debt-market turmoil, they said.

“Just because Portugal trades where it trades doesn’t mean it needs a haircut,” said Padhraic Garvey, head of developed market debt at ING in Amsterdam. “Our baseline view is that Portugal probably needs another two or three years of help from the European Union and International Monetary Fund, but that haircuts will be avoided.”

The nation’s two-year note yields reached a euro-era high of 21.82 percent on Jan. 31, surging almost 10 percentage points, or 1,000 basis points, in less than three weeks. Ten-year yields also rose to a euro-era record that day, climbing to 18.29 percent. The rates were 17.63 percent and 14.32 percent, respectively, at 11:29 a.m. London time.

Bond Price Slump

The price of the 10-year Portuguese bonds sank to less than 40 percent of face value on Jan. 30, even as the government said there’s no risk of investors being asked to take losses on the securities. Greek bonds of similar maturity trade at about 20.74 cents on the euro, while Irish bonds maturing in October 2020 are worth 86.68.

Portugal followed Greece and Ireland in seeking an international bailout last year as the euro-region crisis intensified. This year’s slump in bond prices, exacerbated by a Standard & Poor’s rating cut, fueled speculation that investors won’t buy new bonds from the nation next year before funds from its 78 billion-euro ($102 billion) rescue run out. That in turn may lead to efforts to persuade existing bond holders to accept losses, mirroring Greece’s debt forgiveness program.

Current prices overstate that risk, according to Ricardo Santos, a European economist at BNP Paribas in London, because Portugal is making more progress with its reforms than Greece, its government has a stronger political mandate, and its 2011 deficit will probably be below 6 percent while Greece’s will be closer to 10 percent.

Huge Contagion

Europe’s authorities, working to contain the region’s debt crisis, may also be reluctant to impose losses on Portugal’s lenders because such a deal could spread contagion to the region’s third- and fourth-largest economies, Italy and Spain, Santos said.

“The attitude of the European authorities toward Portugal is different to Greece,” he said. “Portugal’s 2013 funding needs are much lower than Greece, there’s a funding gap of around 10 billion euros, according to our estimates, which is low compared with the cost of potential spillover effects of a private-sector deal in Portugal. The contagion would be huge.”

Unlike Greece, Portugal is on track with the austerity plan it agreed to implement in return for its bailout cash. The adjustment program is “well on track,” Finance Minister Vitor Gaspar said on Feb. 1, saying yields don’t reflect the progress that the country has made controlling its budget deficit.

Austerity Plans

The government’s plan is to trim its budget deficit to 4.5 percent of gross domestic product in 2012, and to the EU ceiling of 3 percent in 2013, down from 9.8 percent in 2010. Its debt load is projected to “stabilize” at 112 percent of gross domestic product in 2013, after reaching 111 percent this year, the European Commission forecast in November. Greece’s ratio of debt to GDP was predicted to be more than 198 percent this year, with a 2012 deficit of 7 percent, the forecasts show.

Prime Minister Pedro Passos Coelho’s majority also puts the nation in a more favorable position than Greece, which will probably hold elections after a second bailout agreement for the nation is reached, according to Mohit Kumar, head of euro-area rates strategy at Deutsche Bank in London.

“Portugal is structurally different from Greece,” he said. It has “better debt dynamics in terms of debt to GDP and better political dynamics with the newly elected government having a clear mandate for austerity measures.”

Greece’s inability to implement reforms led the IMF to cut its economic forecasts for the country three times in six months last year and to delay payment of loans. The nation is negotiating a voluntary debt exchange with bond investors to slice 100 billion euros from the 205 billion euros of privately-owned Greek debt. That would help it reach a debt-to-GDP ratio of 120 percent by the end of 2020.

Coelho Majority

Passos Coelho, Portugal’s Social Democratic prime minister, formed a coalition with the People’s Party, known as the CDS-PP, after June elections. Coelho’s majority coalition took over from the Socialist Party’s minority administration, easing the passage of spending cuts and asset sales.

The underperformance of Portuguese bonds this year was “largely driven by index rebalancing related flows following the S&P downgrade,” according to Kumar.

Portugal’s credit rating was cut two levels to BB by S&P on Jan. 13 as the ratings agency said the debt-swap process in Greece could alienate potential investors in Portuguese debt. The downgrade to below investment grade meant Portugal was removed from Citigroup Inc.’s European Government Bond Index.

‘Committed and Credible’

Greece presents a higher risk of default than Portugal, according to Fitch Ratings. Portugal’s government “is committed and credible,” David Riley, head of the sovereign-debt unit at Fitch Ratings, said at a conference in New York on Feb. 1. “In the near term we don’t see them as a significant risk to the rest of the euro zone.”

Still, Portugal’s two-year yield difference with similar-maturity benchmark German notes is 1,739 basis points, compared with 234 basis points for the Spanish-German spread and 273 basis points for the Italian-German spread. Greece’s two-year yield spread over Germany is 18,430 basis points.

“The market is getting way ahead of itself, looking for the next victim,” said Eric Wand, a fixed-income strategist at Lloyds Bank Corporate Markets in London. “Talking about private sector involvement is premature. There’s no need at the moment, but Portugal has become the next target after Greece.”

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