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Portuguese Bailout Expectations Anchor Yield Curve: Euro Credit

Portuguese Prime Minister Pedro Passos Coelho
Pedro Passos Coelho, Portugal's prime minister. Photographer: Michele Tantussi/Bloomberg

Portugal commemorates the one-year anniversary of its bailout with two-year yields back below 10-year levels as government officials and investors say the nation will procure sufficient backing to avert a debt restructuring.

Portuguese Prime Minister Pedro Passos Coelho, who plans to resume bond sales next year, has said a failure to regain market access would trigger additional “support” from European Union peers. He has cut spending and raised taxes to comply with the terms of a 78 billion-euro ($104 billion) aid plan from the EU and the International Monetary Fund.

Two-year borrowing costs, which reached 21 percent at the end of January, have declined to about 9.99 percent. That’s below the 11.76 percent investors demand to own debt repayable in a decade, signaling investors are less concerned Portugal will follow Greece in imposing losses on bondholders.

“If Portugal does not have capacity to go to the financial markets in 2013, it may obtain a second aid package,” said Andre Pinheiro, who helps oversee the equivalent of $133 million at Orey Financial SA in Lisbon.

Investors made 13 percent on Portuguese bonds maturing in more than a year in the first quarter, including reinvested interest, the most of 26 sovereign markets tracked by indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German bunds rose 0.3 percent.

Price of Unity

“We certainly cannot rule out the possibility that there will have to be a second bailout,” Eric Maskin, a Nobel Prize winning economist and Harvard University professor, told reporters in Lisbon on March 30. “I wouldn’t regard that as a disaster. I think that’s part of what you have to do to keep a union together.”

Borrowing costs for debt repayable in more than two years remain higher than when the country requested its first bailout. The difference in yield that investors demand to hold Portugal’s 10-year bonds instead of German bunds reached a euro-era record of 16.48 percentage points on Jan. 31 and was at 9.94 points today, up from 5.11 when former Socialist prime minister Jose Socrates sought the rescue on April 6 of last year. On June 6, the day after Passos Coelho defeated Socrates in an election, the yield gap was 6.70.

Help at Hand

Socrates made the bailout request after lawmakers rejected his minority government’s proposed deficit-cutting plan, offering his resignation in March 2011. Social Democrat Prime Minister Passos Coelho started a four-year term in 2011 by forming a coalition government with the People’s Party. He’s backed by a majority in parliament, easing the passage of spending cuts.

“Unlike Greece, the Portuguese administration and the people are fully behind the reforms,” said Andrew Bosomworth, Pacific Investment Management Co.’s Munich-based head of portfolio management. “They are implementing them. I think we are going to observe slippage on those programs. They will therefore require more money, but the signals are there that that money is going to come.”

At debt auctions, borrowing costs have declined. Portugal on March 21 sold 1.61 billion euros of 12-month bills at the lowest rate in more than a year. The country sold 10 billion euros of bills in the first three months of the year, more than planned for the quarter. Tomorrow it’s selling as much as 1.5 billion euros of six-month and 18-month bills, the longest maturity since March 2011.

Recycled Cash

The European Central Bank in February approved the temporary use of additional collateral in funding operations by seven euro-area members’ central banks, including Portugal. It also offered unlimited three-year loans to the region’s financial institutions, which banks say they have recycled into higher-yielding government debt.

“The ECB’s program to provide liquidity has also helped lower financing costs in the short term,” Orey’s Pinheiro said.

Banco Espirito Santo SA, Portugal’s biggest publicly traded bank, is “slowly” buying longer maturities of the country’s bonds in secondary markets and doesn’t expect a debt restructuring, Chief Executive Officer Ricardo Salgado said in a March 6 interview. “I believe that our yield curve will move toward the Irish one,” he said.

Yields on Irish debt repayable in 2021 peaked at more than 15.5 percent in July, and have since dropped to about 6.83 percent. Two-year securities offer about 5 percent, down from more than 23 percent in July.

No Restructuring

Greece carried out the biggest-ever sovereign bond restructuring in March, forcing holders of 197 billion euros of securities issued under domestic law to accept new bonds with a 53.5 percent reduction in face value. European leaders have insisted that Greece’s situation is exceptional.

“I don’t see any kind of possibility that my government could in a few years ask to restructure Portuguese debt,” Passos Coelho said in a March 5 interview. He reiterated that if Portugal is unable to return to markets as planned in September 2013 due to “external reasons,” it would be able to count on continued support from both the IMF and European agencies.

Portugal should be able to resume bond sales next year and private creditors aren’t expected to take writedowns on the nation’s debt, Abebe Aemro Selassie, who heads the IMF’s mission to the country, said on March 5. The IMF expects Portugal’s debt to “stabilize” at about 115 percent of gross domestic product in 2013, and “begin a gradual decline after that,” he said.

In January, Standard & Poor’s followed Fitch Ratings and Moody’s Investors Service in cutting Portugal’s credit rating to non-investment grade, or junk.

Moritz Kraemer, head of sovereign ratings at S&P, said on March 22 that Portugal has a “good fighting chance” of avoiding debt restructuring. “Compared to Greece, the debt is not as high.”

Portugal has “the implementation capacity for policy reform,” Kraemer said. “The institutions in Portugal are much stronger than in Greece.”

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