Portugal: A Bailout Is Just the Start

Another day, another downgrade. On Tuesday, Mar. 29, Standard & Poor's (MHP) lowered Portugal's debt rating for the second time in less than a week to BBB-, the lowest investment grade. Portuguese bonds were hammered, with the yield on its 10-year debt at one point climbing to 8 percent, its highest level since at least 1997, when Bloomberg began collecting data. The small, struggling nation seemed to take a step closer to seeking an emergency bailout, as Greece and Ireland did last year.

The latest crisis was triggered by the Mar. 23 resignation of Prime Minister José Sócrates, after Parliament rejected his proposed austerity measures. The political uncertainty in Lisbon makes its economic future much more certain. "I regard the Portuguese bailout as a given," says Jacob Funk Kirkegaard, an economist at the Peterson Institute for International Economics. "There's no way they're going to avoid it."

Portugal has about €9 billion ($12.7 billion) in debt coming due in the next three months, and analysts at Barclays Capital (BCS) estimate the government has no more than €5 billion in cash available. That's only enough to get the government past April, says Antonio Garcia Pascual, chief southern European economist at Barclays. Treasury and Finance Secretary Carlos Costa Pina says Portugal can meet its debt commitments for the year. Yet with hobbled leadership—Sócrates' government now has limited powers, and new elections aren't expected until May or June—the country will likely be unable to borrow money and is in a "suspended animation status," says Kirkegaard.

Euro zone members and the International Monetary Fund would have no problem footing the bill for a bailout. Portugal's gross domestic product of €162 billion is about 30 percent less than the market capitalization of Apple (AAPL). Even at the high-end estimate of €70 billion, a bailout would be manageable for France, Germany, and the others in the currency union, who have already pledged €177.5 billion to Greece and Ireland.

The road to health for Portugal, however, is less clear than the solutions for other troubled European countries. Greece's problems were massive but obvious: It misled the world about the state of its public finances, and many experts now say the country never should have been admitted into the euro zone in the first place. In Ireland, the bursting of a massive property bubble plunged the country into recession and its government into indebtedness.

The causes are less clear in the case of Portugal's crisis. It didn't fiddle with the figures as Greece did, and it didn't experience a financial runup along the lines of Ireland's. What it has experienced is grindingly slow growth. Portugal is the poorest of the original euro zone countries. Economists had expected it to grow fast and catch up with richer economies when the euro debuted in 1999. Yet unlike other European countries, Portugal did not experience a boom during the last decade. In fact, since 2000, Portugal's GDP has grown, on average, less than 1 percent a year, among the slowest rates in Europe. Unemployment is stuck at 11.1 percent, and the economy is expected to shrink 1.4 percent this year.

Portugal has "fundamental problems," according to a research note by Emilie Gay, Roger Bootle, and Jonathan Loynes of Capital Economics. They cite the country's uncompetitive export sector, poor education standards, and high unemployment benefits as factors that "have held back the economy for the last 10 years." As part of the euro zone, the government could mask those problems by borrowing cheaply, throwing money at its massive public sector, and piling up debt. Those loans are coming due, and Gay, Bootle, and Loynes see the possibility of another "lost decade" unless the country makes deep reforms. It's also a warning as the euro zone considers extending membership to poorer countries along Europe's perimeter, such as Bulgaria and Romania.

As Portugal struggles to stay upright, many wonder whether it is the last in a line of dominoes, or about to tip over the next one. In a note to investors, Stephen Lewis, chief economist at London-based Monument Securities, says prolonged political uncertainty in Portugal has a silver living since "a quick bailout might have shifted [attention] on to the state of the euro zone's peripheral banks, including those in Spain." Kirkegaard says Spain could withstand the spotlight: It has already implemented deep austerity measures, aiming to slash last year's deficit of 9.2 percent to 6 percent this year, and on Mar. 17 sold bonds at a 5.16 percent interest rate, lower than it paid in December. This is "a Portuguese and Portuguese-only situation," says Kirkegaard. "Essentially, Spain has bailed itself out."

The bottom line: For more than a decade Portugal's economy has grown 1 percent a year. That cycle of slow growth may be hard to break.

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