Portugal Tempted by Clean Bailout Exit After Rally: Euro Credit

Portugal may be tempted to follow Ireland in exiting its bailout without asking European partners for a precautionary program after a bond rally let the nation already start to raise funds for 2015.

“The good strategy is to aim, like Ireland, for a clean bailout exit,” said Diogo Teixeira, chief executive officer of Optimize Investment Partners, a Lisbon-based firm that manages 80 million euros ($110 million) in assets including Portuguese government debt. “This implies that Portugal needs to build, like Ireland, a sufficient cushion of cash in order to avoid any short-term stress in the market.”

Portugal is trying to regain full access to debt markets with the end of its 78 billion-euro rescue program from the European Union and International Monetary Fund approaching on May 17. It has raised 6.25 billion euros selling bonds through banks so far this year as signs of economic recovery spurred a rally in higher-yielding European fixed-income assets.

“The domestic and European narrative has now flipped: the debate is no longer between a second full bailout and precautionary credit line but rather between a precautionary credit line and a so-called clean exit,” Eurasia Group analysts Mujtaba Rahman and Antonio Roldan said in a Feb. 6 note.

‘Too Early’

“Portugal is on a very good way and may be able to repeat what Ireland did in December and exit the existing program without any need for any further direct or indirect assistance,” Klaus Regling, head of the European Stability Mechanism rescue fund, said in an interview published by Swedish newspaper Dagens Industri on Feb. 8 and posted on the ESM’s website. “But it is too early to say,” he said.

The government will take a decision about the bailout exit at the “right moment,” Parliamentary Affairs Minister Luis Marques Guedes said at a press conference in Lisbon yesterday. That moment still hasn’t arrived, he said.

A decision on how Portugal will exit its bailout will have to be taken before the program ends on May 17, “possibly in April,” Finance Minister Maria Luis Albuquerque said on Jan. 27 in Brussels, where she was attending a meeting of EU finance ministers. “But the meeting in May is also before the 17th.”

Dutch Finance Minister Jeroen Dijsselbloem, who leads the euro-area finance ministers’ group, on Jan. 27 said “we’ll come to that decision later, in March or April.” The latest developments can then be taken into account, he said.

Following Ireland

The next scheduled meetings of euro-area finance ministers in Brussels are on Feb. 17, March 10 and May 5. An informal meeting of European finance ministers is also planned for April 1-2 in Athens. The 11th and penultimate review of Portugal’s financial aid program will start on Feb. 20.

“Even if a backup option is not formally set up, it will still be quite easy to later agree to an intervention by the ESM if market conditions drastically deteriorate,” Optimize’s Teixeira said.

Ireland in December became the first nation to exit a rescue program since the euro area’s debt crisis began in 2009. That country entered its 67.5 billion-euro bailout in November 2010, six months before Portugal got its package. Irish Prime Minister Enda Kenny on Nov. 14 said his country would exit the program without the safety net of a precautionary credit line.

Setting Terms

“Ireland defined the terms of its exit one month before the conclusion of its program,” Portuguese Prime Minister Pedro Passos Coelho said on Jan. 17. “And it did the right thing, because the objective conditions that determine the ease or difficulty of the transition to market financing are related to market conditions that can only be assessed at the right time.”

Coelho on Dec. 18 said his government “does not stigmatize any of the possibilities,” referring to negotiating a precautionary line or not.

Goldman Sachs Group Inc. analysts Silvia Ardagna and Mariano Cena said in a Feb. 3 note that while they would consider a precautionary credit line “a more positive outcome, it is still possible that Portugal will exit the program without a precautionary credit line following the Irish example.”

Gyorgy Kovacs, an economist at UBS AG, has also argued for a precautionary credit line. “While financing should not be a problem for Portugal this year, we think taking up an ESM flexible credit line would be prudent once the Troika program ends in May 2014,” Kovacs said in a Jan. 31 note.

Less Critical

Portugal, which pays interest of about 3 percent on its bailout loans, on Feb. 11 sold 3 billion euros of 10-year bonds to yield 5.11 percent. The 10-year bond yield in the secondary market is at 4.97 percent after dropping to 4.92 percent on Feb. 3, the lowest level since June 2010, and reaching more than 18 percent in January 2012. It compares with a rate of 3.28 percent for Ireland.

“We are finally leaving the critical period of the crisis in terms of confidence in our public debt,” Prime Minister Coelho said in parliament today.

The Portuguese government is so far still relying on banks to sell bonds. European nations frequently hire banks when they offer new securities to boost potential demand for the debt.

Secretary of State for Treasury Isabel Castelo Branco said in a Jan. 10 interview that she “estimates” it will be possible for the country to sell bonds through auctions before its bailout program ends.

“A precautionary credit line would be important for Portugal, regardless of whether Portugal has market access or not,” Michele Napolitano, a director at Fitch Ratings, said in Lisbon on Feb. 6. “Financing requirements of the Portuguese sovereign will be very sizeable in years to come, so the sovereign would need to have low funding costs. Having a precautionary line would help keep those costs low.”

Junk Rating

Gross debt in 2013 was estimated at 211 billion euros and gross domestic product projected at about 165 billion euros, the statistics institute said in September. The government forecasts that debt peaked at 127.8 percent of GDP in 2013, when it narrowed its budget deficit to about 5 percent of GDP.

Economic growth has averaged less than 1 percent a year for the past decade, placing Portugal among Europe’s weakest performers. Portugal emerged from its longest recession in at least 25 years in the second quarter. The economy may grow more than 1 percent in 2014, Economy Minister Antonio Pires de Lima said in a Jan. 21 interview, faster than a forecast announced in October for growth of 0.8 percent in 2014.

“Portugal’s high refinancing needs in the coming years of around 10 billion euros annually mean the sovereign must maintain low funding costs for an extended period of time if it is to achieve sustained economic growth and reduce its debt ratio, something that it is likely to achieve more easily in the context of a precautionary credit line,” Moody’s Investors Service analyst Kathrin Muehlbronner said in a Jan. 30 report.

While Portugal’s securities are rated below investment grade by Standard & Poor’s, Fitch Ratings and Moody’s, Ireland no longer has a junk rating.

“Despite a similar burden of debt, Ireland has the big advantage of being investment grade, and a broad and stable political consensus, which means a much broader and cheaper access to potential investors,” Optimize’s Teixeira said.

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