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Monday, 28 July 2014

Portugal shows it can make the savings, but fails on growth

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While Greece might be the big headline grabber, along of course with Spain in general and Catalonia in particular, little Portugal has been merrily ploughing along as best it can. However, yesterday the “men in black”, the troika inspectors, arrived in Lisbon and will probably do no more than confirm what we already know, namely that the Portuguese administration has done everything it was asked to do and yet, it is slipping closer to the cliff’s edge.

Anthony Peters, SwissInvest Strategist

The equation is simple. Every austerity measure required under the 2011 bailout package has been implemented, but all the results are being undermined by the stark reality that fiscal revenues are falling faster that the savings are being implemented and Portugal will be pitching up, sooner or later, asking for more.

Compared with Greece’s negative GDP growth (whoever invented that ridiculous concept? Negative growth? Sometimes I do wonder) of 7%, Portugal’s shrinkage of closer to 3% looks relatively benign in comparison, but this is still not a good platform for turning around a deficit and stabilising the fiscal ship.

Portugal has certainly earned the right to further support but – and this with absolutely no disrespect to the extraordinary efforts demonstrated by Lisbon – what then?

The global economy can neither afford to let the likes of Greece, Portugal and Spain go, nor can it realistically afford to keep them afloat either. In the abstraction of geopolitics, the answers are simple, but when it comes to the daily lives of those who will ultimately have to pay for all this – be it Hans Sixpack in Hannover or Rui Sixpack in Oporto – things are very different.

In a recent survey in the UK, 48% of those questioned were convinced that it is government policy to reduce the national debt. That it is not the debt but the deficit which is being tackled and that that means no more than slowing the rate at which the debt mountain continues to grow has evidently escaped them. One might have hoped that the economic and fiscal literacy of the voting public might have risen in the five years since the crisis began to hit us, but sadly it is pop stars’ drug habits and royal princes’ lack of talent at strip billiards which occupy their minds.

Hence the policies of piling up more debts on the backs of those who can afford them least can still be sold as being the magic bullet which will save the world from a fate worse than… whatever. On paper, this all looks fine and dandy, especially with German rates at historical lows. The Bundesbank’s “Umlaufrendite”, the average yield of its outstanding bonds which it published daily is 1.09% as at last night, compared with 1.46% for the past 12 months and a low of 0.92% on June 1.

Now, if you are a government whose bonds are trading at 400bp, 500bp or 600bp over German Bunds, what should you be thinking? You can afford the recession but you can’t afford the recovery

That, theoretically, makes debt affordable. However, if we look at the average German yield over the past 25 years, it looks very different indeed. The yield on the entire debt portfolio peaked at 10.85% in September 1981 and it has averaged 5.70% over the full period. Now, if you are a government whose bonds are trading at 400bp, 500bp or 600bp over German Bunds, what should you be thinking? You can afford the recession but you can’t afford the recovery.

One of my esteemed colleagues at SwissInvest takes his holiday in Portugal every year and tells me, having just returned from the country, that the people there are wondering what has gone wrong: in the past, they reckon, they were poor and happy; now they are poor and unhappy. The only reason for Portugal to take on more debt is if it truly believes it can engineer a soft landing before taking off again. The first part of the task looks improbable and the second no more likely either. If the break-up of the euro were to be, as we are told and mostly agree on, an absolute fiasco, then let’s just get on with it for further postponement isn’t going to make the process easier.

Anyhow, as the single currency has been created in perpetuity, if the one or the other member were to exit for 10, 15 or even 20 years in order to bring its economy and fiscal infrastructure back into line with the common conditions before re-entering, then that is only for a small period of time in the cosmic all and surely worth the price – what percentage of eternity is 15 years?

This is not a matter of choosing who is going to be bailing in or bailing out but a socio-economic paradigm shift is upon us and someone, somewhere is going have to grasp the nettle

Theory aside, Catalonia’s appeal for help is not a good sign. Being economically the strongest autonomous region, it should be the one among all that can withstand the pressures of the fierce slow-down in overall activity. By holding its hand up, it signals what Madrid did not want to see or hear, namely that although it can proudly continue to show the much quoted favourable Spanish debt/GDP ratio, it is a case of smoke and mirrors. On aggregate, Spain is bust.

After a summer of relatively benign markets, I’d be prepared to bet that the autumn will not be so kind and that we have some very turbulent sessions ahead of us. This is not a matter of choosing who is going to be bailing in or bailing out but a socio-economic paradigm shift is upon us and someone, somewhere is going have to grasp the nettle.

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