Battle to pay for PIIGS bailout grows
THE request by Portugal on Wednesday for an EU-backed financial bailout has been on the cards for some time.
It was spurred by the steep jump in interest on government bonds from 4.3% to 5.9% on 12-month paper. This bailout follows the one of €67.5 billion for Ireland last November and a €110bn bailout for Greece last May.
Greece is looking for a bridging loan in advance of the full bailout, however, given that €4.2bn of government debt is to be repaid next week and a further €4.9bn falls due on June 15. However, the request at this stage has been extended only to the European Union and not the IMF, who have expressed a willingness to be involved.
The bulk of the money to cover the Portuguese bailout will likely come from the European Financial Stability fund. The EU’s contribution to the Irish deal, however, involved a contribution of €22.5bn from this fund and a further €22.5bn from the European Financial Stability Mechanism, with the balancing of €22.5bn coming from the IMF and bilateral loans with other countries.
The Greek bailout involved €80bn from the EU and €30bn from the IMF.
Two particular questions arise: what interest rate will Portugal be forced to pay, and will the IMF be involved?
The Greek deal was originally announced at 5.2% but last month this was cut to 4.2%. Despite promises by Fine Gael to lower the Irish rate, it still stands at 5.8%.
It is likely that the interest rate on the Portuguese deal will fall somewhere between these two numbers. It is also likely that the EU will demand that the IMF be called in to assist with the burden.
If we assume that the EU will likely finish up funding €50bn of the €70bn Portuguese deal, then the combined cost to the EU for the Greek, Irish and Portuguese deals will reach €227.5bn. Last year before the Irish or Portuguese deals were announced, the European Central Bank had already been buying up tens of billions of Irish and Portuguese bonds in order to prevent the bond markets for government debt from weakening any further.
So, the pressure on the ECB does not end with even these deals. The pressure is further exacerbated by the banking systems in Ireland and Spain.
In March, the borrowing of Irish banks with the ECB rose to €117bn. Last December, the ECB increased its capital reserves from €5.7bn to €10.7bn, given its own exposure to bond purchases across the EU. At this stage, it may well have to increase its reserves again. These will be taken from the central banks of other EU countries.
European economies are being exposed to more risk which, as times go on, may well cause the euro to depreciate. In the medium term, there is a danger that pressure will come on ECB interest rates and on the interbank markets in countries like Spain, Ireland, Portugal, Belgium and Greece.
This tightening of liquidity in these countries due to banking and sovereign government debt pressures could make money even more expensive and crowd out investment capital which could be used for businesses. This could well stall economic recovery and keep unemployment persistently high.
It is looking likely that Spain may be the next country to look for a bailout. The countries to date that have sought a bailout have had rapidly deteriorating deficit and government debt problems: Ireland, from having a government surplus of 2.4% in 2006, registered a 14.4% deficit in 2009 and 12.2% in 2010; Its debt to GDP ratio 65% at the end of 2009 and is projected to be close to 100% at the end of 2011.
Before its bailout last May, the Greek deficit was 15.4% and its debt was 127% of GDP.
Spain’s deficit last year was 9% and even though its debt is not as high at 55% of GDP, it has witnessed the bursting a property bubble. Like Ireland, Portugal and Greece, the country’s credit rating has been cut. Estimates for the recapitalisation of its banks vary between €40bn and €120bn.
It is ominous for Spain also that monthly average yields on long-term government bonds have risen from 3.83% to 5.26%. There has been the same trend in Portugal, where yields rose from 4.31% to 7.34% in the last year. Spain also has the highest unemployment rate in the EU at 18%. This will further pressurise the public finances. The signs of a bailout look ominous.
The Portuguese bailout and the prospect of a Spanish bailout to follow will make it increasingly difficult for our Government to achieve an interest rate reduction.
The EU will seek to punish countries whose finances and banks are doing badly in order to force others to get their finances in order, and to prevent further risk exposure to the European Union.
Nonetheless, it would be wrong to think that the European Central Bank will run out of money. This is virtually impossible. It would also be wrong to conclude that these problems are particularly European. They are not. For example, the deficit in the US is nearly 11% of GDP. In Japan, government debt as a percentage of GDP is 104%.
It would also be unwise for Ireland to settle for a high interest rate of 5.8% simply because the EU may get tougher over Portugal’s bailout. However, the interest rate increase of 0.25% yesterday is worrying. Even though, Jean-Claude Trichet said this was to bring down inflation to 2% in the eurozone and was not connected to the EU bailouts, this may well change.
Despite its recent appreciation against sterling and the dollar, the poor condition of finances within eurozone countries and the bailouts may ultimately cause the euro to depreciate. This may provide a new impetus for interest rate increases which have already re-started.
Ireland is already suffering from high interest rates due to pressures on the interbank market, even though recapitalisation should ultimately ease pressures.
However, it is still likely to be a rocky road ahead for mortgage holders, businesses and consumers.
