(photo credit: .)
Portugal’s decision to follow Greece and Ireland in seeking a European Union-led
bailout may mark a watershed in the region’s debt crisis. Instead of a
falling domino that threatens to topple countries higher up the credit-quality
ladder, the latest aid request will likely speed up the debt restructuring of
the three countries in Europe’s intensive-care unit.
Portugal’s need for
emergency assistance became inevitable last month once its parliament rejected
the government’s plans for yet another round of austerity. Former prime minister
Jose Socrates’s resistance to seek a bailout became untenable in the face of
credit-rating downgrades, deterioration in market spreads and access, and the
added balance-sheet strains on Portuguese banks.
With help coming from
the European Central Bank, Portugal will now access emergency funds from other
governmental sources to meet its debt obligations and to reduce the probability
of a banking crisis.
While Portugal is the third euro-zone country to go
down this road in less than a year, the next phase will likely play out
differently. Portugal is negotiating for a bailout in the run-up to its June
elections. As such, it will find it hard to provide the policy commitments
deemed critical for the type of EU and International Monetary Fund support
keeping Greece and Ireland afloat.
Transitional mechanisms will be needed
to bridge to a new government that’s able and willing to commit to a credible
multi-year reform program. Look for the ECB and EU to carry an even larger burden
in the next few weeks, with the IMF getting involved at a later
Restructuring likely Judging from market pricing of Portugal’s
debt, it’s increasingly likely that this emergency lending will be accompanied
by some type of debt restructuring after 2013. This would be enabled by the
wider set of policy options favored by Germany.
Whether this time line
materializes will depend not only on Portugal, but also on what happens
elsewhere in Europe.
Specifically, will Portugal’s bailout be followed by
a further migration of the debt crisis in the euro zone? Or will Portugal mark
the phase when truly differentiated outcomes are sustained? The fear is that
Portugal’s bailout is yet another indication that Europe’s peripheral debt
crisis will ravage Italy and Spain next. This would be consequential for a lot
more than just these two countries.
Italy and Spain would overwhelm the
euro zone’s rescue mechanisms, thus transforming a peripheral crisis into a
Shift in focus Fortunately, the probability of this
happening is declining as more European banks – including Germany’s Commerzbank
and Italy’s Intesa last week – succeed in raising additional private
If this trend continues, as I expect it to, look for the EU, ECB
and IMF to change their approach to helping the three countries being bailed
out. The focus will shift away from liquidity and on to solvency well before
With reduced concern about the contagion spreading up the
credit-quality ladder, these three official lenders will be less willing to
continue to pile new debt on top of old debt, and rightly so. The approach taken
so far, while succeeding in retarding the day of reckoning for private creditors
and banks, has involved significant costs.
The strategy has shifted even
more of the burden to already stressed taxpayers and users of public services.
It has further undermined the outlook for sustainable economic growth and
employment creation, aggravating social tensions.
And it has contaminated
the ECB’s balance sheet, eroding its hard-earned credibility and policy
On the surface, Portugal’s bailout may look like a replay
of Greece and Ireland.
But don’t be fooled. Seemingly familiar
developments in the next few weeks will likely be followed by a paradigm shift,
especially if European banks continue to raise capital.
accelerate the move from an unsustainable liquidity approach to a more durable
solvency solution for the continent’s debt crisis. (Bloomberg) Mohamed A.
El-Erian is chief executive officer and co-chief investment officer at Pacific
Investment Management Co.
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