Portugal Bears Brunt of Greek Contagion

Posted by: David Tweed on January 31, 2012

Poor Portugal. The country’s bonds have borne the brunt of investor frustration over Greece’s failure to reach an accord with private bondholders on writing down the value of their debt.

The yield on Portugal’s 10-year bond soared yesterday with investors concerned that it too would impose losses on holders of Portuguese debt in a restructuring.

I asked Prime Minister Pedro Passos Coelho last night after the European Union summit if Portugal would ever impose losses on its bondholders. He said it wouldn’t for a couple of reasons, citing first the EU’s statement last night that Greek situation is “exceptional and unique” and insisting that Portugal’s debt is sustainable.

It’s certainly lower than Greece’s. In its autumn economic forecast the European Commission projected that Portugal’s total debt will rise to 111% of GDP this year, compared to 198.3% for Greece, not taking into account bondholder write offs now being negotiated.

Allowing Portugal to impose bondholder losses would be sending a disastrous message to the market. As one Portuguese official put to me last night:

If bondholder losses are extended to a country that is successfully carrying out its program and meeting its commitments then the message to the market is that private sector involvement is a normal way of dealing with the crisis and that’s not the case.

The European Central Bank was right—forcing private-sector losses in Greece was a mistake because it has left investors jittery that such losses will be imposed elsewhere.

Passos Coelho also seemed frustrated that investors aren’t taking into account Portugal’s record in implementing the commitments made under its €78 billion rescue package. After all, the International Monetary Fund’s board approved a €2.9 billion disbursement from the aid program in December.

Portugal’s problem is that there are no natural buyers for its debt, apart from domestic players. Padhraic Garvey, head of developed markets debt at ING in Amsterdam, says emerging-market investors would prefer to buy elsewhere, turned off by the complexities of euro zone politics. Recent price action was amid thin volume and was probably excessive, according to Garvey. ING is a primary dealer in Portugal’s debt.

It doesn’t help that Standard & Poor’s cut Portugal’s credit rating to below investment grade on Jan. 13 when it downgraded nine European nations.

All of this is not to say that that Portugal won’t seek a second dip at the trough. Passos Coelho says that if external factors stop the country from doing so, then both the IMF and the EU will continue to “support our program.”

If bond yields stay this high, it will soon be a question of how much and when?

(Photograph by Sean Gallup/Getty Images)