Portugal finally capitulated to reality last night and followed Greece and Ireland in formally seeking an €80bn bailout from her eurozone partners and the IMF to save her from default on unsustainably high foreign debts.
The Portuguese prime minister, Jose Socrates told his people in a televised address that Portugal was throwing the towel in after a year-long struggle to solve her problems without outside assistance. Mr Socrates said: "We have reached the moment. This is an especially grave moment for our country, and things will only get worse if nothing's done." He said a bailout was "the last resort". Portugal has been forced to pay unsustainably high rates of interest to foreign investors; the fact that a loan from the EU and the IMF would be cheaper is the brutal calculus that lies behind this national humiliation.
Other European countries have long urged Portugal to accept help in the hope of containing the continent's debt crisis. As with Greece and Ireland before her, the doleful pattern of futile resistance has repeated itself: profuse official denials of help followed by intolerable market scepticism and pressure; and chaos before Europe's leaders were able to get ahead of events. Last month's EU summit was the last opportunity for the leaders of the euro area to come together and agree on an enlargement of the current bailout fund, the European Financial Stability Facility. They were supposed to agree a €250bn increase in funding to €440bn: instead they deferred a decision to June, in deference to pleas from the Finnish government which faced tricky elections. Thus did the Greek and Irish tragedies replay themselves against a Portuguese backdrop.
While a serious burden on the already stretched eurozone bailout fund, the Portuguese rescue package – likely to amount to around €80bn – is well within the fund's means. However if the "contagion" now spreads to Spain, the costs could be far larger, and threaten the euro itself.
During the latest episode in the euro's existential crisis, Spain has managed to avoid the taint of imminent collapse. But there are many who wonder whether this can be sustained, not least because Portugal, her nearest neighbour is such an important trading partner. Spain is a much larger economy than Portugal but her smaller regional banks, the cajas, are badly exposed to her collapsed property market, and are proving costly to shore up.
Legendary investor and economist Nouriel Roubini, the so-called "Dr Doom" who correctly predicted the coming of the credit crunch and subsequent slump, summed up the danger to the euro: "I think the big question is not Portugal – that is too small – but rather whether the contagion could spread, over time, to Spain, a country that is on one side too big to fail, but from the other side too big to be saved."
Though widely regarded as an inevitability, the timing of the Portuguese denouement nonetheless came as a surprise. It comes ahead of a "crunch" roll-over of government debt due by the end of next week, and many judged the Portuguese would be able to muddle through once again, the assumption being that further covert assistance form the European Central Bank would be forthcoming. Yet opinion within the ECB, based in Frankfurt and heavily influenced by Berlin, has been turning against Portugal and other peripheral nations that have used their banks' right to borrow from the ECB at easy rates, as a conduit for state funding, a form of "addiction" that the ECB wants to end.
The ECB has been ready, if reluctantly, to accept near "junk" bonds from the Portuguese, Irish and other governments as collateral for loans that eventually found their way back to national treasuries. This was essential for governments effectively locked out of capital markets – but not a long-term answer to their problems.
So today the ECB seems determined to raise interest rates from 1 to 1.25 per cent – yet the imminent decision seems to have triggered the latest crisis. The president of the ECB, Jean-Claude Trichet, has long signalled his desire to hike rates to prove his anti-inflationary credentials. But such a move may well make matters worse. It will directly increase the cost of servicing debts among the already-stressed eurozone peripheral nations and would also depress spending power across the EU by hiking mortgage bills and the cost of bank loans.
Nor is the Portuguese crisis likely to draw a line under the eurozone's crisis – even if Spain escapes. Almost a year on from her own crisis, Greece is almost certainly headed for default on her debts, because even another loan from her partners would not be enough to support her huge debts. They have simply overwhelmed her economy. Meanwhile, Ireland's newly-elected government has declared its intention to "renegotiate" the EU/IMF rescue deal reached last November and has the holders of bank debts with partial default.
While suffering from the same crisis of confidence, savage downgrades by credit agencies, and being shunned by the markets, Europe's problem children all have different flaws. Before the banking crisis, Ireland enjoyed enviable growth rates and low public debt. Portugal and Greece did not suffer banking crises; yet their economies are simply uncompetitive and locked into the euro, unable to devalue their way out. There is no "one size fits all" solution to the challenges they variously face; but there is no solution of any kind readily available from Europe's leaders as the eurozone lurches into its latest trauma.
How the problems spread
The first eurozone country to require a bailout, Greece received €110bn from the EU and the IMF last May. With increasing doubts about its ability to meet fiscal targets and once again use the markets for funds, there is talk the debt will need to be restructured.
The country took €85bn from the EU and the IMF last year, but with another bank bailout needed only last week – the fifth since the 2008 – the Irish economy is still on life support, its banking system still stressed, and it could default.
It has been estimated that about €80bn will be needed for the latest of the bailouts, which the Portuguese have been saying for months would not be necessary. They have now bowed to the inevitable.
Which countries could be next?
Spain Potentially the most fundamental threat to the eurozone's future, with unemployment running at 20 per cent plus. The country is slashing spending in a desperate bid to not suffer the same fate as Portugal but its neighbour is an important trading partner.
Italy Giorgio Napolitano, the President of Italy, the eurozone's third-largest economy, said last week that he saw no danger of his country requiring a bailout. But his aim of achieving a "zero percent deficit and GDP ratio" looks a long way off yet.Reuse content