Many See Portugal Next in Line for EU Bailout After Ireland

Friday, 19 Nov 2010 09:05 AM

 

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Ireland edged toward taking a bailout loan from the European Union to bolster its debt-crippled banks — but that likelihood offered little reassurance that Europe could soon overcome its wider crisis caused by crushing levels of government debt.

After Greece and potentially Ireland, Portugal may be the next country using the euro to need assistance. Some analysts suggest the crisis is now less about about panic and more about a growing realization that debts may have grown too big to refinance, never mind pay back.

As an army of experts from the European Commission, European Central Bank and International Monetary Fund descended on Dublin to explore the scope and terms of a bailout, Irish Finance Minister Brian Lenihan insisted his government was still not certain it needed any emergency aid at all.

He told lawmakers that Ireland and the outside experts were exploring the prospect of forming "a contingency capital fund that would stand behind the banks," but said no decision was imminent.

And underlining the government's determination to negotiate a hard-fought deal, Deputy Prime Minister Mary Coughlan declared that Ireland's 12.5 percent rate of corporate tax — a key magnet for foreign investment that Germany, France and other EU heavyweights want to see raised — "is non-negotiable."

Such inflexibility, while widely supported in Ireland, has been questioned elsewhere as unrealistic. The terms of any EU-IMF loan could come with specific requirements on restructuring Ireland's tax system.

"When does denial turn into delusion?" Joan Burton, finance spokeswoman of the opposition Labour Party, said to Lenihan and Coughlan. She accused the government of lying to the public about the inevitability of a bailout.

All across the eurozone, analysts say, debt-burdened governments are living in denial about their long-term ability to keep drumming up fresh cash from bond markets and banks for refinancing debts.

Many say weak growth means Greece remains vulnerable to potential default, or a second rescue, when its current 110 billion euro EU-IMF loans come due for repayment in 2013.

Default — telling bondholders they won't get all their money — solves the problem by reducing the amount of debt — but could result in market chaos, hit European banks holding Greek debt and leave Athens cut off from borrowing for an unknown period. European officials are discussing procedures to let a member of the eurozone default in a way that minimizes financial turmoil — a complex question that may not be solved for months or years.

Meanwhile, Portugal is reduced to hoping interest rates on its bonds will fall once the EU and IMF cap concerns about Ireland. Spain is struggling with less debt but a stalled economy with 19.9 percent unemployment.

The immediate focus is on Dublin because its banks have broken the patience of their major recent source for funding, the European Central Bank. The banks have already required a 45 billion euro ($62 billion) government bailout program that has pushed the Irish deficit this year to an unprecedented 32 percent of GDP.

In recent months loans from the Frankfurt bank to Irish banks have surged, and recently reached an apparent breaking point whereby the Irish banks could no longer provide sufficient collateral. The Irish Central Bank, controversially, has been filling the cash void by providing its own ECB-backed loans to the Dublin banks that have taken total ECB exposure in Ireland above 130 billion euros, a quarter of its eurozone loan book.

Irish Central Bank governor Patrick Honohan, forecast that Ireland would negotiate a loan facility with the EU and IMF worth "tens of billions." He said the funds would be used to strengthen the financial foundation of Irish banking.

Three of Ireland's six locally owned banks have been nationalized since 2009, while the government is the biggest shareholder in two others.

Honohan said the likely loan facility would provide a financial "buffer" for Irish banks that would be put on deposit, not spent. "It's true that our banks need additional confidence," Honohan said in an interview with Irish state broadcasters RTE.

He said the capital would be "shown but not used." It "goes in as buffer and comes out again when it's not needed."

While Ireland has stressed it has cash reserves sufficient to pay government bills though mid-2011, other struggling members of the eurozone have paying high rates to tap bond markets. Higher and higher rates can threaten to make it too expensive for a country to roll over its debt, or borrow to pay off expiring bonds. That's the situation Greece faced in May when it was bailed out.

This week Spain, Italy, Portugal and Greece all have auctioned treasuries that required high interest rates to woo buyers. Spain and Portugal have appealed to Ireland to take an aid package soon in hopes that will lower their own interest-rate pressures.

Just like Ireland, Spain has been laid low by the 2008 collapse of a runaway property market. Its own exposure to ECB borrowing exceeds 70 billion euros.

Analysts caution that any announcement of an Irish aid deal won't stop a "contagion" effect in other eurozone countries — because they are suffering from their own specific ailments, most immediately Portugal.

"The resolution of the Irish crisis is really irrelevant for Portugal," said Daniel Gros, a former IMF economist who directs the Center for European Policy Studies, a Brussels think tank.

"People always think that markets are irrational" and that panic will spread from one country to another, Gros said. "But after awhile, markets look at the fundamentals, whether a country is vulnerable — and on the fundamentals Portugal is very weak."

Portugal has the eurozone's worst current account deficit, which means its residents consume far more than they export. While the 16-nation bloc's current account deficits average just 1 percent, Portugal's is 12.3 percent.

"They have to make an adjustment not just of fiscal policy but of the entire country," Gros said.

As in Ireland, Portugal's own treasury officials stress that everything is under control.

Alberto Soares, head of Portugal's debt agency, said in an interview published Thursday that Portugal is having no trouble selling its bonds — albeit at interest rates approaching a painful 7 percent. Germany, benchmark of safety, borrows for 10 years at 2.67 percent.

Further denting the ability of the indebted PIGS — Portugal, Ireland, Greece and Spain — to borrow at lower rates is the stance of Germany, the primary bankroller of the rescue loans.

Chancellor Angela Merkel again emphasized her view that bondholders, sophisticated investors who make loans knowing they could lose money, must start taking part of the losses when Europe's current ad-hoc system for providing emergency aid to eurozone states expire in 2013.

"For me, it is a question of principle to what extent politicians expect market participants to be responsible to some extent for their risks," she told a conference of German insurers.

The governments of Spain, Portugal, Greece and Ireland all have accused Merkel of driving up their immediate borrowing costs by raising the specter of bond defaults or hefty losses down the road.

Thursday's behind-closed-doors talks in Dublin could last days and involve Ireland's Department of Finance, Central Bank, National Treasury Management Agency, Financial Regulator Matthew Elderfield and Ireland's state-owned "bad bank," the National Asset Management Agency. It has been buying tens of billions of Irish banks' dud property-based loans at hefty discounts in an exercise to remove toxic debts from the banks' books.

Britain, Ireland's major trading partner, has already pledged it could contribute around 6 billion pounds (7 billion euros, $9.6 billion) to any Irish aid package. That reflects in part Britain's exceptional exposure to liabilities in Irish banks, which in turn funded construction projects all over Britain.

Britain is the No. 1 country in exposure to Irish bank loans, with $222 billion, Germany second with $206 billion, and the United States third with $114 billion, according to the Bank for International Settlements.

© Copyright 2014 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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