THE THIRD BAIL-OUT / THE ECONOMIST ( VERY HIGHLY RECOMMENDED READING )

Portugal

The third bail-out

How to make sure the latest bail-out marks the beginning of the end of the euro zone’s debt crisis


Apr 7th 2011

IT MAY have been inevitable, but it was a sad moment for Portugal: Europe’s oldest nation state brought low. In a prime-time television address on April 6th, after months of denial, Portugal’s caretaker prime minister, José Sócrates, at last admitted what had long been obvious to everyone else: his country needed a rescue loan from the European Union.


Portugal now joins Greece and Ireland in the euro zone’s intensive-care ward. Its public debts are nowhere near as monumental as Greece’s; its banks not as reckless as Ireland’s. It has succumbed because of a humdrum failure to rein in wage increases and to modernise a bureaucracy schooled in tallying the quiet remains of the first global empire, as well as an inability to coax upstanding family companies, which for centuries have crafted textiles, ceramics and shoes, into competing with the Chinese. As a result, harsh as it may seem, a country whose collective memory is still scarred by the austerity demanded by the IMF in the early 1980s must once again subject itself to tough reforms demanded by foreigners.


However painful for its citizens, Portugal’s plight will not shock financial markets. The spreads on its debt have been climbing for weeks, particularly since Mr Sócrates’s government fell on March 23rd after failing to win support for yet more austerity measures. By April 6th ten-year bond yields had reached almost 9%, and the government had to pay almost 6% to borrow money for just a year. No country with a stagnant economy and a big debt stock can do that for long. Mr Sócrates’s decision represents a recognition of the inevitable, not a sudden deterioration of the euro-zone mess.


Three things will now determine whether this marks the beginning of the end of the crisis—or the start of even deeper distress. The biggest immediate source of uncertainty will be the Portuguese government itself. Can a caretaker administration credibly agree on far-reaching reforms with a general election due on June 5th? Barely a week ago Portuguese officials said they lacked the constitutional authority to deal with either the IMF or the EU. Tellingly, they did not ask the fund for help on April 6th: Mr Sócrates may be hoping for a bridge loan from Brussels without IMF involvement or many conditions. But the EU will surely not lend Portugal stacks of cash for long without the fund alongside or without tough reforms attached. Either Mr Sócrates must get the opposition’s endorsement for a deal or the negotiations could drag on until after the election. That could be dangerous; fears of endless delay could precipitate a bank run: Portugal has huge private-sector debt, much of it raised abroad and funnelled through its banks. Eventually, the country will have to sign up to a serious reform plan: the sooner the better.


A second risk is contagion. Investors are bound to ask: “Where next?” Spain is the most likely (and alarmingly big) candidate. Although the spreads on Spanish bond yields have narrowed sharply in recent weeks, and continued to fall on April 6th, it cannot be complacent. Its banks are heavily exposed to Portugal. Its prime minister, José Luis Rodríguez Zapatero, has announced that he is not standing for re-election. Freed from the need to court popularity, he should now redouble his efforts at reform.


What Brussels must do


But whether Portugal’s capitulation marks a turning point in the euro zone’s crisis depends at least as much on decisions in Brussels as on those in the Iberian peninsula. Getting Portugal’s reform package right is the priority. The country surely has some financial skeletons: countries that borrow so heavily while growing so slowly usually do. But its main problem is a lack of competitiveness—which suggests a greater need for structural reform than for austerity. So top billing should go to deregulating cosseted industries and reforming the labour market. Portugal, one of the rich world’s most rigid economies, must become one of the more flexible. Greece’s experience shows how hard this will be.


European politicians’ responsibilities do not stop there. This newspaper has repeatedly argued that the debts of Greece, Ireland and Portugal are unpayable and must be restructured. With all three countries now being “rescued”, the politicians at Europe’s core should start work immediately on an orderly restructuring of their debt. That will require a boldness that Europe’s policymakers have lacked. But it is a prerequisite for drawing a line under the European debt mess.