Greece and Portugal should both go gracefully

by Simon Tilford

Financial Times
May 12, 2011

Even as the ink is drying on Portugal’s European Union and International Monetary Fund bail-out agreement, evidence is mounting that last year’s bail-outs of Greece and Ireland have failed. Far from improving their access to the financial markets, Greece and Ireland face record borrowing costs. Notwithstanding the slightly less draconian terms of Portugal’s agreement, it will surely suffer a similar fate. The EU will try to get away with “soft” restructurings, involving a combination of longer maturities and lower interest rates. But this will not work and by 2013 there will be no viable alternative to “hard” restructurings (default), comprising debt write-downs of 50 per cent or more. Unfortunately, in the case of Greece and Portugal at least, even this will not guarantee continued membership of the euro.

After all, interest payments on the crisis-hit countries’ outstanding public debt account for a relatively small proportion of their budget deficits. Reducing the cost of servicing the outstanding stock of public debt by 50-60 per cent would make these countries’ fiscal positions more sustainable. But unless the defaulting countries can engineer a return to economic growth, they will continue to struggle to tap the capital markets on anything but prohibitively expensive terms. Of the three peripheral economies, only Ireland stands a good chance of convincing investors of its solvency.

Assuming creditors write off 50 per cent of Irish and Portuguese public debt and 60 per cent of Greece’s in 2013, all three countries will have public debt ratios of a manageable looking 60-65 per cent of gross domestic product. But they will still have huge budget deficits, demanding ongoing budget austerity. In Ireland’s case, investors will probably calculate that the Irish economy will be strong enough to weather continued austerity. Ireland is now running a current account surplus – so the foreign balance is not a drag on its economy and the government is able to finance its budget deficit domestically. Irish exports should perform relatively strongly, holding out the promise of decent economic growth. As a result, Ireland could regain access to financial markets relatively quickly.

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