Contagion hits Portugal as Ireland dithers on rescue
Confused reports continued to swirl as Irish finance minister Brian Lenihan prepared to meet eurozone colleagues over dinner in Brussels on Tuesday night. Dublin has so far admitted to holding talks over “market conditions” with EU partners but insists that it is fully-funded until June and hopes to calm nerves with €6bn (£5.1bn )of budget cuts in early December.
Simon Derrick from the Bank of New York Mellon said the negotiations over Ireland’s bail-out have been astonishing. “The creditors say please take the money, and the debtor says ‘we don’t want it’. It’s very odd.”
“Still, the EU is doing the right thing to try to create a fire-wall as quickly as possible. They learned from Greece that once bond yields reach this level they have 10 trading days left to avoid a self-feeding crisis. They cannot allow this to spread to a large country because at that point contagion would become uncontainable,” he said.
Contagion has already pushed Portugal to the brink, pushing yields on 10-year bonds to the danger level above 6.5pc. Finance minister Fernado Teixeira dos Santos said the country was at the mercy of global forces and may be forced to call for help.
“The risk is high because we are not only facing a national or country problem. It is the problems of Greece, Portugal, and Ireland. Markets look at these economies because we are all in this together in the eurozone. Suppose we were not in the eurozone, the risk of contagion could be lower,” he told the Financial Times.
Mr Teixeira made a thinly veiled attack on Germany’s Angela Merkel and France’s Nicolas Sarkozy, who precipitated the latest crisis by opening the door to sovereign defaults and bondholder “haircuts” for eurozone states in trouble.
“We were like the soccer player running to the goal and ready to kick for the goal, and then someone fouls us, but this time there was no penalty.”
A simultaneous bail-out for both Ireland and Portugal might run to €200bn, depleting much of the EU rescue line. The European Financial Stability Facility (EFSF) can raise up to €440bn on the bond markets but only two thirds of this would be available. The IMF is expected to loan a further €3 for every €8 from the EU under the bail-out formula.
The great concern is that the crisis could spread to Spain, which has a far bigger economy that Greece, Portugal, and Ireland combined. Foreign banks have €850bn of exposure to Spanish debt.
David Schautz, credit strategist at Commerzbank, said the EU bail-out fund would come under “severe strain” if Spain needed a rescue. Yet this remains a serious risk since Spain must roll over or raise €175bn of debt next year.
Mr Schautz said funds would become wary if yields on 10-year Spanish bonds rise much above 5pc, compared to 4.5pc at the moment. “Investors are nervous and panic can break out fast,” he said.
Jose Manuel Campa, Spain’s economy secretary, said his country is “neither Greece, nor Ireland, and never will be”. Spain’s economy has stalled again but public debt is still just 66pc of GDP, and both budget and current account deficits are falling fast.
The same cannot be said of Greece, where the debt crisis is going from bad to worse despite its €110bn rescue in April. Eurostat has revised Greece’s debt from 115pc to 127pc of GDP last year, while the deficit was even worse than thought at 15.4pc. The debt will jump to 144pc of GDP this year, risking a debt-compound trap.
Premier George Papandreou said the country may ask for an extension of its debt repayment schedule, a move interpreted by investors as the start of a slippery slope towards default.
He accused Germany of pushing weaker EMU states over the edge by pressing for bondholder haircuts, saying Mrs Merkel’s proposals had “created a spiral of higher interest rates for the countries in a difficult position. This could create a self-fulfilling prophecy. It is like saying to someone, ‘since you have a difficulty, I will put an even higher burden on your back.’ This could force economies towards bankruptcy,” he said.
For Ireland, recourse to the EU or IMF would be traumatic, an unanswerable verdict on a Fianna Fail government that was still basking in glory of the Celtic Tiger just three years ago.
Mr Lenihan appears determined to dress up any rescue as a bail-out for banks rather than for the Irish sovereign state. This may not be easy. The ECB’s vice president, Vitor Constancio, said the EFSF “cannot lend directly to banks: the facility lends to governments.”