November 29, 2010 / 6:56 AM / 8 years ago

Analysis: Portugal, Spain in crosshairs as Ireland bailed out

BRUSSELS (Reuters) - The European Union’s bailout of Ireland is unlikely to halt expectations that the euro zone debt crisis will spread to Portugal, or provide reassurance that a firewall can be built around Spain.

Europe’s debt contagion has moved on from Greece to consume Ireland in a matter of months, even though Ireland had complained it was not like Greece and did not need help to sort out its bad banks or a gaping budget deficit.

Sunday’s decision by EU finance ministers to prop up Ireland with 85 billion euros may temporarily halt financial market pressure on euro-zone debt.

But renewed pressure is likely to be applied to Portugal and Spain, where yields on 10-year government bonds rose sharply last week as debt markets priced in the risk that Iberia could be next in line after Ireland.

“I think it is almost impossible now to stop the contagion,” said Mark Grant, managing director of corporate syndicate and structured debt products at Southwest Securities in Florida.

“If Ireland is dealt with, it will not be solved and then bond owners will turn their attention to Portugal, Spain, Italy, Belgium et al as the monetary union is full of structural defects. With the possible exception of Germany, it appears to me that no sovereign debt is safe.”

Spanish Prime Minister Jose Luis Rodriguez Zapatero said last week there was no chance Madrid would follow Dublin and Athens in requesting aid, a line repeated by his economy minister as she arrived for Sunday’s EU talks in Brussels.

Portugal’s prime minister has said similar things about Lisbon. But the words may not be enough to stop it happening.

Ireland’s situation may be different to Greece’s, Portugal’s different to Ireland’s and Spain’s different to Portugal’s, but they all still have enough bad ingredients — whether high deficits, low growth prospects, large debts or bad banks — to create market uncertainty and raise their risk profiles.

“If we look at the wider situation, markets are already concerned about contagion spreading to Portugal, and then Spain, and to a certain extent the European Union are playing catch up to market fears,” said Philip Shaw, chief economist at Investec.

“There’s absolutely no indication that the agreed package for Ireland is going to soothe those concerns spreading from the Iberian peninsula.”

DIFFICULT CHALLENGES

European Union leaders and senior finance officials now find themselves confronted by an array of unappealing challenges.

If Ireland’s bailout does not stop the rot, they will have to convince financial markets they have the capacity to bail out Portugal and potentially Spain too. Otherwise yields on Portuguese and Spanish debt will go on rising and further contagion would be self-fulfilling.

In theory, they have the money to help both.

The European Financial Stability Facility, a joint EU-IMF fund created in May, started with 750 billion euros in the kitty. After Ireland’s bailout, there is 665 billion euros left — Greece’s package was a separate 110 billion euro arrangement.

If Portugal were to seek EU assistance, economists estimate it would need up to 100 billion euros, well within the EFSF’s reach. Spain, however, is a very different case. It’s economy is twice the size of Portugal, Ireland and Greece combined.

While there may in theory be enough funds to help Spain as well, such a bailout would come close to using up everything, which would be a red rag to those determined to see what the EU would do next if, say, Belgium or Italy came under pressure.

In terms of macroeconomic fundamentals, Portugal and Spain do not need a bailout. But this has become a sentiment-driven crisis, with bond market fears driving up yields, raising the cost of funding and forcing EU states to crisis point.

“The problem is that the markets have moved,” said Alan McQuaid, chief economist at Bloxham stockbrokers.

“I don’t think they really care about Ireland any more, they’ve moved on to Portugal and Spain. The crisis has moved on. The politicians don’t seem to realize, but the markets have.”

In the long term, the best defense against attack will be Portugal, Spain, Ireland and others retooling their economies to improve primary budget balances, increase productivity and growth, and lower unemployment. But that will take years.

In the short term, the EU is faced with dealing with the immediate problems and communicating better on how it plans to overcome them. Past communications have been patchy and may well have exacerbated the crisis.

On Sunday, as well as agreeing the Irish bailout, finance ministers discussed how a permanent mechanism for resolving future euro zone sovereign debt crises — which the EU plans to introduce from 2013 when the EFSF expires — will work.

Germany had insisted that the permanent mechanism should involve substantial write-downs for private bondholders, a view that provoked more turbulence on financial markets last week, aggravating the situation for Ireland, Portugal and Spain.

Those demands were dropped on Sunday as finance ministers laid out a more nuanced mechanism that would involve private bondholders being dealt with on a case-by-case basis, with debt restructurings handled along IMF lines.

Those measures and others may calm the more critical voices, but it remains to be seen whether it will be enough to convince financial markets that the EU actually has its crisis in hand.

Additional reporting by Mohammed Abbas and Sarah Young in London; editing by Ron Askew

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