May 5, 2011 / 1:00 PM / 8 years ago

Portugal faces tough road under 78 billion euro bailout

LISBON (Reuters) - Portugal faces profound economic problems and will have be bold to tackle them successfully, the European Union and IMF said on Thursday as they confirmed a three-year, 78 billion euro bailout for Lisbon.

Rasmus Ruffer from the European Central Bank, European Union delegation leader Jurgen Kruger and Poul Thomsen from the International Monetary Fund (L-R) attend a news conference in Lisbon May 5, 2011. REUTERS/Jose Manuel Ribeiro

European Central Bank President Jean-Claude Trichet, speaking after the bank decided to keep euro zone interest rates on hold at 1.25 percent, said the deal had the necessary ingredients to reboot Portugal’s economy.

The financial aid package will push Portugal into recession for the next two years, require a painful overhaul of labor markets and force the government to sell shares in state utilities, but Portugal’s finance minister said it would also help overturn decades-old structural problems.

“This programme’s success will require a truly national effort,” the EU and IMF said in a joint statement, saying it combined the need to stimulate long-term growth, reduce the deficit and restabilize Portugal’s banking and finance sector.

Trichet said it was up to Portugal’s caretaker government, and whichever government takes office after a parliamentary election on June 5, to make the bailout work.

“The program contains the necessary elements to bring about a sustainable stabilization of the Portuguese economy,” he told a news conference in Helsinki. “We are confident. Of course, it calls for the present government ... and future governments to do the job.

Germany, as the euro zone’s largest economy, pays the largest share of bailouts; Chancellor Angela Merkel said the package must be based on realistic growth targets.

Portugal had resisted a bailout for months, mindful of the hardship and popular resentment after it had to call in the International Monetary Fund in the 1970s, when the nation was emerging from decades of authoritarian rule.

But financial markets pushed Lisbon’s cost of borrowing to historic highs, forcing the country to follow Greece and Ireland into EU/IMF protection.

While three of the euro zone’s 17 member states are now effectively quarantined, there is little evidence so far that their rescue programs are having the desired effect.

Greece, whose debts are expected to rise to 340 billion euros ($505 billion), or 150 percent of gross domestic product, this year, has indicated it wants to renegotiate the terms of the 110 billion of loans granted to it last May. Originally for three years, the loans are now for seven years and have an average interest rate of 4.2 percent.

Ireland, which agreed an 85 billion euro bailout in November, wants a lower interest rate on its seven-year loans, which carry an average rate of 5.8 percent.

Without any adjustment to the programs, there is growing concern among financial analysts and policymakers that Greece, and possibly Ireland, will be forced to restructure their debts.

That would have a profound knock-on impact on Greek and Irish bondholders, who include many major French, German and British banks and the European Central Bank. Seventy percent of Greece’s sovereign debts are held by foreign institutions.

The ECB’s Trichet insisted that any Greek move to negotiate more lenient terms with its debtholders “is not on the cards.”

The ECB is particularly concerned to avoid a euro zone debt restructuring to avoid inflaming market worries about Spain, a much bigger economy and a large holder of Portuguese assets.

In recent months, Spain has worked to distance itself from others on the euro zone periphery and an auction on Thursday suggested Madrid remains on track, raising five-year funds at an average yield of 4.549 percent, up only marginally from 4.389 percent at the last comparable auction in March.

WORK TO BE DONE

While Portugal talked up the terms of its bailout on Thursday, it has yet to agree the interest rate and when the first tranche will be paid. Portugal will need outside help to meet a 4.9 billion euro bond redemption on June 15.

Euro zone finance ministers meet in Brussels on May 16 to discuss the bailout, including the interest rate. It should get the required unanimous backing from all 17 member states, but Finland, where the anti-bailout True Finns party did well in a parliamentary election last month, could prove a sticking point.

The bailout allows around 12 billion euros for shoring up Portugal’s banks, eventually bringing their Tier 1 capital ratios to 10 percent, though Portugal’s banking association said the money probably wouldn’t be necessary.

While tough — and the EU and IMF insisted it would require long and diligent work by Portugal — caretaker Prime Minister Jose Socrates has touted the fact the terms, including on budget targets, are softer than for Greece or Ireland.

A euro zone official said that partly reflected the fact Portugal’s budget deficit is not the most pressing issue — its banks and labor market are more immediate concerns — as well as lessons learnt since the Greek bailout agreed a year ago.

The harsh conditionality attached to Athens’ program has in some respects made the situation more difficult, the euro zone official said, adding that the EU and IMF were now trying to take a more realistic approach.

“If the aim is to have credibility with the markets, then the assistance packages have to be credible,” said the official, speaking on condition of anonymity.

With additional reporting by Axel Bugge, Daniel Alvarenga and Shrikesh Laxmidas in Lisbon, and Stephen Brown in Berlin; Editing by Ruth Pitchford

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