Investors not sufficiently rewarded for Portugal risk, warns Western Asset manager

Andrew Cormack, portfolio manager at Legg Mason Subsidiary Western Asset, has said that spreads around debt issued by Portugal are not enough to compensate investors for the risk they are taking on in the current environment of uncertainty.

Cormack said that despite reasonable attempts to reduce Portugal’s budget deficit to below 4% of GDP from about 8% two years ago, developments recently have resulted in poor numbers, putting the targets agreed with the so-called ‘Troika’ at risk.

More time has been given to the country by the European Commission, but with most of the improvements having come through increased tax revenues rather than spending cuts, should growth stall further then it will lead policy to focus on cuts.

“This is not the first peripheral coalition government put at risk by austerity fatigue and it is highly unlikely it will be the last,” Cormack said.

“Portugal has been largely ignored by the market since the new government accepted the Troika bailout in 2011 and spreads to German bunds have rallied by over 1,000bps since the peak of the crisis in Q1 2012 – in part because Portugal has managed to reduce a large part of its fiscal deficit – but also because general sentiment towards risk has improved following the announcement of OMTs (Outright Monetary Transactions) in September last year. That said, Portugal remains in recession, unemployment continues to rise (currently 17.7%) and the current coalition government’s popularity with the electorate has plummeted.”

“Our view is that this recent increase in volatility is just another symptom of the current crisis, namely austerity fatigue in the periphery leading to increasing levels of social unrest. The recent resignations by key politicians in the government’s junior coalition partner (CDS) increases the likelihood of early elections this year; further resignations from party members are expected which puts the current coalition government majority at risk. Adding fuel to the fire the socialist opposition party (who by no coincidence are currently 10 points ahead of their nearest rivals in recent opinion polls) are calling for new elections to be held as soon as possible.”

“We expect volatility to remain until we gain clarity on the current coalition government’s position. We think current spreads do not compensate investors for potential risks of a renegotiation of the current bailout agreement which may involve private sector involvement (PSI) as was the case in Greece.”


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