Natixis’ Jesus Castillo asks: What does the future hold for Portuguese public debt?
Jesus Castillo, southern Europe economist at Natixis, has reviewed the data around Portuguese public debt, and the different options available for those seeking to reduce it over time.
Despite strenuous efforts to balance its budget, Portugal’s economy is likely to suffer from rising public debt for some time to come if nothing else is done. Further challenges lie ahead in the endeavour to stabilise the debt ratio – not least due to the country’s growth outlook, interest rate levels and primary fiscal balance.
As a potential way out of the quandary, some commentators have put forward the suggestion of debt restructuring. But for this to be effective European institutional lenders would need to be involved – a scenario highly unlikely at present.
Instead of restructuring, we propose three solutions that could allow Portugal to restore its financial independence and regain full access to the market by the end of its aid programme. First, new debt buyback and exchange transactions should be put in place by the Portuguese Treasury. Secondly, there should be a noticeable increase in new privatisations. And finally, temporary precautionary credit lines should be implemented by the European Stability Mechanism (ESM).
Is Portuguese debt sustainable?
Before we explore these potential solutions in greater detail, however, let’s first look more closely at the nature of Portuguese debt.
When the economic crisis hit Portugal in 2008, the country’s public finances were already in a state of disorder. In fact, the country was unable to meet the European Union’s Maastricht criteria on public finances within the proposed timeframe, with public debt exceeding the 60% threshold in 2004, and the budget deficit remaining higher than 3% of GDP. The situation remains dreary today, with Portugal’s public debt having increased by 52 percentage points of GDP since 2008 – and the country is yet to achieve any semblance of sustainability.
In a recent study, we attempted to ascertain the required primary budget balance that would be needed to correct this, by using the usual equation SPs = D x (r – g), where ‘SPs’ is the stabilising primary balance as a percentage of GDP, ‘D’ is the debt ratio as a percentage of GDP, ‘r’ is the interest rate of public debt and ‘g’ is the GDP growth in value. Illustrated in the graph below, which represents the difference between the stabilizing primary budget balance and the observed primary balance, the equation revealed that Portugal would have needed to achieve a primary surplus of around 7.5% in 2012 (versus the observed deficit of 2%) to stabilise its public debt. If such efforts had been made, the end of 2012 could have seen an improvement in the primary budget balance of around 10 GDP percentage points.
A debt level compatible with Portuguese growth
In the same study, we also sought to determine the ideal debt ratio for a stable level of debt.
Based on the assumptions that GDP growth in value will stabilize around 1.5%, the primary deficit will fall to its 2000-2008 average level (-1.45%) and the OMT will be activated if necessary to keep the interest rate on public debt at around 3.7%, we calculated that the public debt ratio must not exceed 66% of GDP if it is to stabilize from 2014 onwards – requiring a drop of 64 GDP percentage points (€105 billion) compared to the level expected in 2013 (130% of GDP).
Clearly, these figures are unlikely to be realised under present conditions, and so steps must be taken to address Portugal’s debt burden more effectively. As restructuring Portugal’s debt is not an option at present – it being improbable that loans granted under the European aid programme will be restructured as well – we instead propose three alternative counsel of action.
The first is to refocus on debt exchange or buyback transactions by the Portuguese Treasury. This programme was developed in 2001 to ensure the liquidity of securities through exchanges or outright purchases. For example, in October 2012 – in order to reduce debt amortisation in 2013 – the Treasury exchanged €3.8 billion worth of securities maturing in September 2013 for bonds maturing in October 2015. Such a strategy needs to be continued – and indeed, stepped up.
Secondly, the Portuguese government should look to new privatizations. It owns around €35 billion of equity interests in business corporations – sometimes as a majority shareholder in nearly all sectors of the economy.
Finally, a credit line in the context of a precautionary programme should be implemented. Rather than a classic assistance programme, this would be contingent on a “pared down” conditionality. It would be temporary (possibly for one-year, with the chance to renew each six-months), and would authorize the ESM to operate on the primary and secondary market, and to grant loans.
Furthermore, the country’s return to the market would be assisted by the European Central Bank via its Outright Monetary Transations (OMT) programme.
The table below shows the predicted financing needs of the Portuguese government from 2014 to 2017. Assuming that the Treasury continues to finance itself for around €20 billion in the short-term, it should raise around €15 billion a year in medium- and long-term issuances, for the period 2014-2017. This amount is compatible with the size of the ESM, even if it were to buy 100% of the issues on the primary market in 2014.
As these calculations indicate, the ‘restructuring’ strategy is not the only way to stabilize Portuguese debt ratio.