Friday, June 22, 2012

How Portugal Found Itself in Crisis

Despite Being a Well-Managed Economy
NY Times Article on Crisis in Portugal
The story of Portugal is one of how a small, soundly run economy can be battered by unstable market forces in its immediate environment. Prior to the crisis, Portugal had a well-managed economy which had low debt levels, roughly in line with the Maastricht criteria, as well as economic growth rates ranging from 3-5% per annum. As soon as the crisis emerged however, Portugal became a victim of increased borrowing costs due primarily to panic on the European markets, as well as high levels of exposure to financial sector external shocks. 

According to the New York Times, Portugal has reduced its budget deficit by more than one-third since this time last year. Furthermore, the IMF reports that contraction in output due to austerity measures has been milder than expected. Nevertheless, the IMF reports that the 2012 outlook for Europe has deteriorated substantially, affecting primarily the PIIGS economies. Essentially, Portugal's situation has been quite seriously undermined by continually deteriorating market sentiment, which is largely being driven by Eurozone stress (for which, Portugal is not responsible).

To illustrate matters further, the European national debt graph below, originally published by the NY Times last quarter, outlines that Portugal began 2009 with debt levels equal to those of Germany and have faced an increase in borrowing costs only since the Greek situation -and resulting mismanagement of the crisis- unfolded.

In other words, the IMF reports that while Portugal's fundamentals are fine in and of themselves, as is Portugal's management of the stormy economic climate thus far, Portuguese assets are being sold-off based on contagion fears stemming from the EU's (and Germany's) lethargic reaction to the crisis.

What Should Be Done?
In short, Portugal should be offered financial stabilization along the lines extended to Central and Eastern Europe under the auspices of the Vienna Initiative. In 2009, as the crisis swept through Eastern Europe, a coordinated crisis response was swiftly agreed and implemented primarily by the EIB, EBRD, The CEE region central banks, and the Austrian government. The Vienna initiative was a win-win response so effective in restoring confidence and avoiding severe economic contraction and austerity in Central and Eastern Europe that by 2010, the ECFIN Country Focus Report for Poland was titled “The Polish Banking System: hit by the crisis or merely a cool breeze?”
About the Author: 
Max Berre is a financial-regulatory economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands. 

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