The Next Global Problem: Portugal

Peter Boone and Simon Johnson:

Next on the radar will be Portugal.  This nation has largely missed the spotlight, if only because Greece spiralled downwards.  But both are economically on the verge of bankruptcy, and they each look far more risky than Argentina did back in 2001 when it succumbed to default.

The main problem that Portugal faces, like Greece, Ireland and Spain, is that it is stuck with a highly overvalued exchange rate when it is in need of massive fiscal adjustment.  Portugal spent too much over the last several years, building its debt up to 78% of GDP at end 2009 (compared to Greece’s 114% of GDP and Argentina’s 62% of GDP at default).  The debt has been largely financed by foreigners, and as with Greece, the country has not paid interest outright, but instead refinances its interest payments each year by issuing new debt.  By 2012 Portugal’s debt-GDP ratio should reach 108% of GDP if they meet their planned budget deficit targets.  At some point financial markets will simply refuse to finance this Ponzi game.

To resolve its problems, Portugal needs major fiscal tightening.  For example, just to keep its debt stock constant and pay annual interest on debt at an optimistic 5% interest rate, the country would need to run a 5.4% of GDP primary surplus by 2012.  With a 5.2% GDP planned primary deficit this year, they need roughly 10% of GDP in fiscal tightening.  It is nearly impossible to do this in a fixed exchange rate regime – i.e., the eurozone – without massive unemployment.  The government can only expect several years of high unemployment and tough politics, even if they are to extract themselves from this mess.

Posted via email from Jim Nichols