Portugal Won't Redeem The IMF As Early As Expected - That's Positive!

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Includes: PGAL
by: Ana Teresa Esteves

Summary

In the last weeks a lot of headlines were released about Portugal, with negative impact on the perception of financial markets;

In particular, the implementation of the bank bail-out directive in the concrete case of Novo Banco and Esprito Santo, contributed to a decrease confidence in the country.

The pace of reduction of early redemptions of debt to the IMF will provide the country with 6.7 bn EUR of extra cash and that’s positive.

Although financial markets are generally under stress, Portuguese ones are suffering even more. PSI20 index reached August 2012 crisis levels and in the last month, the government yield curve moved up, particularly in the longer segment, while most of its European peers have stayed stable. There are several reasons to explain the phenomenon.

First, uncertainty regarding the left wing government managing the country, which started its mandate by announcing several measures to boost domestic consumption. Lower taxes and de-freezing of civil servants wage cuts, on top of a long list of other initiatives due to be discussed, have been received with a pinch of salt by financial markets.

Second, the government program lacked disclosure of revenue and expense assumptions, in particular GDP growth assumptions, which are key to determine budget revenues and expenses as well as debt levels. This suggests that underlying GDP assumptions are overly optimistic and would likely reduce the credibility of the program if publicly released.

Third, the entity in charge of managing public debt, IGCP, revised up its estimate for financing needs in 2016 from 500 mn EUR in October 2015 to 7 200 mn EUR in January 2016, mostly to be funded in financial markets. Financial markets based funding, taking into account maturing debt and other events, is likely to reach 20 000 mn EUR this year.

Fourth, in conjunction with the revision of financing needs, the general budget balance assumption for 2016 presented by IGCP in the debt management program update moved up from a deficit of 1.8% in October 2015 to a deficit of 2.8% in January 2016. While in October, the projection for the primary budget balance expected in 2016 was a surplus of 2.6%, in January's presentation this relevant information was not disclosed.

Fifth, there was another bank failure in Portugal which led to the seventh largest bank fire sale to Santander (OTCPK:BCDRF), at very attractive prices from the buyers' perspective, and with large costs for the country - 2.255 mn EUR at least. Even if this money will not be accounted under "Excessive Deficit Procedures" by European partners, it will have to be funded, and that will contribute to increase total debt and delay a faster path to convergence with fiscal policy targets.

Sixth, the Bank of Portugal, decided to transfer 1.985 mn EUR of bonds from Novo Banco (NB) back to the original and failed issuer, Banco Espírito Santo (OTCPK:BKESY), arguing that NB, the good bank that emerged from BES bankruptcy back in 2014, was still suffering the consequences of such failure in its current activity.

The move is consistent with the new bail-in regulatory framework for insolvent banks, which started in full force in the European Union on 1 January, 2016 and which aims to resolve the lack of adequate tools in the European Union to deal effectively with unsound or failing credit institutions by calling creditors to support the losses instead of placing the burden on the taxpayer.

The problem is that the move also breaks the pari passu bond clause that states all creditors with the same seniority rank equally and therefore should get equal treatment in case of default. With the transfer of the bonds, it is arguable, correctly, that senior bondholders of the bonds transferred will be in a different position and will have a different treatment from the bondholders of senior bonds also issued by BES but staying at Novo Banco. The press is suggesting that the Portuguese Resolution Fund may support part of bondholders' losses, but there is no factual evidence of that.

The matter is being closely followed by the press and the Bank of Portugal's decision is raising uncertainty due to several discussions in place: about if this will create an event of default, about if the new bail-in regulatory framework conflicts with established bond market clauses, about the legitimacy of the actions and about the track-record it creates in financial markets. ISDA and international investors are analyzing the issue.

Seventh, well known exposure of Portugal to relevant export markets like Angola and Brazil, which are in dire straits at the moment due to low commodity prices, could be negative for economic performance as exports slow. In addition, with the government taking measures to stimulate domestic consumption imports are likely to grow faster, having a double negative effect in the external sector's contribution to GDP growth.

Eighth, IGCP announced on Tuesday that in this environment it will not be able to pay debt to the IMF as much earlier than expected by the previous government (Portugal is paying debt to the IMF ahead of schedule). Payments in 2016 will be reduced from a previous estimate of 10 000 mn EUR to 3 300 mn EUR. Future payments were also revised down.

At this point I don't know who is contributing more to increase financial markets' risk perception about the country - the government or the Bank of Portugal - but one must admit that the withdrawal of the plan to decrease the pace of early repayments to the IMF was a good decision. Only in 2016, 6 700 mn EUR will be freed and the amount will be sufficient to absorb current losses related to the financial system bailout, amounting 2.3 bn EUR and pay a budget deficit slightly over 5 bn EUR.

Although this contributes to increase market risk perception about the country and will cut a degree of freedom in public debt management, the fact is that the country needs this amount due to bank failures and an expansionary fiscal policy.

In general, the government's economic policy that materialized so far is a stimulus for domestic consumption while ignoring corporate investment and underestimating the negative impact of imports in the external balance. In the current environment of low oil prices, there is already a material stimulus to consumption in place, and in my view the corporate sector needs more attention than individuals, particularly in a time when Portugal's main export partners (which contrary to common sense are not Brazil nor Angola, but Germany, France and Spain) have solid economic growth perspectives ahead.

The noise related to NB/BES bond transfer is likely to continue causing much uncertainty until a clarification about bondholders' treatment is issued. Depending on the conclusion of the process this could be positive or negative for the Portuguese economy and markets. However, at least the recent financial failures are softened by the IMF's pillow.

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