Saturday, November 14, 2015

14/11/15: My Comment on Portuguese Political Crisis

Two comments from myself on the topic of Portugal's political crisis effect on country macroeconomic and fiscal positioning: and

Full comment in English:

Do you think the financial markets and the debt agencies will move its focus from Greece to Portugal now and later on for Spain near or after theDecember 20 elections?

The latest euro area ‘periphery’ political crisis - the collapse of the Centre-Right Government in Portugal - sets the stage for a potential replay of the logistics of the Greek crisis of Summer 2015 scenario.

Both the markets and European leadership are likely to present the crisis as an isolated event, linked to the lack of ‘programme ownership’ in Portugal and not indicative of the broader political and policy trends across the EU. In other words, all official players in the sovereign debt markets will attempt to paint Portuguese situation as a ‘one-off’ event with no risk of contagion to other member states. As a result, rating agencies’ downgrades can be expected only if the crisis persists or if the new Government includes the elements of what is perceived to be ‘extreme Left’. At the same time, the rhetoric surrounding political crisis will be shifted into the discussion of domestic failures and the allegedly destructive role of populist politics. The key to this approach is the clear desire by the European leaders to contain the spread of political opportunism and limit the extent to which democratic politics can transmit public anger and dissatisfaction with post-crisis recovery from one ‘peripheral’ state to another, namely from Portugal to Spain and Italy, as well as, potentially, to Ireland which is likely to face elections in the first quarter of 2016. There are strong incentives for European authorities to send a warning message to Spanish electorate and political elites before December 20th elections, albeit it is difficult to see how such a warning can be structured in the case of Portugal. In my view, we are likely to see renewed talks about Portugal’s compliance with fiscal harmonisation rules and, potentially, a warning concerning the risk of the country running excessive deficits in 2016-2017 on foot of political realignment.

How do you evaluate the present risk of Portugal regarding the debt sovereign market? Yields will go for new highs in 2015?

Currently, CDS markets are pricing in 15.5% chance of sovereign default (under ISDA2003 rules) for Portugal, up on 14.5% a week ago, compared to 3.5% for Ireland, down from 3.8% a week ago. The trend to-date suggests some increased pressure on sovereign risk position for Portugal that has been priced in since the appointment of the Centre-Right Government and this is consistent with a view that relatively sharp increases in government debt yields represent possible overshooting of risk valuations. Two critical aspects of the crisis in the context of debt sustainability view are: how long the new political impasse will last and what signals a new Cabinet will send after appointment. If the crisis continues over a relatively prolonged period of time (more than a week) and /or if the new Cabinet is slow in clearly defining its position vis-a-vis the European policy direction toward sustained fiscal and structural reforms, bond yields are likely to continue rising, putting pressure on Portugal’s access to new funding. Absent significant worsening of the political crisis, Portugal’s debt sustainability dynamics are likely to remain hostages to economic fundamentals: the rate and the nature of economic growth over 2015-2016, rather than to political risks.

Most likely, given the degrees of uncertainty relating to the political nature of the latest crisis, DBRS will take a ‘wait-and-see’ position, issuing negative watch warning on its ratings, but staying out of moving for an outright downgrade this time around. However, the risk of the downgrade remains significant and the impact of such a downgrade can also be material. Given that all major rating agencies have already downgraded Portugal Sovereign ratings, a DBRS downgrade will force the ECB to either halt purchases of Portuguese bonds in its QE programme or to issue a waver for eligibility criteria. In the former case, pressures on sovereign yields are likely to be severe making new issuance of debt much more costly proposition.

Note: DBRS did take a 'wait-and-see' position on Friday (see here)

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