Ambrose Evans-Pritchard: Cyprus goes from bad to worse by the day; so does Portugal
The Telegraph, London
Friday, April 12, 2013
On cue, Angela Merkel's Christian Democrat base in the Bundestag has warned that there can be no increase in the EU-IMF rescue package for Cyprus.
The Cypriot people alone must carry the extra cost of up to E5.5 billion beyond what was already agreed in the E17.5 billion deal in March.
"Should that not be possible, the assent of the German Bundestag next week is out of the question," said Christian von Stetten, a key member of the finance committee.
"The escalating gap in funding is huge and confirms my doubts in the finance framework prepared by the Troika and the Republic of Cyprus. It is going the way of Greece. Ever more funding gaps keep coming to light," he said.
So we have a standoff yet again. Cypriot president Nicos Anastasiades says the country needs "extra assistance", and indeed it does since the extra demands on Cyprus are a further 28 percent of GDP.
If the eurozone refuses to offer any further help, there must surely be a greater temptation to withdraw from the euro and default on sovereign debt in a classic restructuring deal with the IMF.
That is what the IMF is there to do. Such restructurings have been done countless times across the world over the last 50 years. It is traumatic, but countries usually recover after a couple of years.
The crucial point for the Cypriot people is that the cost-benefit calculus is moving in that direction.
Whether they have understood this is another matter. They may in due course as the ghastly reality of Troika policy hits them.
And just to clarify, the reason why the rescue costs are shooting up is because the Troika has finally recognised that its treatment of Cyprus is pushing the economy over a cliff. The depressionary spiral itself is causing the numbers to spike.
So Cyprus is very far from being solved, and so is Portugal. A fresh Troika leak, this time to the Pink Sheet, has confirmed what anybody following Portugal already suspected. The country is stuck in a debt-compound trap. The economic slump is proving much deeper than forecast. The deficit has been rising not falling, in spite of austerity cuts.
Specifically, it will need to need to borrow E14.1 billion in 2014, and E15bn in 2015. This is 30 percent more than required when the crisis blew up in 2011. The average interest rate will be higher than it was then.
The leaked report said: "Portugal has the challenge of needing to finance more than pre-crisis albeit with a sub-investment grade rating. There is substantial funding risk for Portugal given that it is still subject to substantial vulnerabilities at the end of the programme."
"The task of issuing medium and long-term debt above what is already held by market participants might be very demanding without an improvement in Portugal's sub-investment grade rating and the build-up of a stable investor base."
In other words Portugal is in a deeper hole after its E78 billion bailout than it was before. Public debt will reach 124 percent of GDP this year. The "financing burden" will keep rising until 2017.
Which raises the question, what will Germany and the northern creditor states do if/ when it becomes undeniable that Portugal needs a second rescue?
They have given a solemn pledge (another one) that there will be no repeat of the "PSI" private haircut on sovereign debt that is deemed to have been a disaster in Greece. So they have three choices:
a) They violate their pledge and impose a Greek-style debt restructuring, destroying bond market confidence and risking contagion to Spain and Italy.
b) They take the money from Portuguese bank accounts, regardless of whether the banks have done anything wrong.
c) They pay for it themselves and acknowledge to their parliaments at long last that it costs real taxpayer money to hold EMU together.
I suppose there are other possibilities. They could try to bully the ECB into buying debt, but there are obvious limits to this. Germany's Jorg Asmussen has to agree.
There is of course great sympathy in Berlin, The Hague, and Helsinki for the free-market team of premier Pedro Passos Coelho. His drive for austerity has been nothing less than heroic.
However, there is less sympathy for him at home. The austerity consensus in the Assembleia has collapsed.
Ex-premier and elder statesman Mario Soares said this morning that all opposition parties on the left -- socialists, Bloco, communists -- should get together to "bring down" the government.
"In its eagerness to do the bidding of Senhora Merkel, they have sold everything and ruined this country. In two years this government has destroyed Portugal. We absolutely have to end this austerity," he said.
He also said to Antena 1 that Portugal will "never be able to pay its debts however much it impoverishes itself. If you can't pay, the only solution is not to pay."
"When Argentina was in crisis it didn't pay. Did anything happen? No, nothing happened," he said.
Raoul Ruparel from Open Europe said Portugal has now exhausted its "internal devaluation" policy. "Portugal's austerity programme is coming up against huge political and constitutional limits. The previous political consensus in parliament has evaporated. Fundamentally, as so often in this crisis, the eurozone is now coming up against the full force of national democracy."
The top court ruled a week ago that pay and pension cuts for public workers in Mr Passos Coelho's budget are illegal, driving a coach and horses through the government's whole strategy.
Exports are doing well but the country's trade gearing is too low (30 percent of GDP) to offset the violent contraction in internal demand. External debt is 300 percent of GDP. The International Investment Position is 105 percent of GDP in the red.
And let me close with this chart that Raoul has put together. It shows that the gap in unit labour costs with Germany is no longer closing. It is widening again:
As predicted by so many, the attempt to drive down wages in modern democracy is not only brutal but often impossible. What you gain from wage compression you lose from lagging productivity as investment collapses.
Did nobody ever explain this to them?