When Will Portugal Ask for Assistance

Portugal will be selling 750 mln to 1 bln euro of 2 1/2 year bonds on Wednesday. It will be the first bond offering since the syndicated offering in mid-Feb. It has been trying to buy back bonds that expire this year, but these have generally seen lukewarm interest. Portugal is trying to raise funds not only to cover this year's deficit, but it also faces a 5 bln euro maturities in April and another 5 bln in June (and roughly 2 bln in coupon payments). It has already raised about 6 bln euros.

The problem is that foreign investors have been net sellers of Portuguese bonds. Today the on the run 10-year yield hit a EMU-era high. Most of last year's issuance was absorbed by domestic financial institutions, which historically were not large holders. Some estimates suggest that the ECB purchases have essentially covered the foreign selling, but ECB purchases are not transparent or detailed, making it difficult to know what it actually has purchased.

Today is the 22nd consecutive session that Portugal's generic 10-year yield has held above the 7% threshold, which is longer than Greece or Ireland did before seeking aid. The Portuguese government says that the overall interest rate on its debt is 3.5%. This would confirm the country's ability to withstand market yields a bit longer, but not indefinitely.

Portugal's challenges are different than Greece and Ireland and it does not neatly fit into the fiscal profligacy narrative. Portugal's debt to GDP was about 63% before the crisis. This compares with about 65% for Germany. The crisis caused the debt levels to balloon and Portugal's debt stood at about 83% of GDP at the end of last year. Portugal's budget deficit was about 7.3% of GDP last year, but was below 3% in 2007 and 2008 before the crisis hit.

Portugal does not appear to have had the boom that Ireland and Spain had. Portugal's problem is the chronic grind loss of competitiveness due to high costs and low productivity. We note that Portugal's latest inflation reading of 3.6% in January is among the highest in the euro zone, suggesting it continues to lose competitiveness. At about 10.2% of GDP in 2010, Portugal's current account deficit was among the largest in the euro zone.

Meanwhile, Portuguese banks continue to borrow around 25% of GDP from the ECB. In fact, February was the third consecutive month that Portuguese bank borrowing from the ECB increased. February borrowings were 41.1 bln euros, up slightly from January. The peak was last August just above 49 bln euros. Ironically, nearly all of Portugal's large banks have reportedly claimed to have been reducing their reliance on the ECB.

Portugal, like Ireland and Greece, will deny intentions to ask for assistance until the moment they do ask. One key difference for Portugal is that it has seen the failure of the aid programs to really address the crisis and bring down interest rates, or even stabilize them. Our best guess is that Portugal was receive an aid package as part of the "comprehensive plan" to be finalized at the March 24-25 European Summit.