Thoughts on Portugal's Package

Portugal's caretaker Prime Minister Socrates appears to have negotiated a better deal than Greece and Ireland.  The plan actually sanctions larger deficits that Socrates are pressed for, under pressure pressure from the EU and ECB when he was a minority government.  This is simply astounding.  

Less than two months ago, Socrates proposed additional savings measures that he projected would mean a 4.6% budget deficit this year.  The new plan allows for a 5.9% deficit.  Socrates proposed a 3% deficit in 2012.  The EU/IMF now says 4.5% is good enough.  Socrates had projected a 2% budget deficit for 2013 (apparently assuming the world survives the winter solstice of 2012 and the end of the Mayan calendar). The EU/IMF says 3% is fine.

Recall in late April, Eurostat reported that Portugal's budget deficit was really 9.1% not 8.6% of GDP due to how a few highways were accounted for.  Even that minimizes what really happened in 2010.   Socrates budget deficit target was 7.3%.  It was overshot by nearly 25%.  

The agreement does not appear to require dismissal of state workers or cuts in their pay.  Minimum wage need not be cut.  The state-owned savings bank need not be sold.  Consultation with the other political parties will begin now.  If the EU had not pressed for the earlier aggressive moves, Socrates would not be a caretaker prime minister.  

EU ministers seemed to blink.  When Portugal first signaled it would accept assistance, EU finance ministers insisted on ambitious fiscal adjustment and privatization program.  It is not what was delivered.  On one hand the plan seems more realistic.  On the other hand, it is not clear from what has been announced precisely where the savings of almost 3% of GDP are going to come from.  

Nevertheless, the market will likely find favor in the deal and there may be some additional consolidation of Portuguese bonds are the dramatic decline seen last month.  Yet since Portuguese developments did not seem to weigh on the euro, it is not clear that new developments will necessarily lead to the euro's rally.  

Still, the ECB meets Thursday and a Portugal package eases one potential, albeit minor, risk to ECB hawkishness.  Last week's higher than expected CPI reading has been followed by a stronger PMI reading, indicating another rate hike is likely.  The key issue in the market's mind, and one that will be resolved at Trichet's press conference after the ECB meeting is whether it hikes in June or July.