“Monetary policy responsibility cannot substitute for government irresponsibility.” So said Jean-Claude Trichet in a speech on January 7. Few would probably disagree with that statement, at least initially. But doubts and dissent may arise about whether the European Central Bank (ECB) should cut its financial support for Portugal and force it into the arms of the International Monetary Fund and European Financial Stabilization Facility (IMF-EFSF).
Like Ireland, Portugal faces a choice—not whether to accept a bailout but rather from whom to take the help, along with whatever conditionality the outside assistance comes. Like Dublin in November 2010, Lisbon today is already on the “ECB payroll” and protestations of Portuguese politicians that “we can do without a bailout” belong in the satirical political theater category.
In November (latest data), Portuguese banks relied on the ECB for about €40 billion in liquidity support (still at about a quarter of GDP, which is much below Ireland’s 80 percent of GDP on the eve of its November 2010 bailout). In addition, reasonable estimates of ECB purchases of Portuguese government securities through the Securities Market Program1 (SMP) and similar collateral holdings2 easily run into the tens of billions of euros. Since a standard estimate of the required size of an actual IMF program would be three years’ worth of government refinancing—in Portugal this comes to about €73 billion from 2011–133—it is not unreasonable to argue that Portugal is already benefitting from various types of ECB financial support of a magnitude that begins to approach an actual IMF program.
Portugal, however, is blatantly reneging on its part of the deal with the ECB from May 2010, which called for the “additional commitments taken by some euro area governments to accelerate fiscal consolidation and ensure the sustainability of their public finances.” It has a high, but not outrageous, existing government debt burden (83 percent of GDP in 2010), a highly indebted private sector, and an atrocious economic growth record in the euro era. Indeed, like the economy of Greece, the Portuguese economy needs revolutionary structural reforms to improve its growth and competitiveness outlook.4 In contrast to the reform performance of other countries in the region, the Portuguese government has not responded with the policy resolve required to assure financial markets. Next to no meaningful structural reforms of labor and product markets have been announced since May 2010. Even worse, the Portuguese government’s budget consolidation strategy relies on the kind of accounting gimmicks that the Greek crisis ought to have put an end to.
Incredibly, given the focus on Greek budget data shenanigans resulting from the crisis, the Portuguese government intends to meet its budget consolidation targets by transferring the pension funds of Portugal Telecom to the Portuguese state, and book the €2.8 billion (1.6 percent of 2010 GDP) as revenues right away, while showing no increase in general government liabilities.5 This is a time-tested type of “government accounting standards arbitrage” transaction—the kind perpetrated by the French government and its part-privatized electricity incumbent Electricité de France (EDF) in the early 2000s.6 It should not be the role of a responsible ECB to subsidize such behavior by a eurozone government without conditions in 2011.
Instead, the Portuguese government must be forced to seek its financial support—with full conditionality attached—from the IMF-EFSF.
Obviously, for political reasons, the ECB cannot publicly ostracize Portugal and reprimand elected Portuguese officials. Instead, the governing board should immediately stop any purchases of Portuguese debt through the SMP, while signaling its intent to remain active in other peripheral government debt markets. If this gentle “nudge” proves insufficient, the ECB governing board should escalate and—like the Swiss Central Bank—proceed to exclude Portuguese government bonds from the list of accepted collateral in credit operations.7 Without ongoing ECB support in the markets, it looks unlikely for Portugal to raise the required debt financing in the markets at sustainable interest rates in the first quarter of 2011.
As a supranational European central bank, the ECB is in a unique position to force reluctant eurozone politicians to act expeditiously, without fear of attempts to bully it by various individual governments, as Hungary has tried to do with its (still) national central bank. Having independently decided to provide eurozone peripherals with a liquidity lifeline, the ECB governing board should seize the moment to use that financial support and their independence as a coercive tool to promote reforms.
A Portuguese IMF-EFSF program could be implemented through the use of existing European and IMF facilities, with the eurozone-only EFSF likely to provide the biggest share of financing. Some participation of the EU-27-wide European Financial Stabilization Mechanism (EFSM) is also possible. Hence a Portuguese program would not require new initiatives in terms of EU-eurozone policymaking, but instead simply and expeditiously rely on the existing tool kit.
An expeditious Portuguese approach to the IMF-EFSF would moreover fit well into the broader eurozone agenda. It would roughly coincide with the announced new EU bank stress tests and—in combination with substantial new transparency on the financial state of the Spanish caja sector and pledges of government financial support from Madrid—serve to ease contagion risk and broader uncertainty about the fiscal sustainability of Spain in 2011.
By sitting on its hands and failing to implement reforms throughout 2010, the Portuguese government has its battle to restore credibility. Now it must be forced by the ECB—with the political assistance of the other eurozone countries behind closed doors8—to help Europe win the war and draw a line at the border with Spain.
1. Goldman Sachs. 2011. The EMU Sovereign Crisis, One Year On. Global Viewpoint (January 5).
2. Buiter et al. 2011. The Debt of Nations. Citi Global Economics View (January 7).
4. The list of required structural reforms is long and well known. See for instance the latest IMF Article IV report, [pdf] the most recent OECD Economic Survey, or the latest European Commission country recommendations for Portugal.[pdf]
6. See Baily and Kirkegaard (2009) appendix 7A for a detailed description of this transaction.
7. The ECB in its press statement on July 28, 2010, explicitly recalled “that, if required, the Eurosystem has the possibility to limit or exclude the use of certain assets as collateral in its credit operations, also at the level of individual counterparties.”
8. Demands that a country hand over fiscal and general sovereignty is best kept below the radar screen. Overt political pressure on a eurozone government to accept a bailout package could result in subsequent anti-European political sentiment in that country.