In Portugal Crisis, Worries on Europe’s ‘Debt Trap’

By STEVEN ERLANGER
PARIS — For the third time in a year the European Union is going through the same ritual, bailing out another insolvent country. Portugal now follows Greece and Ireland to the European welfare office to ask for new loans on the condition of ever more drastic spending cuts.

So far the markets have taken Europe’s third successive sovereign financial crisis in stride. But many economists are a good deal more alarmed, most notably because the bailout formula European leaders keep applying to their most indebted member nations shows no signs of working.

Greece, Ireland and now almost certainly Portugal have access to hundreds of billions of dollars in emergency European aid to help them avoid defaulting on their debt. But the aid is really just more loans, and the interest rates the countries are paying, if a little lower than what the private market would charge, are still crushingly high. Their pile of debt gets bigger with every passing day.

Moreover, the price of these loans has been a commitment to slash government spending far more drastically than domestic leaders would have the desire or the political power to accomplish on their own. And for countries that depend a good deal on government spending to generate growth, rapid decreases in spending have meant sustained economic stagnation or outright recession, making every dollar of debt that much harder to pay back.

Economists call this “the debt trap.” Escape from the trap generally requires devaluation of the currency, which cannot happen among countries that use the euro as their common currency, or strong economic growth, which none of the three have, or some kind of bankruptcy process, which all three forswear. Add to that the likelihood that all three countries will continue to have unstable governments until they figure a way out, and Europe’s financial crisis has no end in sight.

“What has been missing, in the debate about how countries can restore their finances to some kind of sustainability, is the limit of how much they can cut in a period of austerity,” said Simon Tilford, chief economist for the Center for European Reform in London. “There is a limit of how much any government can cut back spending and survive politically unless there is a light at the end of the tunnel, a route back to economic growth.”

The problems of the weaker countries are not just sovereign debt, but also lack of competitiveness, both in Europe and the larger world. Without the nations’ restoring competitiveness and selling more goods abroad, which can come only through a longer-term process of reducing wages and taxes to spur private sector investment, economists are not optimistic about prospects for new growth soon.

The crisis in Portugal also raises new questions about whether the European Union will come to grips with the other side of its crisis: the banks. Banks in well-off countries like Germany, France and the Netherlands, as well as Britain, hold a lot of Greek, Portuguese and Irish debt. And if these countries cannot pay their debts, they would have to reschedule them, reduce them or default, causing a major banking crisis in the rest of Europe.

That reckoning would require governments to ask their taxpayers to recapitalize the banks, which is exactly what political leaders are afraid to do.

“We have a banking crisis interwoven with a sovereign debt crisis,” Mr. Tilford said. “Europe needs to address both, and it needs to acknowledge that the banking sectors of creditor countries — especially Germany — are not now in a position to handle restructuring and default, and that governments will have to pump money into the banks to recapitalize them.”

In essence, Mr. Tilford said, it is the taxpayers of Greece, Ireland and Portugal who are bailing out German, French and British taxpayers and depositors — not the other way around. The indebted countries are not really getting bailouts, he said, “but loans at high interest rates.” For there to be a real bailout, he said, there would have to be a default.

António Nogueira Leite, a former Portuguese secretary of the treasury and an adviser to the center-right opposition, said that the bailout packages “don’t really take into account the arithmetic of the debt.” The experiences of Greece and Ireland show, he said, “that once austerity sets in, the country doesn’t generate the means to be able to pay for the already incurred debt.”

The Economist this week, in an article about Greece’s problems, said, “The international plan to rescue Greece is instead starting to paralyze it.”

Of course the indebted countries have responsibility for their own dire straits. Greece lied about its statistics, Ireland decided to guarantee the enormous debts of its reckless banking sector and Portugal borrowed cheap money but did not restructure its economy. Still, Mr. Nogueira Leite said, “If you can’t devalue, and you say no restructuring of the debt, and say that the taxpayers of Germany must receive a risk premium in interest to loan to the peripheral countries, then it’s impossible to avoid the debt trap.”

Portugal is not in a great position to bargain, he said, but “we must fight to get as low an interest rate as possible, so we don’t end up like Greece and Ireland.”

Portugal’s decision to seek a bailout from the European Union was hardly unexpected, and funds had already been set aside to cover its needs. But the decision is also a marker about the political costs of austerity.

Portugal went to the European Union after the opposition refused to support the minority government’s fourth austerity package, and the government of José Sócrates, the Socialist prime minister, finally fell. Portuguese bankers also made it clear that they would no longer keep buying up Portuguese government debt, which was approaching junk status, even if they could offload it to the European Central Bank.

“The government had a cash problem, but was just kicking the can down the road,” said Ricardo Costa, deputy editor of the weekly newspaper Expresso.

He said that when the European Union failed to agree on more flexible measures to aid countries like Portugal — blocked in February by Germany and Finland — Mr. Sócrates “was alone against the markets.” Elections in June are likely to bring the center-right Social Democrats to power in a coalition.

They accept the need for cuts, but how they react to the bailout deal Mr. Sócrates will have to negotiate before then is complicated, Mr. Costa said.

Portuguese efforts to get a small “bridging loan” to get the country through the elections failed because the European Union has no such practice and no country would give a bilateral loan. So on Friday, in Hungary, European finance ministers said they would begin negotiations, together with the International Monetary Fund, for a roughly 80-billion-euro rescue package for Portugal with all political parties.

“If the opposition signs the package before elections, voters will say, ‘You’re the same, raising taxes, closing schools,”‘ Mr. Costa said.

“But our main problem is that we’re not growing enough; actually we’re not growing at all,” he said. “And if we don’t grow, we won’t get out of this problem in a decade.”

There are also fears about Spain, one of the largest economies in the euro zone, which has problems with bank debt, unemployment and bad mortgages that are still on the books after the construction bubble burst. If Spain needs a bailout, the euro will be in deep trouble because the rescue fund, the European Financial Stability Facility, is not big enough. On Friday, European officials insisted that the Portuguese bailout would reduce the risk to Spain.

The Spanish government has worked hard to pacify the markets by cutting spending, but its economy must also grow to convince markets that it can handle its debt. The austerity program already in place has made the Socialist prime minister, José Luis Rodríguez Zapatero, and his party so unpopular that he announced this week that he would not run again.


Stephen Castle contributed reporting from Brussels.