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2013 Whos Next in Line

2013 Whos Next in Line

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Published by zerohedge
2013 Whos Next in Line
2013 Whos Next in Line

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Published by: zerohedge on Apr 11, 2013
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11 April 2013
Who’s next in line in the eurozone crisis?
Portugal and Slovenia are the prime candidates
Key points
Both Portugal and Slovenia could need external assistance of somesort.
Portugal
Domestic demand, government spending and investmentare contracting sharply, leaving the country heavily reliant onuncertain export growth to drive the economy.
By cutting wages and costs at home (internal devaluation),Portugal has in recent years improved its level of competitiveness in the eurozone relative to Germany.However, this trend actually started to reverse sharply in 2012, meaning that thedivergence between countries such as Portugal and Germany has begun growingagain
 –
exactly the sort of imbalance the eurozone is seeking to close.
In its austerity efforts, Portugal is now coming up against serious political andconstitutional limits. For the second time, the
country’s constitutional
court has ruledagainst public sector wage cuts
 –
 
a key plank in the country’s EU
-mandated austerityplan
 –
while the previous political consensus in the parliament for austerity hasevaporated.
In combination, it will be increasingly difficult for Portugal to sell austerity at homeand consequently to negotiate its bailout terms with creditor countries abroad.
 
Portugal may well need some further financial assistance before long. It is unlikely to
take the form of a full second bailout, but could involve use of the ECB’s OMT,
assuming Portugal can return to the markets fully beforehand (even briefly).
 Slovenia
Slovenia is not Cyprus
 –
in fact it is much more like Spain. Its banks are significantlyundercapitalised with toxic loans now standing at 18% of GDP. Banks only haveprovisions to cover less than half the potential losses resulting from these loans.
At the same time, a heavily indebted private sector is now desperately trying to getdebt off its books, which alongside continued austerity and lack of investment, havecaused growth to plummet.
Though a full bailout is unlikely, the country could soon need an EU rescue package
worth between €1 billion and €4 billion (between 3% and 11% of GDP) to helprestructure the country’s bust and mismanaged banks.
Such a plan is likely to include losses for shareholder (bail-ins) but, unlike in Cyprus,it may not hit large (uninsured) depositors and there will be no attempt whatsoever attaxing smaller (insured) depositors.The troubles in Cyprus have set off a new examination of the health of the eurozone, with aparticular focus on which country might be next in line for a bailout and the extent to whichshareholders and depositors will take losses when banks fail (bail-ins). Much of the attentionhas settled on two countries. Portugal, which has been propelled back into the headlines,with the co
untry’s
constitutional court recently ruling against some of the government
’s EU
-mandated budget cuts. Secondly, Slovenia, which is facing a massive banking crisis, in turnproviding
another potential testing ground for the eurozone’s vaguely defined ‘bail
-
in’ plans.
Below we provide a quick rundown of the key points to watch in each country.
For more information, pleasecontact the office on0044 (0)207 197 2333,or Raoul Ruparel on0044 (0)757 6965823www.openeurope.org.ukFollow us on Twitter 
 
Portugal
 –
The forgotten man of the eurozone?
Over the past year, Portugal has avoided the spotlight of the eurozone crisis and been left tocontinue its programme of cuts and reforms with relatively little market scrutiny. However,last
week the country’s
Constitutional Court sparked jitters across Europe, by ruling againstsome of the government
’s
budget cuts. This
has put Portugal’s ability to fulfil the
conditionsattached to its bailout in doubt. Complicating matters, Portugal is currently locked in talkswith its creditors, including Germany and the IMF, to extend the maturity of its bailout loans(which would give Portugal some much needed breathing space). If Lisbon is seen as failingto deliver its promised cuts, creditors are unlikely to grant it this extension. Fundamentally,as so often in this crisis, the eurozone is now coming up against the full force of nationaldemocracy.
What are the main risks to watch in Portugal?
1) Overreliance on fragile export-led growth
Source: Eurostat 
 As Graph 1 above shows, domestic demand has declined sharply and is set to continuedoing so over the next few years
 –
partly due to the private sector trying to get debt off itsbooks, and a lack of credit in the economy. Although household deposits have held up wellduring the crisis, non-financial corporation deposits have fallen 20% in the past year, withfirms depleting cash reserves. With the government also cutting spending, the only avenuefor growth will come from exports.Fortunately, Portuguese exports have performed well over the past few years, but it cannotbe taken for granted that they will continue to do so. In particular, the deeper and longer recession in the wider eurozone will reduce demand for Portuguese goods and services,having a negative knock-on effect. Furthermore, exports represent a much smaller share of GDP than domestic demand or government spending, meaning that even strong growth inexports cannot indefinitely fill in for collapsing domestic demand. Unlike many other eurozone countries, Portugal has already experienced a
lost decade
since it joined the euro
 –
even Italy was more economically dynamic. With government debt set to peak at 124% of GDP in 2014 and political uncertainty growing it cannot afford to be locked into low growthfor a sustained period.
 
90951001051101150510152025303540451999200020012002200320042005200620072008200920102011201220132014
Graph 1: Contributions to GDP in Portugal (% GDP)
Exports (lhs)Domestic demand (rhs)
 
External debt also remains very high at 300% of GDP, even with the substantial cut in thecurrent account deficit. Out of the struggling eurozone countries, only Ireland has a worse
external debt position, although Portugal’s net in
ternational investment position is worseeven than that of Ireland (at 105% of GDP in 2011).
1
These factors mean that a change in
sentiment abroad regarding Portugal’s economic future could seriously hamper debt
sustainability, while they also highlight that assets will continue to be transferred abroad.This would be less of an issue if the debt built up had helped promote productive investment,but Portugal has been stuck with low growth for some time and much of the investmentseems to have artificially boosted wages and standards of living.
2
 In addition, in order to have any chance of sustained export growth Portugal must massivelyimprove its competitiveness
 –
stuck with an overvalued currency in the euro this must comefrom internal devaluation.
2) Improvements in competitiveness have stalled 
Source: Eurostat and Open Europe calculations
Despite some positive steps up to the first quarter of 2012 there has been far too littleimprovement in the cost competitiveness of Portugal. Unit labour costs
 –
a keymeasurement for the relative competitiveness of a country inside the eurozone
 –
indicatethat
Portugal’s level of competitiveness is now starting to fall once again. In other words, the
divergence between Germany and Portugal is again increasing. The dotted line shows the
path which Portugal’s unit labour co
sts should have taken, in order to make its position in the
1
The net international investment position of a country is the difference between its total financial assets abroad
and its total financial liabilities to foreign investors (both public and private). In Portugal’s case the liabilities
significantly outweigh the assets. This not only means that money will continually be flowing away from thecountry due to interest and profits on these investments but also that any swing in the sentiment of theseinvestors could increase pressure on Portugal, particularly through borrowing costs.
2
 
For an example of a more detailed discussion of this problem, see ‘The PIGS’ external debt problem’, posted on
Vox 
 
9095100105110115120125130135140
     1     9     9     9     Q     1     1     9     9     9     Q     3     2     0     0     0     Q     1     2     0     0     0     Q     3     2     0     0     1     Q     1     2     0     0     1     Q     3     2     0     0     2     Q     1     2     0     0     2     Q     3     2     0     0     3     Q     1     2     0     0     3     Q     3     2     0     0     4     Q     1     2     0     0     4     Q     3     2     0     0     5     Q     1     2     0     0     5     Q     3     2     0     0     6     Q     1     2     0     0     6     Q     3     2     0     0     7     Q     1     2     0     0     7     Q     3     2     0     0     8     Q     1     2     0     0     8     Q     3     2     0     0     9     Q     1     2     0     0     9     Q     3     2     0     1     0     Q     1     2     0     1     0     Q     3     2     0     1     1     Q     1     2     0     1     1     Q     3     2     0     1     2     Q     1     2     0     1     2     Q     3
Graph 2: Unit labour costs (1999Q1 = 100)
PortugalGermanyPortugal (required adjustment)

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