What happens to Portugal and Ireland if Greece reprofiles/restructures?
June 13, 2011 3 Comments
There is currently a debate raging about how exactly private investors will be involved in a Greek debt reprofiling in order to secure a second bail-out for the government. I wrote in a blog post last week that I think Greek debt will probably be rolled over as demanded by the European Central Bank (ECB). If Greece reprofiles or restructures its debt, would the same be inevitable in the other two insolvent euro area countries, Portugal and Ireland?
I do not think a Greek debt reprofiling or restructuring would necessarily lead to one in Portugal and Ireland, though it might if either country were to opt for a strategic default.
If Greece were to reprofile or restructure its debt, the markets would immediately ask who is next. The clear answer to this is Portugal given its high deficit and debt levels, rigid economy and extremely poor growth prospects. However, it would make less sense for the EU, the ECB and the IMF (the so-called troika) to support a debt reprofiling or restructuring in Portugal than in Greece for a number of reasons. First, Portugal just held a general election on June 5th in which the main opposition centre-right Social Democrats (PSD) won a decisive victory. A PSD/People’s Party coalition government is likely to emerge and may bring more energy to fiscal austerity and structural reform than the previous minority Socialist government. Second, while Greece has had a full year to make progress on the demands made by the troika in exchange for an EU/IMF bailout, the new government will only begin implementing the terms of Portugal’s bailout when it takes office in a few weeks’ time. The troika is therefore likely to wait to give Portugal some time to hit the targets set out for the new government before allowing a reprofiling or restructuring of debt to take place.
A restructuring or reprofiling of Greek debt may also not trigger one in Ireland. While there would be some market disruption from a credit event in Greece, there would likely be some market differentiation between Greece and Ireland. The former has missed nearly all of its deficit reduction and structural reform implementation targets in the past year, whereas Ireland has hit most of the targets stipulated in its bailout programme. Furthermore, most Greek debt is held by Greek banks, pension funds and insurance funds. A reprofiling or restructuring of Greek debt would therefore mainly impact the domestic economy. In Ireland, on the other hand, it is mostly foreign banks that are exposed to Irish bank debt. Consequently, Ireland would likely be placed under significantly more pressure from the troika to avoid a debt restructuring or reprofiling.
There is a chance, however, that Portugal or Ireland could opt for a strategic default. This would involve either government deciding that, while it could continue along a path of austerity and reform, it would rather avoid the pain, default, clear the deck and return to growth. This is a far more likely scenario for Ireland than for Portugal. If Portugal were to reprofile or restructure its debt, it still would not have implemented any of the necessary structural reforms to return the country to a path of sustainable growth. This is not the case for Ireland, which has already implemented many of the structural reforms that Greece and Portugal are only beginning to address. Furthermore, Ireland benefits from a highly skilled labour force, flexible product and labour markets and a vibrant export sector. The Irish government may also be motivated to undergo a strategic default because of its debt profile. If most of Irish bank debt is held abroad, then the government could be incentivised to burn bondholders and let other countries take the pain.