Sunday, July 13, 2014

Focus on Portugal

Concerns about the financial stability of the parent of one of Portugal's largest banks emerged last week.  Markets wobbled as fears rose about this being a sign of problems at other Eurozone banks.  That's too soon to tell but this latest event highlights the risk of complacency about the financial stability of the Eurozone and its banking sector in particular.

I've warned about this on numerous occasions, but promise not to say I told you so.  The challenge is the significant and ongoing private deleveraging that is playing out across the Eurozone in a low growth environment.  Until that process is complete there is the risk of the occasional wobble especially in economy's such as Portugal with still high levels of non-financial corporate debt.

That said, the risks of a return to the deepest darkest days of the Eurozone debt crisis are unlikely.  While I think complacency has been too high, significant progress has been made in restoring public finances and economic growth in many of the problem member countries.

Portugal itself has been doing an outstanding job.  The economy is growing on the back of gains in export competitiveness, private savings are rising and public finances have been restored so that a primary budget surplus is expected this year.  The economy is thus on a far firmer footing than it was during the depths of the crisis and is now in a better position to withstand shocks.

Such has been Portugal's success that it recently exited its bailout program, having met the harsh conditions set by the troika of the IMF, European Commission and the European Central Bank.  That means it no longer automatically qualifies for support through the Outright Monetary Transactions (OMT) program.  However, should push come to shove, the ECB's commitment to do whatever it takes to save the Euro will come to the rescue.  Portugal will not be penalised for having successfully met the troika's demands.

I expect this event, which followed an earlier profit downgrade from one of Austria's banks, will put renewed focus on the ECB's banks stress tests later this year.  Watch this space.