Euro on the brink - Scott Appleton

Another bailout for Greece brings a reprieve, but the plight of Italy, Ireland and Portugal has the potential to push Europe and the global financial system further into turmoil. The consequences, should Spain catch the contagion, are unthinkable.

The latest bailout for Greece in July may have earned temporary respite for the Eurozone. But, the bailout of Portugal earlier in the summer by the ‘troika’ of the European Union (EU), European Community Bank (ECB) and IMF (International Monetary Fund) may not be a cause for celebration though it has brought some certainty to the country’s finances, say lawyers in Lisbon.

Following Greece and Ireland, Portugal became the third eurozone country to seek a financial rescue package since the onset of the global financial crisis in 2007. The country’s newly elected centre-right government led by Prime Minister Pedro Passos Coelho is working on the implementation of a three-year programme that will see funds worth €78bn committed to the country.

A Memorandum of Understanding (Memorandum) drafted by the EU, ECB and IMF was agreed by all Portugal’s major political parties ahead of the Parliamentary elections on 5 June, although the detail surrounding the implementation of the proposals has yet to be fully revealed.

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‘Many of the remedial measures included in the Memorandum were previously contemplated but had always proved politically unattractive,’ says Manuel Santos Vítor, Deputy Managing Partner of PLMJ, Portugal’s largest law firm. ‘We had reached a point where the domestic banks were unable to add further liquidity to the market and had stopped buying government debt, which itself had begun having trouble paying its own bills.’

Lawyers in Lisbon insist however that Portugal’s troubles are neither the result of over-stated public finances nor a systemic banking failure, as was the case with Greece and Ireland respectively, but instead a lack of fiscal efficiency, competitiveness and fundamentally an inability to reduce public spending.

‘Portugal is not facing structural difficulties but we must restructure our debts. A bailout is not desirable but what it may finally provide is certainty to business, the capital markets and international investors,’ says Diogo Leónidas Rocha, corporate Partner with Garrigues in Lisbon, which is advising the IMF.



For too long, Portugal has been a minor player in a massive financial upheaval, believe many. Portugal’s national debt currently stands at around 83 per cent of GDP, although the budget deficit has fallen from 9.3 per cent of GDP in 2009 to 7.3 per cent in 2010, albeit with the domestic economy expected to shrink by up to two per cent this year.

A formal bailout request was made on 6 April shortly after the resignation of the former Socialist Prime Minister José Sócrates after a failure to win parliamentary support for a fourth austerity budget. At the time, yields on Government bonds had hit a record 7.7 per cent on ten-year issues and 8.2 per cent for five-year issues with Portugal needing to refinance an estimated €4.5bn of bonds later that month.

The troika has therefore made the ‘difficult’ decisions that Portuguese politicians had been previously afraid or unwilling to commit to. Funds will however only be released once the government meets the milestone targets set out in the Memorandum, which proposes far more than a quick fix to Portugal’s economic problems. It sets out economic and legal reforms that will have a deep impact including a requirement for the government to privatise a number of major Portuguese companies, to sell its ‘golden shares’ in companies such as Portugal Telecom, recapitalise and restructure the banking system, renegotiate public works projects, change aspects of the tax, court and labour law systems, and reduce regional budgets. 

The deficit must drop to 5.9 per cent in 2011, 4.5 per cent in 2012 and three per cent in 2013 to increase efficiency and national competitiveness. Targets have been set to reduce public spending on schools and healthcare and a proposed freeze on public sector pay and pensions until 2013, as well as a special tax on pensions over €1,500 a month. There are also proposals to reduce corporate tax and increase VAT and excise taxes.  

‘As a small and peripheral eurozone economy we cannot help but be tossed about in the storm,’ says Francisco Sá Carneiro, partner with leading Lisbon banking and corporate firm Campos Ferreira Sá Carneiro & Associados.

Significant will be the way the government implements the planned privatisations, say lawyers. The airports operator ANA (Aeroportos de Portugal) and state airline TAP are scheduled for sale. In the energy sector, the government’s preference and other holdings in companies such as Galp, EdP and REN are also to be sold, while there exists the potential to review existing renewable energy feed-in tariffs. Much of this is expected to happen by the end of the year.

The Portuguese Government had already announced the cancellation or delay of major infrastructure spending – meaning no new Lisbon airport or third bridge over the River Tagus – but the Memorandum  stipulates a moratorium on any new public-private partnerships (PPPs) and a reassessment and potential renegotiation of the 20 most significant ongoing PPP and concession agreements.

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Financial preservation


A key aim of the Memorandum is to ‘preserve financial sector stability, maintain liquidity and support a balanced and orderly deleveraging of the banking sector’. Portuguese banks had until the end of June 2011 to present medium-term funding plans, while the Bank of Portugal will impose a nine per cent tier one capital ratio by the end of the year, rising to ten per cent in 2012.

Up to €12bn will be made available to recapitalise banks as part of a €35bn issue of government backed bonds – although any institutions benefitting from equity injections will need to meet specific management commitments, following a general rise in regulatory scrutiny and stress testing. Nationalised Banco Português de Negócios must be sold without a minimum price, and state-owned Caixa Geral de Depósitos is to be streamlined – through the sale of its insurance arm and non-subsidiary operations, and a potential reduction of international operations.


A bailout is not desirable but what it may finally provide is certainty to business, the capital markets and international investors
Diogo Leónidas Rocha


But liquidity concerns extend well beyond Portugal’s own banks. Spanish Government officials may remain confident that there is little risk of economic contagion but there are concerns over how the bailout will affect Spanish investors and businesses with interests in the country. As the biggest foreign investor in Portugal, Spanish banks and businesses have the most to gain or lose from the plans.

‘Many investors can afford to remain clear of Portugal but for Spain the country remains strategically important, in order for businesses to expand their regional footprint and to open up further new market opportunities internationally,’ says Jorge Santiago Neves, a Lisbon-based partner with one of Spain’s largest firms Gómez-Acebo & Pombo.

A number of foreign banks have already begun to limit their exposure to both the shrinking Portuguese economy and the tougher regulatory requirements of the bailout package, including potentially restructuring their operations as local branches rather than distinct Portuguese entities. Such a move would enable them to draw on the capital ratios of the parent bank and to avoid the need to raise extra local liquidity in Portugal. Foreign banks are now seeing increased deposits as Portuguese savers move away from the perceived more vulnerable domestic banks.

‘After the elections we have begun to see businesses implement the moves required to either safeguard their interests or look to capitalise on the new opportunities presented in Portugal. We already see international investors monitoring events but no-one wants to commit until there is certainty as to what lies ahead,’ says Santiago Neves at Gómez-Acebo & Pombo.


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Portugal’s financial assistance package is intended in part to act as a ‘firewall’ to prevent contagion of the Spanish economy, the fourth largest in the eurozone. If it went into default it might call into question the stability of the entire eurozone, believe many. At the end of 2010, Spain’s public debt to GDP ratio stood around 60 per cent, with a public deficit comparable to Portugal at 9.1 per cent, albeit but with the highest unemployment rate in the EU at 21 per cent.

Lawyers admit that there remains investor uncertainty over the future direction of the Spanish economy, but nearly all insist that it remains fundamentally sound. Events in Portugal may be distressing but more significant is the perceived strength of the euro as a whole and particularly the EU and ECB’s ability to manage the uncertainties surrounding the Greek economy.


Many investors can afford to remain clear of Portugal but for Spain the country remains strategically important, in order for businesses to expand their regional footprint
Jorge Santiago Neves
Gómez-Acebo & Pombo


‘Spain has suffered significant downturns before but around the time of the [first] Greek bailout, last May, there was a definite sense that Spain might go the same way. The result was a pause of activity particularly among international investors who took a ‘wait and see’ approach to how things would play out. Our domestic economy clearly faces challenges but we now see more positive signs internationally,’ says Ignacio Ojanguren, Managing Partner of Clifford Chance in Spain.

Spain has nonetheless seen market yields rise on Government short and long-term bond offerings – peaking at 250 basis points above the benchmark German bund in recent weeks – but continues to raise funds on the international debt markets. Investor concerns may be subsiding but the summer months will prove a significant test of confidence in the country’s capital markets and its financial sector.

A proposed first initial public offering of 2011, of 50 per cent of Atento (Telefónica’s call centre operation) scheduled for mid-June has already been abandoned. More significant however will be the success of the proposed July IPOs of two of Spain’s newest banks, Bankia and Banca Cívica, alongside the newly created CaixaBank, say lawyers.

All were formerly cajas (savings banks), although the past year has seen their number shrink from 43 to 17, encouraged by the Bank of Spain, following institutions’ exposure to the collapse of the country’s real estate market and the imposition of new capital adequacy rules. Alicante-based Caja Mediterráneo (CAM) has already been taken over by the state after the disclosure of a €2.8bn hole in its accounts – twice the €1.45bn shortfall calculated by the Bank of Spain.

Barcelona-based giant La Caixa has restructured as CaixaBank with a public listing completed on 1 July following a complex asset swap with its listed industrial holding entity Criteria. The new bank has a market capitalisation of around €18bn, placing it among Europe’s largest banks, and the listing came days after Bankia and Banca Cívica published the details of their sharply discounted listing plans.

Bankia is the product of the merger of seven cajas: Caja Madrid, Bancaja, La Caja de Canarias, Caja de Ávila, Caixa Laietana, Caja Segovia and Caja Rioja. Led by former IMF Chief Rodrigo Rato, it is now one of Spain’s largest domestic banks and hopes to raise around €4bn from a mid-July float. It will be closely followed by Banca Cívica – the product of the merger of Cajasol, Caja Navarra, Caja Canarias and Caja de Burgos – which intends to raise around €850m. Also lined up for an IPO later in the year is Banco Mare Nostrum, a merger of Caja Granada, Caja Murcia, Caixa Penedès and Sa Nostra.

A key benefit of the restructuring of the cajas has been to enable them to secure private investment and to operate internationally. The desire of many new banks is to emulate Spain’s leading listed institutions Santander and BBVA, both of which have emerged relatively unscathed by the domestic financial crisis, largely because a significant share of their revenues is now generated outside of Spain (and Portugal).

Santander last year undertook the globe’s largest IPO capitalising on Brazil’s economic boom by raising €5.4bn for a 14 per cent stake in its local subsidiary Santander Brasil. It has this year already acquired one of Poland’s leading banks Zachodni WBK and is reportedly preparing plans to float its enlarged UK operations, which combines banks that failed or were failing as a result of the financial crisis. BBVA is the owner of Mexico’s largest bank BBVA Bancomer and has this year acquired a stake in leading Turkish bank Garanti for €4.2bn.


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No guarantees


The situation in Spain may be less precarious than in previous months but there are however no guarantees over an economic upturn. There continues to be a slowdown in consumer spending, a stagnant real estate market (with a glut of properties built during the bubble of the past decade), rising bad loans for the country’s banks, and record youth unemployment – prompting street demonstrations by thousands of people (los indignados) in cities including Madrid and Barcelona.

The national government may be regarded internationally as making the ‘right’ moves in trying to turn around the economy – cutting debt and reducing public spending – but the public finances of Spain’s 17 Autonomous Communities continue to cause concern. Bilbao is reportedly the only city in Spain to be debt free, while a recent bond auction of local government debt managed by Santander reportedly raised only 50 per cent of the target amount.

‘The biggest immediate test will be the success of the listings of the former cajas. If all goes well, Spain and its financial institutions will begin to be back on track. If the IPOs fail, even at heavily discounted prices, then the recovery will take longer and the doubts that surrounded the strength of the economy at the time of the original Greek bailout, last May, could return,’ says Ojanguren.


Spain has suffered significant downturns before but around the time of the Greek bailout, last May, there was a definite sense that Spain might go the same way.

Ignacio Ojanguren
Clifford Chance


There is a perception in Portugal also that the new government has a relatively narrow window of ‘opportunity’ to bring the country back on to the path of financial stability and economic recovery. Prime Minister Passos Coelho is however already looking to go beyond the requirements of the Memorandum. In his debut Parliamentary address he announced plans to halve the annual traditional Christmas tax bonus, saving an estimated €800m, equivalent to a third of the deficit reduction target for 2011.

‘If Portugal were a company, we would have to refine our levels of service, ensure that revenues were properly accounted for, and develop new strategies for a changed world. We basically have to spend less and achieve more,’ says Santos Vítor at PLMJ.

But systemic issues remain to be addressed including in the area of justice. The inefficiency of Portugal’s courts was identified by the Memorandum as a significant barrier to the timely enforcement of disputes – with greater alternative dispute resolution methods proposed – while law firms should also have greater freedom to promote themselves, it proposes.

‘Nobody wished for the current situation but at least we do now have an economic recovery plan. The challenge for businesses is to assess what lies ahead, to adapt to the changes or to capitalise on any new opportunities presented,’ says Santiago Neves at Gómez-Acebo & Pombo.

The election of Portugal’s new government is therefore just a first step in an anticipated long and difficult process of change. But the hope is that success in Portugal should help to ensure economic stability across the Iberian peninsula. For the sake of the eurozone, Spain is ‘too big to fail’.



Scott Appleton is a freelance journalist. He can be contacted at

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