Why Portugal is different from Greece?
1 - Conditionality and Country Ownership of the Programs
IMF/Troika lending in support of adjustment programs to Portugal, Ireland and Greece are conditional on the countries undertaking certain agreed policy measures, in the case set in the Memorandum of Understanding (“MoU”) that sets the specifics of the economic policy conditionality. The MoU specify the set of conditions that needs to be implemented by the borrower country (this can be viewed as complex loan covenants, written into the loan agreement), which provide the safeguards that the country will be able to rectify its macroeconomic and structural imbalances and will be in a position to service and repay the loans.
Research into previous adjustment programs raises many questions about whether the conditions imposed by the IMF lending programs on borrowing countries have been too intrusive and whether the IMF conditionality has undermined the country ownership of adjustment programs to correct the macroeconomic imbalances.
This raises an important aspect that the country ownership of the programs is a crucial aspect to the program success, because it aligns the incentives of the borrower and the lender. These has happened to date with the Portuguese and the Irish program but regarding Greece the case has been very different. Before the appointment of the technocrat government led by Lucas Papademos the political support for the Greek program has been very weak.
Nevertheless even after his appointment the public support for the program is very small and given the political instability in Greece this may bring further headwinds to the program implementation even after the recent PSI success.
Ownership of the program raises the probability of success and increase the “value” of the safeguards for the international lenders (EU/IMF). In any borrower lender relationship there is always asymmetry of information, which gives rise to two incentive problems adverse selection and moral hazard. Adverse selection arises before the transaction as the lender faces a selection problem the country only looks for IMF resources when is in distress.
The moral hazard arises after the lender provides the funds, as having obtained the funds the borrower may be incentivized to take risks that would increase the likelihood of the program failure (or default). In the traditional financial world of banking this is mitigated by collateralization, contract covenants, transparency, reporting requirements and monitoring to raise early flags.
The IMF/Troika lending to the countries above and the conditionality set in the MoU’s follow broadly the same principles as traditional lending, thus they serve to provide assurances that the countries in question will solve the imbalances and would be in a position to repay the loans and return to the markets.
2 - The implementation and effectiveness of the IMF/Troika conditionality in Portugal
The implementation of the Portuguese program has follow the recommendations, the deadlines and targets set in the MoU and Portugal has met the targets set by Troika so far. Two big privatization have take place with the sale of the 40% stake in the Portuguese power-grid operator REN that was sold to China State Grid and Oman Oil - they took 25% and 15% respectively for EUR 593 Million and China Three Gorges bought 21% of EDP Energias de Portugal in January for EUR 2.7 Billion and other policies and structural reforms set in the Troika MoU had been implemented to date with broad political support.
Even the labor unions seem to have bought the arguments for the reforms signing an important agreement at the end of 2011, which paves the way for the labor reforms. There are broad reasons to be positive and above all, there is a political consensus in Portugal with all the main parties supporting the program of reform agreed with the Troika last year. Moreover there is not much in the way of public dissent despite some tough spending cuts and salary cuts on top of tax rises. These effectiveness nevertheless will be tested next year when Portugal is expected to return to the markets.
But the consensus is wide that not withstand the fact that the progress has been very positive the external shocks following the Greek PSI and the external macroeconomic environment is very unlikely that Portugal will be able to return to the markets in 2013 and that maybe be pushed to 2014 with an additional package of EUR 30 billion being needed. As defended by Tobias Blatter, economist from Daiwa Securities, in an interview I agree that the fastest is clear to the markets that a new package would be available if needed the more likely that the market would abandon the suspicion that a PSI is likekly to follow in Portugal.
This may alleviate the country of the pressure of the moment and set room fro growth after the tough reforms that have been implemented so far. Because even more important than the sole return to the markets is future prospects for growth in Portugal after the program implementation, but that can only be analyzed ex-post.
Nevertheless the 3% decline forecasted for 2012 is seen by many analysts as an optimist target. Also important is the fact that to many of the deficit reduction measures were extraordinary revenue measures as the transfer of the Portugal Telecom and Banking pension schemes and more still to be done on the expenses side.
A.Richmond
CEO, Richmond Hill Capital Management S.a.r.l