Why I signed the petition for a Portuguese debt restructure

21/03/2014 by

Pray for portugalJorge Rodrigues, of  Portuguese daily Expresso, asked me to explain why it is that I signed the petition of 74 economists calling for an immediate debt restructuring of Portugal’s public debt, how this ‘call’ squares up with our Modest Proposal and what type of debt restructuring I had in mind. Click here for the interview as published in Expresso. My original answers in English follow… (See also this piece on lessons for Portugal from the Greek PSI – click here for the Portuguese published version)

Why did you decide to support the proposal for a debt restructuring in Portugal, announced before the end of the troika program?

There are two interpretations of the troika program.

Interpretation 1: It is a potentially successful fiscal consolidation agreement that will, upon completion, lead the member-state to a sustainable public debt and broad economic recovery.

Interpretation 2: It was, always, a cynical attempt to ‘extend and pretend’ so that non-Portuguese banks get the opportunity, and time, to unload their bad assets (i.e. Portuguese government bonds) onto the ‘official sector’ (mainly the Portuguese and European taxpayer) while (a) public debt rises and (b) national income suffers.

Under the first interpretation, we should wait until the troika program is finished and, if some extra ‘measures’ need to be taken afterwards (like a small debt restructure), the time to introduce them will come later. However, under the second interpretation, the troika program will most certainly fail, especially given that it was never really designed to succeed. So, the reason why I signed the petition in favour of an immediate debt restructure is because I espouse the second interpretation and reject the view that the troika program ever had a chance to (or indeed that it was designed) succeed in its stated purpose. When a debt restructure is of the essence, the sooner it is implemented the better.

You have a different idea about the debt mutualisation regarding the Maastricht threshold for the Debt-to-GDP ratio, but you still supported the Manifesto. Why?

Our Modest Proposal for Resolving the Euro Crisis, which is what I think you are referring to as my ‘different idea’ (and which is co-authored with Stuart Holland and James Galbraith), did propose a different solution to the debt crisis to that of the troika; one that would have not necessitated any haircut had it been implemented (especially if it had been implemented in a timely fashion). In brief, we proposed, that the ECB (a) services each member-state’s Maastricht Compliant portion of maturing bonds, (b) issues its own ECB-bonds in order to finance this partial bond servicing, and (c) charges the member-states for the full servicing of these ECB bonds.

Such a limited debt conversion program would have ensured that no haircuts are necessary in the Eurozone – not for Greece, not for Portugal, not for any member-state. But it was not implemented. Instead, large loans were extended to our governments on condition of income-sapping austerity, the result being that our nations’ public debt is, now, even less sustainable than it was in 2011. Given this sorry development, and granted Europe’s unwillingness to implement our proposal, the only rational course of action by Portugal (indeed, the government’s moral duty to its people) is to effect a deep debt restructure immediately. To haircut the debt that Europe’s inane policies have allowed to get worse than ever.

Do you think Portugal needs a classical hair cut in the principal and not only changes in maturities and interests?

After three years of ‘extending and pretending’ the haircut has to be deep. A simple elongation of maturities (even if it pushes repayments into the distant future) plus a small reduction in interest rates will simply extend the crisis into the future. However, there are smart ways of effecting such a haircut that minimise the political cost in Berlin, and elsewhere, from conceding such a deep debt restructure. For example, the Portuguese government could issue new ‘bisque bonds’ or GDP-indexed bonds (i.e. bonds whose repayments, principal and interest, are automatically postponed if GDP growth is below a certain threshold) of the same face value as the size of Portugal’s public debt that is held by the ESM and the ECB and then use them to pay back the ESM and ECB ‘in full’. It would, essentially, translate into a haircut whose magnitude is inversely related to growth.

Is it necessary to implement not only a PSI in Portugal but also an OSI regarding ECB SMP portfolio and loans from European Funds (EFSF-ESM)?

Absolutely. Of the total €166 billion of Portugal’s public debt (as of December 2013), €91 billion, i.e. 54%, has already been transferred to the official sector. Domestic banks hold €31 billion of the remaining €63 billion. If the official sector is excluded from a haircut (i.e. if only a PSI happens), the Portuguese banks will take a major hit (if the haircut-PSI is to make a significant into overall pubic debt). But then the banks will need to be recapitalised and, since no genuine banking union is on the cards, they will be recapitalised by the… government (precisely as it happened in Greece), therefore pushing public debt right up again. It would be senseless to do this.

So, an OSI is even more important than a PSI at this stage (i.e. once the most debt was unloaded onto the official sector, following the ‘bailout’). Remember: The most important lesson from the Greek debt restructure of early 2012, which failed spectacularly to stabilise Greek public debt, was that: prolonging an unavoidable debt re-structure makes the problem worse, especially when a bailout is given in order to shift bad assets from the banks’ books to the taxpayers. Unless something like our Modest Proposal is implemented at a Eurozone level, an OSI is inevitable and the only serious question about it concerns when it will happen, how much suffering its delay will cause and, finally, how Brussels, Frankfurt and Berlin will ‘market’ it so as to minimise their political cost.

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