Portugal, Spain EU's next weakest links

Europe's efforts to contain its debt crisis have come under increasing strain as bond market jitters shook Portugal and Spain, seen as the 16-nation eurozone's next weakest links now that Ireland has followed Greece by accepting a massive international rescue.

The nations' borrowing costs rose, suggesting investors are more worried about default, while Spain limited the size of a bond sale because traders demanded sharply higher premiums.

Stock traders panicked and dumped shares across all sectors, sending Portugal's benchmark stock index down 2.2 percent by the close, while Spain's sank 3.1 percent to a level not seen since July. The euro slid below US$1.34 (NZ$1.76) for the first time in two months.

Spooked by the scale of Greece's bailout requirements in May and Ireland's banking failures, international investors are looking much closer at the public finances of eurozone countries and they don't like what they're seeing, particularly in Portugal.

Traders are "looking for their next target" and Portugal fits the bill, said Emilie Gay, an analyst at Capital Economics in London. She predicts Portugal will have to ask for help by early next year, when it has to begin refinancing billions of euros in government bonds. A bailout for Portugal would cost at least €50 billion, according to Capital Economics.

European Union President Herman Van Rompuy insisted Portugal's finances are sound because the country's banks are well capitalized, they haven't had to cope with a severe housing market bubble, and the government has a strong program to bring the deficit down.

Asked during a visit to Stockholm whether the Irish bailout package was big enough and whether it can prevent the crisis spreading, Van Rompuy said "there is no need for help in Portugal and of course the safety net is big enough to support Ireland."

Portugal accounts for less than 2 percent of the eurozone's total economy but a potential bailout would crank up pressure on Spain, the European Union's fourth-largest economy, and entail possibly dramatic repercussions for the entire bloc.

Analysts at Capital Economics described the risk of a Spanish bailout as "fairly low" but warned that "the cost would be devastatingly high."

"This threat is therefore closely linked to the risk of some form of eurozone breakup, stemming either from Spain being forced to leave and default or perhaps even from Germany jumping ship," the analysts said in a report to investors Tuesday.

Ireland's decision to accept a loan to prop up its banks, which may reach euro100 billion, and make sharp budget cuts has come just six months after the EU and IMF provided a similar sum for Greece.

Greece, meanwhile, is still grappling with its promised reforms and must make an extra effort to meet next year's deficit targets, its international donors said on Tuesday.

The establishment of a €750 billion safety net, following Greece's bailout, for any other eurozone members facing the risk of imminent loan defaults has done little to quell market fears.

Portugal's recent public finance figures have sharpened concerns' about its ability to handle its debt load. Public spending rose 2.8 percent in the first 10 months of the year compared with a year earlier. Crucially, higher interest payments on its loans outweighed an increase in tax revenue, suggesting the weight of existing debt may be unsustainable as it offsets any progress in public finances.

The interest rate on 10-year Portuguese bonds rose to 6.9 percent Tuesday from 6.8 percent the previous day. That was close to the record 7 percent breached earlier this month.

Ever since Greece's bailout, Portugal was considered a risk because of its meagre economic growth and high debt. It has borrowed huge amounts to finance sacred welfare entitlements and private spending - while protecting jobs through outdated labour laws that make it difficult to hire and fire workers. Its industry has also broadly failed to move with the times.

Spain, though much larger than Portugal, is also feeling the heat of the market spotlight. Its borrowing costs soared Tuesday in a sale of 3- and 6-month bills and the government declined to sell as much of the debt as initially planned because of the higher rate.

The central bank says the treasury was obliged to pay 1.7 percent in average interest to sell €2.1 billion in 3-month bills, nearly double the 0.95 percent rate paid in the last such auction in October. The rate for the sale of €1.2 billion in 6-month bills jumped to 2.1 percent from 1.3 percent.

The difference between 10-year Spanish bonds and the equivalent benchmark German bund rose nearly 15 basis points to around 2.32 percentage points in midafternoon trading. That equals a record set in June, right before the results of stress tests on European banks were released.

Spanish Central Bank governor Miguel Angel Fernandez Ordonez said the effects of the Irish crisis had "spread rapidly to periphery" countries.

He said Spain's fiscal consolidation program "is not without risks" and warned the government against straying off course.

Spain is struggling to emerge from nearly two years of recession. Third-quarter growth was flat, after two quarters of timid expansion and unemployment is at a eurozone high of 19.8 percent.

The government has enforced austerity measures including a freeze on pensions and a cut in civil service wages by an average of five percent.

The 2011 budget foresees cutting the deficit from an expected 9.3 percent of GDP this year to 6.0 percent in 2011. Last year it stood at 11.2 percent of GDP.

Portugal, which last year had the fourth-highest deficit in the eurozone after Greece, Ireland and Spain, is also readying an austerity package, featuring tax hikes and pay cuts, for introduction January 1 Parliament is due to approve the measures on Friday.

However Portugal, like other European countries, is facing a popular backlash against its cuts. A national 24-hour strike Wednesday is expected to bring the biggest shutdown in public services in over 20 years.



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