Legal skull-duggery in Greece may doom Portugal By Ambrose Evans-Pritchard

Legal skull-duggery in Greece may doom Portugal
Europe has ring-fenced Greece’s debt crisis for now but its escalating
recourse to legal legerdemain has shattered the trust of global bond
markets and may ultimately expose Portugal, Spain, and Italy to
greater danger.

Marchel Alexandrivich from Jefferies Fixed Income: “It does not matter
how often the EU authorities repeat that Greece is a ‘one-off’ case,
nobody in the markets believes them.” Photo: Reuters
Ambrose Evans-Pritchard

“The rule of law has been treated with contempt,” said Marc Ostwald
from Monument Securities. “This will lead to litigation for the next
ten years. It has become a massive impediment for long-term investors,
and people will now be very wary about Portugal.”

At the start of the crisis EU leaders declared it unthinkable that any
eurozone state should require debt relief, let alone default. Each
pledge was breached, and the haircut imposed on banks, insurers, and
pension funds ratcheted up to 75pc.

Last month the European Central Bank exercised its droit du seigneur,
exempting itself from loses on Greek bonds. The instant effect was to
concentrate more loss on other bondholders. “This has set a major
precedent,” said Marchel Alexandrivich from Jefferies Fixed Income.
“It does not matter how often the EU authorities repeat that Greece is
a ‘one-off’ case, nobody in the markets believes them.”

The ECB holds €220bn (£185bn) of Greek, Portuguese, Irish, Spanish,
and Italian bonds. Its handling of Greece implicitly subordinates
private creditors in each country. All have slipped a notch down the
pecking order.

The Greek parliament’s retroactive law last month to insert collective
action clauses (CACs) into its bonds to coerce creditor hold-outs has
added a fresh twist. These CAC’s are likely to be activated over
coming days. Use of retroactive laws to change contracts is anathema
in credit markets.

This might not matter too much if Greece were really a “one-off” case
but markets are afraid that Portugal will tip into the same downward
spiral as austerity starts to bite.

Citigroup expects the economy to contract by 5.7pc this year, warning
that bondholders may face a 50pc haircut by the end of the year.
Portugal’s €78bn loan package from the EU-IMF Troika is already large
enough to crowd out private creditors, reducing them to ever more
junior status.

EU leaders said last June that “Greece is unique” and promises that
haircuts would “not be replicated in Portugal”. They have since
pledged that the EU’s new bail-out (ESM) fund will not have protected

Portugal has been praised by the International Monetary Fund for
grasping the nettle of reform, but the IMF’s own figures show that
public debt may reach 118pc of GDP next year. The debts of state-owned
bodies add another 10pc.

Combined public and private debt is 360pc of GDP, 100 percentage
points above Greece. This is a huge burden on a shrinking economic
base. Its current account deficit was still 8pc of GDP last year, much
like Greece. Both countries are overvalued by 20pc on a real effective
exchange rate, though Portugal has barely begun to cut unit labour

Dimitris Drakopoulos from Nomura said Portugal relied on “fiscal
engineering” last year to massage deficit figures, raiding 3.5pc of
GDP from private pension funds.

Matters will come to a head soon. The IMF must decide by September
whether Portugal needs more money and debt relief. If Portugal now
spirals into a Grecian vortex, large haircuts loom. This time EU
leaders will have to accept that their own taxpayers will suffer
losses – avoided until now – or violate their pledge.

Bondholders are not waiting to learn whether Europe will keep its word
this time. There has been no rally in Portuguese debt since the ECB
flooded banks with €1 trillion. Ten-year yields are stuck at 13.2pc.
Return to market access is a distant dream.

The risk for Europe is that investors will charge a “political risk”
premium to invest in any EMU country subject to EU legal whim. The
greater risk is that Euroland’s crisis rumbles on as fiscal
contraction in Italy and Spain plays havoc with debt dynamics, and
reforms come much to late to close the North-South trade gap.

Europe’s handling of Greece has guaranteed that global funds will rush
for Club Med exits at the first sign of trouble. The next spasm of the
debt crisis will that much dangerous if it ever comes. As the saying
goes: Hell hath no fury like an abused bondholder.