In my view the contagion has already occurred. Credit markets are in practice closed for Portuguese debt. The debt funding is carried out either through the EFSF, IMF or ECB funding or short-term debt which markets are willing to fund because Portugal is under the troika bailout programme. In addition, banks are probably using some repo funding with collateral.
Despite all this, there are large funding problems for both businesses and banks, public sector firms also face a substantial challenge in rolling up debt. The funding foreseen in the first bailout was not sufficient from the beginning and so the government will need to tackle huge difficulties in ensuring the economy is able to obtain liquidity over the next year. The government has sought to obtain further funding by negotiating the agreement which in the end has been rejected by Eurogroup President, Jean-Claude Juncker.
How can Portugal avoid the Greek debt contagion? It cannot, it is already affected.
I think that the government should stop following the advice of the European Commission, ECB and IMF because their policies do not address the imbalances that caused the crisis and will result in recession as well as aggravate the debt dynamics as we have witnessed it in Greece and to some extent in Ireland.
2) What are the prospects that the budget targets and GDP forecasts for the next year will be achieved?
There are little chances for reaching those targets, unless they are modifications to the adjustment programmes. It is possible that the budget targets and forecasts will be reached because the adjustment programme put in place the budget for 2012 by this government is so drastic in terms indebtedness so if they are aiming at the 6% of the GDP. The likely adjustment is even larger, so it is ensured that it will not fail. But even if the short-term budget deficit targets are reached, it will be at the cost of compromising the revenue raising credibility of the government in future, so compromising the dynamics and budget deficit in the future.
In my view, the IMF adjustment programme cannot work by definition. The flawed of the economic theory have to be put in a simplified form: one cannot reduce the budget if one does not reduce the trade and the income balance deficits. This is an accounting identity taught to undergraduate students.
I believe that the troika team has overseen this identity. Their theory is that one should reduce nominal salaries and prices in order to increase exports. This approach was implemented in Latvia, Hungary, Romania, Greece, Ireland and Portugal; and the same type of policy is asked to be introduced even in Spain and Italy.
3) How would you comment on the new bail-out for Portugal from the troika?
The government has already asked for a new bail-out from Jean-Claude Juncker, Eurogroup's President, when he was visiting Portugal. Juncker's response was: "No way". The problem is that the funds arranged for the first bail-out were insufficient. They did not meet the net borrowings of Portugal for the years of the programme.
The same happened to Greece, by the way. So I think that at the rate the European Union is going, if nothing is done, the chances that something unexpected occurs somewhere are very high, for instance, a default somewhere by some entity. There is a number of instruments the governments could use if they wished, even Portugal could use some of them, but, unfortunately, there is very little being done in terms of contingency planning.
4) What could be the scenarios for further economic developments in the Eurozone? For instance, if Greece abandons the euro how will Portugal be affected?
On current trends, the Eurozone is likely to disintegrate chaotically. There is basically the "stay the route" and "don't look at the alternatives" policy imposed by the EU governing institutions.
If the problems are not addressed then the policies put in place will turn out just reinforcing, like the strategy that was developed at the beginning when the EU was formed, then there will be a big failure. I would say that there are too many decision makers and the solution given the legal constraints by the Treaty of the European Union is too complex.
If Greece abandons the euro, it is likely that pressure on Portugal to do the same will increase significantly. Hopefully, it does not happen, but for now I do not see any clear strategy to prevent this scenario.
The root problem of this crisis is not the peripheral countries' lack of fiscal discipline. Instead, it is a flawed Economic and Monetary Union design. There are 12-13 countries of the 27 countries in the European Union with large external imbalances and that are at different stages of facing a balance of payments and external debt crisis, such as that now faced by Greece, Ireland and Portugal. These countries followed the advice from the center (governing institutions of the EU – European Commission, ECB, European Council, Ecofin) in the last 10-15 years. This advice, specifically, the Stability and Growth Pact, was and is flawed.
The EU governing institutions response to the crisis has been to argue that these countries did not follow the Stability and Growth Pact close enough in the past.
However, these policies are the cause of the current crisis. Staying the course, in this context, just means aggravating the crisis. It hasn't worked in the past (since the EMU was created), so it should be obvious that it won't work in the future.
The EU governing institutions should seek to identify what went wrong, and seek to identify policy alternatives going forward. Only by identifying policy alternatives will the European Union be able to truly address this balance of payment crisis within its midst. The problem, of course, is that it is hard for the institutions that made the policy mistake to acknowledge their authorship. It is always easier to blame it on someone else (in this case, the peripheral countries).