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There are two ways to think about Portugal's predicament. One is to look at it as a game of multidimensional chess involving the government, the markets and the so-called troika of official lenders that comprises the European Central Bank, the European Commission and the International Monetary Fund. The object is to restore Portugal's market access while avoiding at all costs any solution that involves forcing private sector bondholders to take losses, given damage to Portuguese banks and wider eurozone contagion.
Success hinges on a series of delicate judgements. In Portugal, the focus is on whether the troika will relax the 2014 budget deficit target agreed to in June—the issue that triggered the summer political crisis. Is this target really achievable, particularly if the Constitutional Court continues to block public sector pay and pension cuts? How would markets react to a decision to ease austerity? What signal would relaxing the target send to other eurozone states such as Spain and Italy? What would be the political consequences in Portugal of not relaxing the target?
For investors and the troika and the markets, the more urgent question is whether Portugal's debt load—forecast to peak this year at 124 per cent of GDP—is sustainable. The answer depends partly on how fast one assumes the economy can grow.
Would an official backstop be sufficient, such as access to the European Central Bank's Open Market Transactions bond-buying facility, or a precautionary credit line similar to the one under discussion with Ireland as its bailout programme ends? Or will investors demand that official creditors first ease the debt burden by further extending the maturity and cutting the interest rates on their loans? Would the best solution be to keep Portugal out of the markets via a new bailout programme?
Of course, these are urgent questions. But if the chess players focus too intensely on Portugal's next move, they risk losing sight of the endgame. The truth is that what really matters for Portugal—and Europe—in the long term isn't whether the deficit target is 4 per cent or 4.5 per cent next year, but whether Portugal will ever succeed in turning itself into a dynamic economy capable of escaping its grim history of recurring debt crises and thereby removing all doubt about its place in the eurozone.
The risk is that the crisis is causing Portugal's elites to retreat to familiar comfort zones just when they need to be embracing radical change. Viewed this way, the multidimensional chess game is the least of Portugal's problems. No doubt a way will be found to finesse the immediate financing challenge, most likely involving some official sector debt rescheduling and a precautionary credit line. But that will only buy Portugal some more time. The question is, for what?