Nobody expected the eurozone’s latest application of financial sticking plaster to Greece to buy it much time. Even so, the respite before the latest lurch back into crisis was brutally brief.
The decision by Moody’s on Tuesday to reduce its rating on Portuguese government debt sent another shudder through the financial markets.The credit rating agency warned that Portugal might have to follow Greece in seeking a second bailout because it would struggle to meet its deficit reduction targets. This was not just bad news in itself. It also reminded investors of the risk of contagion, not just to Portugal and Ireland, but also to Spain and Italy, which have also seen their borrowing costs rise.
Moody’s move provoked a predictably furious response from Lisbon. The Panglossian credit rating agencies originally made the bubble worse. They are now being accused of the opposite: of exacerbating the bust by competing with each other in their pessimism. Moody’s outflanked its two big rivals by becoming the first to downgrade Portuguese long-term debt to junk. Critics will say, with some justification, that the downgrade risks being self-fulfilling as it makes it more difficult for Portugal to avoid the very crunch that Moody’s highlights. Portugal’s new austerity programme, which has just begun, does look more likely to succeed than Greece’s, not least because of the new Government’s healthy majority in parliament.
But this move still comes at a sensitive moment. Portugal suffers from many of the same problems — including a woefully uncompetitive economy and a population disinclined to pay their taxes — as Greece, and Moody’s is right to say that meeting its fiscal targets will be very tough. Moreover, the tortuous efforts to ensure that investors bear some of the costs of the second Greek bailout imply that a similar approach would be adopted if one were needed for Portugal. So it is not unreasonable to say that the risks of holding Portuguese debt has increased.
With luck, Moody’s move will help to concentrate minds in eurozone capitals on the importance of looking beyond quick fixes to longer-term solutions to the crisis. Despite the brave efforts of their governments and people, few serious economists now deny that Greece, Portugal and Ireland will, at some stage, need a big reduction in the amount of debt they owe or a large cut in the interest rate that they have to pay.
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It is quite understandable that eurozone governments and the European Central Bank are not hurrying to make the necessary adjustments. Most bankers believe that the European financial system is robust enough to handle the fallout, not least because it has had plenty of time to prepare.It it most unlikely to precipitate a Lehman-style crisis. But there is no denying that the complexity of the interconnections between eurozone government and bank debt means that nobody can really be sure. Meanwhile, the debt adjustments will require eurozone governments to bear some of the costs, which will be extremely unpopular, not just in Germany.
The history of such crises teaches us an important lesson: that the longer you wait the more expensive it will eventually become. It is obvious that there is no palatable answer but the sooner the eurozone gets to grips with Greece, Portugal and Ireland, the more likely it is that it can stop the contagion spreading to Spain and Italy.