ECB Largesse Bypassing Portugal

Pedro Passos Coelho, Portugal's prime minister, speaks in Lisbon, Portugal, on March 5, 2012

Photograph by Mario Proenca/Bloomberg

Pedro Passos Coelho, Portugal's prime minister, speaks in Lisbon, Portugal, on March 5, 2012

(Updated to add interview with Banco BPI CEO Fernando Ulrich.)

Portuguese bond yields are rising as investors are busy putting cheap money from the European Central Bank to work elsewhere.

That’s a problem for Portugal’s Prime Minister Pedro Passos Coelho, who is trying to convince investors that his government’s debt is sustainable and that losses won’t be imposed on bond holders, as is the case for Greece.

So what does he make of reports like one from Citigroup (C), which last month predicted Portugal would likely impose writedowns of as much as 50 percent?

“I don’t agree. I don’t agree,” Coelho said in an exclusive interview with Bloomberg TV. “Why? Because in the first place we have the IMF analysis on the sustainability of Portuguese debt and the IMF is saying that Portuguese debt is sustainable.”

I asked Abebe Aemro Selassie, who leads the IMF’s Portugal team in Washington, about rising bond yields on Portuguese debt. He said:

We think it is inconsistent with what we see on the ground, [which] includes relatively strong progress in terms of fiscal adjustments last year. We also see some early signs of the strong reforms the government has done and also a lot of stability in the banking system.

Our interview is here:

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Prime Minister Passos Coelho says he’s confident of reaching the government’s 4.5 percent budget-deficit target this year. Could Portugal–as Spain is expected to do–ask for the target to be relaxed?

“Absolutely not,” Coelho insists.

It’s going to be tough going, though. Fitch, which rates Portugal below investment grade, says the biggest risk facing the country is a deterioration in its economy, which is already forecast to shrink this year by 3.3 percent. A blow-up in some other part of the euro zone could cause further damage.

There is one hopeful indicator in the view of economists: an improvement in the external deficit, which the Bank of Portugal estimates will shrink from 6.8 percent in 2011 to 1.6 percent this year and return to surplus next year.

In the words of Carlos Andrade, chief economist at Lisbon-based Banco Espirito Santo (BES:PL), Portugal’s biggest bank:  “If you show you are not dependent on external financing, it means the economy is adjusting, and this should give way to increased confidence.”

Today, I did a Bloomberg TV interview from the Miradouro da Graça overlooking Lisbon with Ricardo Salgado, the chief executive of Banco Espirito Santo. He said that the bank is changing its bond investment strategy to invest more in long-term Portuguese debt.

“We believe that (Portugal) will not restructure,” Salgado told me.

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That’s at least one voice of support for Passos Coelho, but not every banking chief executive is so optimistic. Fernando Ulrich, CEO of Banco BPI (BPI:PL), the fifth biggest bank in Portugal, told me his bank isn’t adding to its Portuguese bond holdings even after tapping the European Central Bank’s three-year lending facility for €2 billion.

Whether other investors will come back to the market remains to be seen. Many are concerned, like Oxford Economics senior economist Marie Diron, that Portugal may need to seek a second bailout if economic conditions worsen more than expected.

But for now, the Portuguese government is hopeful, pledging to return to the bond market by 2013.

Check out my complete interview here with Portuguese Prime Minister Pedro Passos Coelho.

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