Can Portugal escape its economic history?

It is time for us to take a trip again to the Iberian peninsular and indeed to the delightful country of Portugal. Back on January 16th I highlighted the economic issues facing it thus.

When we do so we see that Portugal has also struggled to sustain economic growth and even in the good years it has rarely pushed above 1% per annum. There have also been problems with the banking system which has been exposed as not only wobbly but prone to corruption. Also there is a high level of the national debt which is being subsidised by the QE purchases of the ECB as otherwise there is a danger that it would quickly begin to look rather insolvent. In spite of the ECB purchases the Portuguese ten-year yield is at 3.93% or some 2% higher than that of Italy which suggests it is perceived to be a larger risk. Also more cynically perhaps investors think that little Portugal can be treated more harshly than its much larger Euro colleague.

The mentions of Italy come about because there are quite a few similarities between the two twins. Both had similar weak economic growth in the better times, both have seen banking crisis which were ignored for as long as possible, and both have elevated national debts currently being alleviated by the bond buying of the ECB. Actually bond markets seem to have caught onto this since we last took a look as Portugal has seen an improvement with its ten-year yield at 3.03% only some 0.86% over that of Italy. This has been happening in spite of the fact that the ECB has in relative terms been buying more Italian than Portuguese bonds. Although sadly for Portugal’s taxpayers the gain from this has been missed to some extent as it issued 3 billion Euros of ten-year debt with a coupon of 4.125% back in January.

What about economic growth?

Back in January the Bank of Portugal was expecting this.

the Portuguese economy is expected to maintain the moderate recovery trajectory that has characterised recent years . Thus, following 1.2 per cent growth in 2016, gross domestic product (GDP) is projected to accelerate to 1.4 per cent in 2017, stabilising its growth rate at 1.5 per cent for the following years.

Actually Portugal managed to nearly meet the 2017 expectations in the first quarter of this year.

In comparison with the fourth quarter of 2016, GDP increased 1.0% in real terms (quarter-on-quarter change rate of 0.7% in the previous quarter). The contribution of net external demand changed from negative to positive, driven by a strong increase in Exports of Goods and Services………Portuguese Gross Domestic Product (GDP) increased by 2.8% in volume in the first quarter 2017, compared with the same period of 2016 (2.0% in the fourth quarter 2016).

As you can see there was strong export-led economic growth to be seen. This had a very welcome consequence.

In the first quarter 2017, seasonally adjusted employment registered a year-on-year change rate of 3.2%,

This makes Portugal look like its neighbour Spain although care is needed as a couple of strong quarters are not the same as 2/3 better years. Also the Portuguese economy is still just over 3% smaller than it was at its pre credit crunch peak. A fair proportion of this is the fall in investment because whilst it has grown by 5.5% over the past year the level in the latest quarter of 7.7 billion Euros was still a long way below the 10.9 billion Euros of the second quarter of 2008.

The National Debt

A consequence of the lost decade or so for Portugal in terms of economic growth has been upwards pressure on the relative size of the national debt which of course has been made worse by the bank bailouts.

This means that Portugal has a national debt to GDP ratio of 133%. Whilst this is not currently a large issue in terms of funding due to low bond yields it does pose a question going forwards. There are two awkward scenarios here. The first is that the ECB continues to reduce or taper its purchases and the second is that it runs up to its self-imposed limit on Portuguese bonds. Actually the latter was supposed to have already happened but the ECB has shown what it calls flexibility as we have a wry smile at all the previous proclamations of it being a “rules based organisation”.

The banks

The various bailouts have added to the debt issue in spite of the various machinations and manipulations to try to keep them out if the numbers. There is also a sort of never-ending story about all of this as we mull that Novo Banco was supposed to be a clean good bank  Let us step back in time to what the Bank of Portugal told us just under 3 years ago,

The general activity and assets of Banco Espírito Santo, S.A. are transferred, immediately and definitively, to Novo Banco, which is duly capitalised and clean of problem assets

Sorted? Er not quite as I note this news from Reuters yesterday,

The sale of Portugal’s state-rescued Novo Banco to U.S. private equity firm Lone Star should be concluded by November following a 500 million euro ($566 million) debt swap that will be launched soon, deputy finance minister said on Wednesday.

That was yet another kicking of the can into the future as we discovered that November is the new August. Meanwhile somethings have taken place such as a 25% cut in the workforce and a 20% cut in branch numbers.

Bank Lending

The recent economic improvement does not seem to have been driven by any surge of bank lending as we peruse the latest data from the Bank of Portugal.

In May 2017 the annual rate of change (a.r.) in loans granted to non-financial corporations stood at -3.3%, ……In May 2017 the a.r. in loans granted to households stood at -1.0%, reflecting a positive change of 0.1 p.p. compared with April

So we see that neither all the easing from the ECB nor the improved economic growth situation have got lending into the positive zone. Mind you the numbers below suggest that the banks have their own problems still.

The share of borrowers with overdue loans decreased by 0.1 p.p., to 27.1% ( companies)……… The share of borrowers with overdue loans in the household sector declined by 0.1 p.p. from April, to stand at 13.2%.

Mind you the Portuguese banks do seem to have learned something from British visitors.

The consumption and other purposes segment also posted a positive change of 0.2 p.p., standing at 4.6%

House prices

Is there a boom here responding to the easy monetary policy?

In the first quarter of 2017, the House Price Index (HPI) increased 7.9 % when compared to the same quarter of the previous year, 0.3 percentage points (p.p.) more than in the last quarter of 2016…….When compared with the last quarter of 2016, the HPI increased 2.1%, 0.9 p.p. higher than in the previous period.

Turning British? Maybe in a way as there is something familiar in the way that house prices began to rise again in late 2013.

Comment

One very welcome feature of the improved economic situation in Portugal has been the much improved situation regarding unemployment.

The April 2017 unemployment rate stood at 9.5%, down by 0.3 percentage points (p.p.) from the previous month’s level and by 0.6 p.p. from three months before….. and is the lowest observed estimate since December 2008 (9.3%).

If it can keep this up it may move into the success column but there are also issues. Portugal has briefly done this before only to then fade away. The banking sector still has problems and we now know ( post 2007) that readings like this can swish away like the sting of a scorpion’s tale.

The Consumer confidence indicator increased in June, resuming the positive path observed since the beginning of 2013 and reaching a new maximum level of the series started in November 1997.

Let us wish Portugal well as it needs to get ahead of the game as we note another issue hovering on the horizon.

Since 2010 Portugal lost 264,000 Inhabitants……..In 2016, the mean age of the resident population in Portugal was 43.9 years, an increase of about 3 years in the last decade.

Let us not be too mean spirited though as some of the latter is a welcome rise in life expectancy.

Me on FXStreet

The ongoing disaster that is Novo Banco of Portugal

A constant theme of this website is an ongoing consequence of the credit crunch where more than a few banks have not been reformed and are still damaged goods. They are banks which were somewhat presciently sung about by the Cranberries.

Zombie, zombie, zombie

Certainly in that list was Banco Espirito Santo of Portugal which found itself in a spider’s web of corruption and bad loans. This led to this being announced by the Bank of Portugal in August 2014.

The Board of Directors of Banco de Portugal has decided on 3 August 2014 to apply a resolution measure to Banco Espírito Santo, S.A.. The general activity and assets of Banco Espírito Santo, S.A. are transferred, immediately and definitively, to Novo Banco, which is duly capitalised and clean of problem assets.

The point of this was supposed to be that Novo Banco would then be like its name, a New Bank. It would be clean of the past problems and would then thrive and the bad bank elements would be removed. Reuters took up the story.

Novo Banco, or New Bank – will be recapitalised to the tune of 4.9 billion euros by a special bank resolution fund created in 2012. The Portuguese state will lend the fund 4.4 billion euros.

At the time there were various issues as Portugal itself had only recently departed an IMF bailout so was not keen to explicitly bailout BES. Thus the bank resolution fund was used except of course it had nowhere near enough money so the state lent it most of it. These sort of Special Purpose vehicles are invariably employed to try to keep the debt out of the national debt. To be fair to Eurostat that usually does not work but left an awkward situation going forwards where in theory the other Portuguese banks created Novo Banco but in reality the Portuguese taxpayer provided most of the cash.

Novo Banco

As regular readers will be aware investors in Novo Banco later discovered that the word “clean” was a relative and not an absolute term.

The nominal amount of the bonds retransferred to Banco Espírito Santo, S.A. totals 1,941 million euros and corresponds to a balance-sheet amount of 1,985 million euros………This measure has a positive impact, in net terms, on the equity of Novo Banco of approximately 1,985 million euros.

This may have happened just after Christmas 2015 but there was no present here for the holders of these bonds who found them worth zero. To say that institutional investors were unhappy would be an understatement and I will return to this later but for now I just wish to point out that the bill is escalating and also how can a clean new bank have to do this?

The sale of Novo Banco

There were various efforts to sell Novo Banco which went nowhere and of course trust in the Bank of Portugal was damaged by what happened above which added to the misrepresentations issued by it as BES declined. Just over a year ago it published this.

Banco de Portugal has defined the terms of the new sale process of Novo Banco, following the re-launch announced on 15 January 2016.

This January the Lex Column of the Financial Times pointed out why buyers have been in short supply.

Available for purchase: one crippled bank suffering from poor credit quality and high costs. Location: Portugal. Important information: Potential for future damages arising from litigious creditors. The sale prospectus for Novo Banco does not look enticing.

It gets worse.

Quarterly losses since Novo’s creation have averaged €250m. A quarter of all loans are delinquent or “at risk” of being so.

Again we are left wondering exactly how the Bank of Portugal defines the word “clean”?! But whilst the FT thought there were bidders it looks to me that the only player was the appropriately named Lone Star.

Lone Star

What happened late on Friday was summarised by Patricia Kowsman of the Wall Street Journal.

Dallas-based Lone Star will inject €1 billion ($1.07 billion) in Novo Banco for a 75% stake, while a resolution fund supported by the system’s banks will hold the remainder. The setup could ultimately leave Portuguese taxpayers exposed to losses, which is what the country’s central bank had tried to avoid when it imposed a resolution on the lender almost three years ago.

Actually they are only paying 750 million Euros up front with the rest by 2020. But as we number crunch this there are a lot of problems.

  1. The nearly 2 billion Euros of bonds written off do not seem to have made the situation much better.
  2. The Portuguese Resolution Fund put in 4.9 billion Euros for a bank which is now apparently worth 1 and 1/3 billion.

The Resolution Fund took steps last September to cover this.

the maturity date of the loan will be adjusted so as to ensure that it will not be necessary to raise special contributions,

I would like to take you back to August 2014 when it told us this.

Therefore this operation will eventually involve no costs for public funds………..This applies even in exceptional cases, such as this one, in which the State is called upon to provide temporary financial support to the Resolution Fund, as that support will later be repaid (and remunerated through payment of interest) by the Fund.

The use of the word “temporary” was a warning as its official use is invariably the complete opposite of that to be found in a dictionary. Also I am reminded of my time line for a banking collapse.

5. The relevant government(s) tell us that they are stepping in to help the bank but the problems are both minor and short-term and are of no public concern.

6. The relevant government(s) tell us that the bank needs taxpayer support but through clever use of special purpose vehicles there will be no cost and indeed a profit is virtually certain.

Back in August 2014 we were told this. From Reuters.

“The plan carries no risk to public finances or taxpayers,” Carlos Costa, the central bank governor, told reporters in a late night news conference in Lisbon.

Litigation

You might think that things could not get much worse. Yet apparently they continue to do so. From Reuters.

Blackrock and other asset management institutions are seeking an injunction this week to block the sale of Portugal’s Novo Banco to U.S. private equity firm Lone Star.

Okay why?

The bond transfer had caused losses of about 1.5 billion for ordinary retail investors and pensioners

Comment

A critique of the banking bailouts has been the phrase “privatisation of profits and socialisation of losses ” and we see this at play here. Whilst there is a veil of a Special Purpose Vehicle ( the Resolution Fund) the Portuguese taxpayer has had to borrow money to back most of it. It is plain that we were not told the truth or anything remotely like the truth when a “clean” bank was created. As no cash at all has been returned from the sale of Novo Banco – the funds are to boost bank capital – they are left hoping that one day the money will be repaid except they have been diluted by a factor of four.

Let us take a happy scenario where Novo Banco now does well the majority of the gains will go to Lone Star and a minority to the Resolution Fund. So the minor stakeholder gets the majority of the returns? Oh and even worse the Fund is backing another sector of potential losses. From the Algarve Daily News.

In a statement issued today, PS party leader Carlos César says MPs “should know in detail all the preparatory and contractual aspects of the sale operation” – bearing in mind the State has no say in the bank’s management, but is guaranteeing to underwrite extraordinary losses of up to €4 billion.

In a happy scenario the other Portuguese banks will be likely to be able to put some extra money into the Resolution Fund but of course many of them have their own problems and the Portuguese economy could do with them backing it.

And a bad scenario? Well look at the sums above……..

 

 

 

Will rising bond yields mean ECB QE is To Infinity! And Beyond!?

Yesterday the ECB ( European Central Bank ) President Mario Draghi spoke at the European Parliament and in his speech were some curious and intriguing phrases.

Our current monetary policy stance foresees that, if the inflation outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council is prepared to increase the asset purchase programme in terms of size and/or duration.

I say that bit was curious because it contrasted with the other rhetoric in the speech as we were told how well things are going.

Over the last two years GDP per capita has increased by 3% in the euro area, which compares well with other major advanced economies. Economic sentiment is at its highest level in five years. Unemployment has fallen to 9.6%, its lowest level since May 2009. And the ratio of public debt to GDP is declining for the second consecutive year.

The talk of what I would call “More,More,More” is also a contrast to the December policy decision which went down the road of less or more specifically slower.

We will continue to purchase assets at a monthly pace of €80 billion until March. Starting from April, our net asset purchases will run at a monthly pace of €60 billion, and we will reinvest the securities purchased earlier under our programme, as they mature. This will add to our monthly net purchases.

There was another swerve from Mario Draghi who had written to a couple of MEPs telling them that a country leaving the Euro would have to settle their Target 2 balances ( I analysed this on the  23rd of January ) whereas now we were told this.

L’euro e’ irrevocabile, the euro is irrevocable

Of course Italian is his natural language bur perhaps also there was a message to his home country which has seen the rise of political parties who are against Euro membership.

Such words do have impacts on bond markets and yields but I was particularly interested in this bit. From @macrocredit.

DRAGHI SAYS ECB POLICY DOESN’T TARGET BOND SPREADS

A rather curious observation from someone who is effectively doing just that and of course for an establishment which trumpeted the convergence of bond yield spreads back before the Euro area crisis. Just to be clear which is meant here is the gap between the bond yield of Germany and other nations such as Spain or Italy. These days Mario Draghi seems to be displaying all the consistency of Arsene Wenger.

Oh and rather like the Bank of England he seems to be preparing himself for a rise in inflation.

As I have argued before, our monetary policy strategy prescribes that we should not react to individual data points and short-lived increases in inflation.

Spanish energy consumers may not be so sanguine!

Growing divergence in bond yields

The reality has been that recently we have seen a growing divergence in Euro area bond yields. This has happened in spite of the fact that the ECB QE ( Quantitative Easing) bond buying program has continued. As of the latest update it has purchased some 1.34 trillion Euros of sovereign bonds as well as of course other types of bonds. Perhaps markets are already adjusting to the reduction in the rate of purchases planned to begin on April 1st.

France

Ch-ch-changes here are right at the core of the Euro project which is the Franco-German axis. If we look back to last autumn we see a ten-year yield which fell below 0.1% and now we see one of 1.12%. This has left it some 0.76% higher than its German equivalent.

Care is needed as these are still low levels but politicians get used to an annual windfall from ,lower bond yields and so any rise will be unwelcome. It is still true that up to the five-year maturity France can borrow at negative bond yields but it is also true that a chill wind of change seems to be blowing at the moment. The next funding auction will be much more painful than its predecessor and the number below suggests we may not have to wait too long for it.

The government borrowing requirement for 2017 is therefore forecast to reach €185.4bn.

Italy

Here in Mario’s home country the situation is more material as the ten-year yield has risen to 2.36% or 2% over that of Germany. This will be expensive for politicians in the same manner as for France except of course the yield is more expensive and as the Italian Treasury confirms below the larger national debt poses its own demands.

The redemptions over the coming year are just under 216 billion euros (excluding BOTs), or some 30 billion euros more than in 2016, including approximately 3.3 billion euros in relation to the international programme. At the same time, the redemptions of currently outstanding BOTs amount to just over 107 billion euros, which is below the comparable amount in 2016 (115 billion euros) as a result of the policy initiated some years ago to reduce the borrowing in this segment.

The Italian Treasury has also noted the trends we are discussing today.

As a result of these developments, the yield differentials between Italian government securities and similar securities from other core European countries (in particular, Germany) started to increase in September 2016……. the final two months of 2016 have been marked by a significant increase in interest rates in the bond market in the United States,

Although we are also told this

In Europe, the picture is very different.

Anyway those who have followed the many debacles in this particular area which have mostly involved Mario Draghi’s past employer Goldman Sachs will note this next bit with concern.

Again in 2017, the transactions in derivatives instruments will support active portfolio management, and they will be aimed at improving the portfolio performance in the current market environment.

Should problems emerge then let me place a marker down which is that the average maturity of 6.76 years is not the longest.

Portugal

Here the numbers are more severe as Portugal has a ten-year yield of 4.24% and of course it has a similar national debt to economic output ratio to Italy so it is an outlier on two fronts. It need to raise this in 2017.

The Republic has a gross issuance target of EUR 14 billion to EUR 16 billion through both auctions and syndications.

To be fair it started last month but do you see the catch?

The size was set at EUR 3 billion and the new OT 10-year benchmark was finally priced at 16:15 CET with a coupon of 4.125% and a re-offer yield of 4.227%.

That is expensive in these times of a bond market super boom. Portugal has now paid off some 44% of its borrowings from the IMF but it is coming with an increasingly expensive kicker. Maybe that is why the European establishment wanted the IMF involved in its next review of Portugal’s circumstances.

Also at just over five years the average maturity is relatively short which would mean any return of the bond vigilantes would soon have Portugal looking for outside help again.

As of December 31, 2016 the Portuguese State direct debt amounted to EUR 236,283 million, decreasing 0.5% vis-à-vis the end of the previous month ( 133.4% of GDP).

Comment

Bond markets will of course ebb and flow but recently we have seen an overall trend and this does pose questions for several countries in the Euro area in particular. The clear examples are Italy and Portugal but there are also concerns elsewhere such as in France. These forces take time but a brake will be applied to national budgets as debt costs rise after several years when politicians will have been quietly cheering ECB policies which have driven falls. Of course higher inflation will raise debt costs for nations such as Italy which have index-linked stocks as well.

If we step back we see how difficult it will be for the ECB to end its QE sovereign bond buying program and even harder to ever reverse the stock or portfolio of bonds it has bought so far. This returns me to the issues I raised on January 19th.

If we look at the overall picture we see that 2017 poses quite a few issues for central banks as they approach the stage which the brightest always feared. If you come off it will the economy go “cold turkey” or merely have some withdrawal systems? What if the future they have borrowed from emerges and is worse than otherwise?

Meanwhile with the ECB being under fire for currency manipulation ( in favour of Germany in particular) it is not clear to me that this from Benoit Coeure will help.

The ECB has no specific exchange rate target, but the single currency has adjusted as a consequence. Since its last peak in 2011, the euro has depreciated by almost 30% against the dollar. The euro is now at a level that is appropriate for the economic situation in Europe.

Portugal is struggling to escape from its economic woes

Late on Friday (at least for those of us mere mortals who do not get the 24 hour warning) came the news that the ratings agency DBRS had reduced Italy to a BBB rating. These things do not cause the panic they once did for two reasons the first is that the ECB is providing a back stop for Euro area bonds with its QE purchases and the second is that the agencies themselves have been discredited. However there is an immediate impact on the banks of Italy as the Bank of Italy has already pointed out.

Italy’s DBRS downgrade: a manageable increase in funding costs…..Haircuts on collateral posted by Italian banks: the value of the government bonds collateral pool alone would increase by ~8bn. ( h/t @fwred )

However this also makes me think of another country which is terms of economics is something of a twin of Italy and that is Portugal.

When we do so we see that Portugal has also struggled to sustain economic growth and even in the good years it has rarely pushed above 1% per annum. There have also been problems with the banking system which has been exposed as not only wobbly but prone to corruption. Also there is a high level of the national debt which is being subsidised by the QE purchases of the ECB as otherwise there is a danger that it would quickly begin to look rather insolvent. In spite of the ECB purchases the Portuguese ten-year yield is at 3.93% or some 2% higher than that of Italy which suggests it is perceived to be a larger risk. Also more cynically perhaps investors think that little Portugal can be treated more harshly than its much larger Euro colleague.

The state of play

This has been highlighted by the December Economic Bulletin of the Bank of Portugal.

Over the projection horizon, the Portuguese economy is expected to maintain the moderate recovery trajectory that has characterised recent years . Thus, following 1.2 per cent growth in 2016, gross domestic product (GDP) is projected to accelerate to 1.4 per cent in 2017, stabilising its growth rate at 1.5 per cent for the following years.

So it is expecting growth but when you consider the -0.4% deposit rate of the ECB, its ongoing QE programme and the lower value of the Euro you might have hoped for better than this. Or to put it another way not far off normal service for Portugal. Also even such better news means that Portugal will have suffered from its own lost decade.

This implies that at the end of the projection horizon, GDP will reach a level identical to that recorded in 2008.

This is taken further as we are told this.

In the period 2017-19, GDP growth is expected to be close to, albeit lower than, that projected for the euro area, not reverting the negative differential accumulated between 2010 and 2013

You see after the recession and indeed depression that has hit Portugal you might reasonably have expected a strong growth spurt afterwards like its neighbour Spain. Instead of that sort of “V” shaped recovery we are seeing what is called an “L” shaped one and the official reasons for this are given below.

This lack of real convergence with the euro area reflects persisting structural constraints to the growth of the Portuguese economy, in which high levels of public and private sector indebtedness, unfavourable demographic developments and persisting inefficiencies in the employment and product markets play an important role, requiring the deepening of the structural reform process.

After an economic growth rate of 0.8% in the third quarter of 2016 you might have expected a little more official optimism as they in fact knew them but say their cut-off date was beforehand, but I guess they are also looking at numbers like this.

According to EUROSTAT, the Portuguese volume index of GDP per-capita (GDP-Pc), expressed in purchasing power parities represented 76.8% the EU average (EU28=100) in 2015, a value similar to the observed in 2014.

It is at the level of the Baltic Republics, oh and someone needs to take a look at the extraordinary numbers and variation in the measures of Luxembourg!

House Prices

Here we see some numbers to cheer any central banker’s heart.

In the third quarter of 2016, the House Price Index (HPI) increased by 7.6% when compared to the same period of 2015 (6.3% in the previous quarter). This was the highest price increase ever observed and the third consecutive quarter in which the HPI recorded an annual rate of change above the 6%. When compared to the second quarter, the HPI rose by 1.3% from July to September 2016, 1.8 percentage points (p.p.) lower than in the previous period.

What is interesting is the similarity to the position in the UK in some respects as we see that house price growth went positive in 2013 although until now it has been a fair bit lower than in the UK. Of course whilst central bankers may be happy the ordinary Portuguese buyer will not be so pleased as we see yet another country where house price rises are way above economic performance. Indeed a problem with “pump it up” economic theory in Portugal is the existing level of indebtedness.

the high level of indebtedness of the different economic sectors – households, non-financial corporations and public sector – ( Bank of Portugal )

The debt situation

In terms of numbers Portuguese households have been deleveraging but by the end of the third quarter of last year the total was 78.6% of GDP, whilst the corporate non banking sector owed some 110.8% of GDP. At the same time the situation for the public-sector using the Eurostat method was 133.2 % of GDP.

Going forwards Portugal needs new funding for businesses but seems more set to see property lending recover if what has happened elsewhere after house price rises is any guide. Also the state is supposed to be reducing its debt position but we keep being told that.

The banks

It always comes down to this sector doesn’t it? Portugal has had lots of banking woe summarised by The Portugal News here just before Christmas.

The Portuguese state provided €14.348 billion in support to the banking sector between 2008 and 2015, according to a written opinion submitted by the country’s audit commission, the Tribunal de Contas, last year and made public on Tuesday.

That’s a tidy sum in a relatively small country and we see that the banking sector shrunk in size by some 3.4% in asset terms in the year to the end of the third quarter of 2016. In terms of bad debts then we are told that “credit impairments” are some 8.2% of the total although the recent Italian experience has reminded us again that such numbers should be treated as a minimum.

Last week the Financial Times reminded us that the price of past troubles was still being paid.

Shares in Millennium BCP fell by more than 13 per cent in early trading on Tuesday after Portugal’s largest listed lender approved a capital increase of up to €1.33bn in which China’s Fosun will seek to lift its stake from 16.7 per cent to 30 per cent.

Oh and this bit is very revealing I think.

The rights issue, which is bigger than BCP’s market value,

Comment

Let us start with some better news which is from the labour market in Portugal.

The provisional unemployment rate estimate for November 2016 was 10.5%

This represents a solid improvement on the 12.3% of 2015 although as so often these days unemployment decreases comes with this.

These developments in productivity against a background of economic recovery fall well short of those seen in previous cycles……. Following a slight reduction in 2016, annual labour productivity growth is projected to be approximately 0.5 per cent over the projection horizon.

Also there is the issue of demographics and an ageing population which the Bank of Portugal puts like this.

the evolution of the resident population,
which has presented a downward trend,

I like Portugal and its people so let us hope that The Portugal News is right about this.

Portugal has been named as the cheapest holiday destination in the world for Britons this year. The country’s Algarve region came top in the Post Office’s annual Holiday Costs Barometer, which takes into account the average price of eight essential purchases, including an evening meal for two, a beer, a coffee and a bottle of suncream, in 44 popular holiday spot around the world.

That’s an interesting list of essential purchases isn’t it? But more tourism would help Portugal although the woes of the UK Pound seem set to limit it from the UK.

 

 

 

 

Portugal seems set to be the worst casualty from higher bond yields

This morning has seen one of my recent themes continue to rumble around markets. The effect of the likely fiscal expansionism from President Trump that I discussed on the 9th of this month has continued for the US bond market. This morning we have seen a big figure change as the US Long Bond ( 30 year) yield has nudged over 3%. If we go back to the 9th it was doing this.

There has been a clear market adjustment to this which is that the 30 year ( long bond) yield has risen by 0.12% to 2.75%.

This has a clear economic impact as some US fixed-rate mortgages in essence track this rate so we will see higher quotes for them. Other US yields have risen too and this has driven yields abroad higher as well as for example the 30 year yield in Germany hit 1%. If we look at the UK there has been quite a change of tone for the UK Gilt market as Micheal Hewson has pointed out.

UK Gilt yields now at pre Brexit levels 1.433%

He means the benchmark 10 year Gilt. This leaves Bank of England Chief Economist Andy Haldane in something of a quandary as you see he promised a “sledgehammer” of monetary action but instead has spent some £33 billion on QE (Quantitative Easing) Gilt purchases to find he has put the UK taxpayer on this.

We’re on a road to nowhere
Come on inside
Takin’ that ride to nowhere
We’ll take that ride

No doubt Bank of England Governor Mark Carney will be along to explain how yet again Forward Guidance looks like one of the “cunning plans” so beloved of Baldick of the TV series Blackadder.

Pain for Portugal

Not much pain is to be seen in the media as I note today it is full of reports of Christiano Ronaldo’s 2 goal haul and penalty miss. But you see the bond market tantrum has meant that the ten-year yield in Portugal is now 3.67%. A while ago the financial media were very concerned about it passing 3% but now a fair bit higher number is mostly passing unnoticed! If we move to intra Euro issues then there is a significance in the fact that it is well over 3% higher than the same maturity of Germany ( 3.31%).

This yield is in spite of the fact that up to the end of last month the ECB had purchased some 22.9 billion Euros of Portuguese Government Bonds.

The National Debt

This is an issue for Portugal as the Bank of Portugal describes in its latest Monthly Bulletin.

At the end of the first half of 2016, the public debt-to-GDP ratio stood at 131.7 per cent (121.8 per cent of GDP, excluding central government deposits), after reaching 129 per cent at the end of 2015 (121.6 per cent of GDP, excluding central government deposits).

Remember when the Euro area established a ratio of 120% for this metric on the early days of the Greek crisis? They must have regretted that very much as Italy and Portugal cruised by it. It is also revealing when you get a different number which of course is always lower but means using a different set of rules to the benchmark! As ever the official view is that the number is about to fall and to 124.8% but even the Bank of Portugal calls that “particulaly demanding”.

Fiscal problems

If we look at the numbers in relative and indeed comparitive terms the deficit is not large. From the Bank of Portugal.

, the general government deficit stood at 2.8 per cent of GDP in the first half of 2016, compared with 4.6 per cent in the same period of the previous year.

The catch is that it comes on top of the national debt and worryingly not with the revenue growth hoped for.

In the first half of 2016 total revenue grew, yearon-year, by 1.7 per cent, which was significantly lower than the yearly projection (3.3 per cent),

Also you may note that Portugal is still under the Euro area austerity program at least implicitly and the switch to fiscal expansionism seems to have by-passed it.

Economic Growth

This is a road which so often seems to start hopefully as Venture Beat illustrate here.

As Web Summit arrives in Lisbon, Portugal tries to seize its startup moment with $220 million fund

Let us hope so although the reports of  this will not have helped much. From @InsurgentPT

Portugal organizes #WebSummit. Wi-fi connection fails in the first day. Investors might not be impressed

In a way it always seems to turn out like that as hopes fade and growth at best ends up of the order of 1% as this from the Bank of Portugal shows.

Projections for the Portuguese economy point to a deceleration in GDP, from 1.6 per cent in 2015 to 1.1 per cent in 2016.

It blames “idiosyncractic structural constraints” which is odd after all the reforms we were told ( Remarkable progress according to Mario Draghi) have happened isn’t it? Actually this is especially worrying for those who have proclaimed reform.

The pace of growth in economic
activity has stood below that of previous
business cycles, namely affected by high levels
of indebtedness in the public and private sectors,
adverse demographic developments and
a macroeconomic environment characterised
by relatively weak external demand dynamics.

So worse rather than better? This poses more than a few questions when we note that the Euro economic experience for Portugal has been dogged by slow economic economic and that is in the better times.

As we look for reasons some can be bad luck as for example there were times that the large Volkswagen plant in Portugal would only bring good economic news. But the problems of corruption and cronyism in the banking sector has not only affected the national debt as more and more bailout have taken place but it has left the banks unable to support economic growth. There is something of a trap here as the weak banks struggle with non-performing loans but not supporting the economy only leads to them being more of a problem. Also Portugal’s businesses are rather indebted according to the Economist.

Investment is being stifled by the weight of the corporate sector’s debt, which is close to 140% of GDP.

Comment

We need some nuance and sense of scale here as the bonds yields of today are nothing like the 17/18% seen in Portugal before it called for a bailout.  But they do pose problems as the fiscal windfall from lower bond yields invariably gets spent which is awkward when it fades. Also what happened to the economic growth from the windfall? This is a familiar theme as remember when Novo Banco was translated as New Bank and then turned out to be “meet the new boss,same as the old boss”?

Novo Banco’s legacy assets, however, turned out to be worse than expected, making it virtually impossible that the lender will be sold for anywhere near the €4.9 billion ($5.46 billion) capital injection it received. ( Wall Street Journal)

There are five bids for it again as we wonder how much they will pay for a bank who has just made a profit but of only 3.7 million Euros.

On the other side of the ledger there have been gains in Portugal as for example the unemployment rate has fallen to 10.5%. If the Algarve Daily News is correct maybe it needs find a way of reducing the undergorund economy.

Portugal’s grey economy, the parallel under-the-counter trade in goods and services, remains buoyant, reaching over 27% of the nation’s Gross Domestic Product last year.

The un-taxed economy, which keeps many from poverty despite its illegality, is running at the highest percentage since 2010……Portugal leads many of its peers too as the OECD average grey economy is just 16.4% of GDP.

Wasn’t this supposed to be another example of reform? Against that even a Euro below 1.08 versus the US Dollar will not help that much.

Also let me give my best wishes to those on South Island in New Zealand after the weekend earthquake.

 

 

 

 

 

How has the Euro era worked out for the economy of Portugal?

It is time again to take a look at the economy of what is the oldest ally of England and Wales. Yes so old that it precedes the union with Scotland. This is because there is news on economic developments in Portugal both from it and the International Monetary Fund or IMF. Having been involved in a program for Portugal the IMF is keen to open with a positive spin on things.

Portugal has achieved a major economic turnaround since the onset of the sovereign debt crisis. Access to financing was restored following the large fiscal adjustment, the external current account position has moved from a large deficit into surpluses, while the unemployment rate—though still at high levels—declined sharply.

Actually there is a bit of a flicker of old era IMF here as we note the emphasis on the current account but there is a catch in that Portugal has not been able to avail itself of the next part of that play book which is a lower currency due to its Euro membership. Also we should welcome the lower level of unemployment.

A very familiar theme

It is kind of the IMF to confirm that my major economic theme on Portugal is in play. For newer readers it goes as follows. Whilst Portugal has down turns sadly in the good times it only manages economic growth of about 1% per annum. So let us note that according to the IMF “Good Times” by Chic should be on the turntable.

still-favorable cyclical tailwinds and supportive macroeconomic policy settings. The fiscal loosening in place since last year and the ECB’s appropriately supportive monetary policy stance…….. Historically low yields, notwithstanding occasional bouts of volatility, have afforded the public and household sectors relatively easy access to finance, and facilitated an expansionary fiscal stance since 2015

And yet.

The slowdown in economic activity that began in the second half of 2015 has persisted.

Putting that another way economic growth in the last three-quarters has gone 0.2%,0.2% and then 0.3%. If we note the lower oil price and all the monetary easing that is not much of a return and reminds me of my 1% cap on economic growth. Also as the IMF implies but does not say the way that the bond buying of the ECB has depressed Portuguese bond yields has allowed its government to spend more.

Looking Forwards

The IMF tells us this.

the 2016 growth forecast has been revised down, from 1.4 to 1.0 percent for this year.

Actually they think the same for 2017 as well as 1.1% the forecast which of course returns us to my theme. Let us now examine why they think this. Firstly we get something very familiar.

Directors emphasized that pushing ahead with structural reforms remains critical to enhancing competitiveness and promoting growth. They encouraged the authorities to fully implement the already-enacted reforms in labor and product markets,

I will leave the IMF to explain how you need to push ahead with something you have already implemented! The reality is of course that far fewer reforms have happened than claimed.

Also another regular theme mentioned yesterday and back on the 25th of July appears.

As banks continue to struggle with a large stock of NPLs, low profitability, and high operating costs, they are unable to reduce corporate indebtedness and provide adequate lending for investment.  (NPLs are Non Performing Loans)

This particular mess is self-reinforcing as of course a weak economy weakens the banks in the same way that weak banks weaken the economy.

Recapitalization needs of the largest bank Caixa Geral de Depósitos (CGD) and possible losses from the sale of Novo Banco may necessitate further injections of public money

There is also an issue with investment which the IMF skirts a little so let me switch to Portugal Statistics or INE.

Investment recorded a year-on-year change rate of -3.0% in volume in the second quarter, after a reduction of 1.2% in the previous quarter.

Same as it ever was

This bit is rather familiar from Portuguese economic history.

The ongoing recovery has largely been consumption-driven. Household consumption has grown by 10 percent between 2013Q1 and 2016Q1, even though disposable income has only increased by 4 percent over that period.

There is a glaring problem there as this looks unsustainable especially as we note this.

an unprecedented decline in the savings rate,

This type of growth has an issue.

The current account posted a surplus in 2015 for the third year in a row, but some weaknesses are emerging.

It is good that the balance of payments improved but it did have a following wind via the fall in commodity prices. We will see going forwards if it can be sustained. Here is the latest data which simultaneously boost recorded GDP and poses a question or two.

In the quarter ended in July 2016, exports of goods decreaseit wasd by 2.3% and imports of goods declined by 3.9%, when compared with the quarter ended in July 2015.

According to the Bank of Portugal tourism is a bright spot.

The ‘Travel and tourism’ item posted a positive balance of €4,385 million, i.e. 11.5 per cent more than in the same period of 2015

More austerity

Actually both Portugal and the IMF are in something of a mess here! Remember the U-Turn the IMF did on austerity and fiscal stimulus? Well not here.

A credible fiscal adjustment is therefore needed to put public debt on a firmly downward trajectory and ensure the medium-term sustainability of public finances.

Okay how much?

A structural primary adjustment of 0.5 percent of GDP in 2017 and 2018 would be an appropriate fiscal path, but that should be underpinned by credible measures.

They have little faith in the current plans it would appear and they are switching Portugal from a small fiscal stimulus to a contraction which if the economy does slow may well plunge it back into the mess it was so recently in.

The Bank of Portugal has told us that the national debt was 240.9 billion Euros at the end of July which makes the national debt to GDP ratio just under 132% by my calculations. This is a number which is always supposed to fall but yet keeps rising even in this better phase for the economy.

In terms of cost of the debt this is being kept under control by the QE bond buying of the ECB.

Unemployment

This is a nuanced situation as whilst it has improved it is still high.

In July 2016, the provisional estimate for the unemployment rate was 11.1%, remaining unchanged from the definitive previous month’s level.

It is not a good time to be young although again the numbers have improved.

Comment

The overall problem can be summarised thus. Back in the second quarter of 2004 Portugal had a GDP of 43.3 billion Euros and in the second quarter of 2016 it was 43.1 billion Euros. Thus we see yet another economic depression in Europe. Meanwhile the lack of economic growth saw the national debt to GDP ratio soar from 61% in 2004 to 132% now.

If we jump back in time to 2004 the European Commission told us this about Portugal.

Starting in early 2001, growth dwindled and the economy slipped into recession in late 2002. In 2003, GDP is estimated to have fallen by ¾%, almost the weakest
performance among EU Member States.

How is the Euro working out for Portugal? Also the future does not look so bright.

Portugal is projected to face large adverse demographic developments. According to UN projections, Portugal’s population has started to decline (by 2.2 percent between 2010 and 2015), and would further shrink by about 30 percent by 2100 in the baseline scenario,

I can vouch for some of the migration as for example Stockwell also has the name Little Portugal.

How are our banks still in so much trouble?

A major theme of the credit crunch era has been the banking crisis in so many places followed by the many bailouts under the Too Big To Fail or TBTF strategy. The catch is that this week has seen more signs of distress for various banks more than 8 years after the collapse of Lehman Bros which by definition shows that the strategy such as it was is continues to fail. What is supposed to happen is that the can is kicked into the future via the bailouts and then we pick the can up later in better times. Indeed in the past central bankers have been able to bask in the reflected glamour of a successful intervention.

Economic policy has been warped to suit the banks

It bears repeating that the economic response has been more for the banking sector than the real economy. The initial slashing of interest-rates benefited them and the proliferation of QE improved the value of their bond holdings. Also in a rather transparent move countries cut interest-rates to a lower bound for their banks. What I mean by this is that the Bank of England stopped originally at 0.5% because it was afraid that the creaking IT systems of the UK banks could not cope with any negative numbers.

More recently we have seen blatant subsidies to the banking sector. The UK started one this week which is the Term Funding Scheme where UK banks will be able to borrow up to £100 billion at an interest-rate of 0.25%. This of course follows on from the Funding for (Mortgage) Lending Scheme which not only gave then cheap finance but boosted one of the main assets house prices. Only yesterday the Bank of Japan warped its buying of equities towards an index in which banks are more strongly represented. The TOPIX bank index rose by 7% on the day.

Also banks are often excepted from negative interest-rates either by also being given money at the negative interest-rate ( i.e even better than free money) like the TLTROs of the European Central Bank or simply being excluded from them like in Japan. Actually the -0.1% interest-rate there is more honoured in the breach than the observance.

House prices

A big gain for banks is rising house prices a subject I have covered extensively in the UK. This week has given us some news on this front from the Euro area as some countries respond to all the monetary easing. From Netherlands Statistics.

Prices of owner-occupied houses (excluding new constructions) were on average 6.0 percent higher in August 2016 than in August 2015. This is the most substantial price increase in 14 years.

And on Tuesday Portugal Statistics joined the party.

In the second quarter of 2016, the House Price Index (HPI) registered an increase of 6.3% when compared to the same period of the previous year….When compared to the first quarter of the year, the HPI increased by 3.1%

Now these are only 2 of the Euro area countries but we do get a clue that the picture has changed for this major part of banks asset books.

UK Banks

The Bank of England has summed up the situation only this morning.

Market valuations of major UK banks remain, in aggregate, well below their book value.

This poses a direct problem for the TBTF strategy as the investments of the UK taxpayer are currently well underwater especially in the perpetually crisis ridden Royal Bank of Scotland. It symbolically has fallen another 2 pence today to £1.81 which compares to a peak over the past year of £3.34. With the travails of the world shipping industry it was sadly typical to find the accident prone RBS affected. Lloyds Banking Group at 56 pence is also well below the price at which the UK taxpayer invested although some of the shares were sold in better times. Whilst HSBC for example has done much better in share price terms the two main bailed out banks have hit more trouble after all these years. Also there is an implicit admittal from the Bank of England that it is still providing a subsidy.

bank funding costs remain significantly lower than during previous episodes in which market valuations have been well below book value.

Deutsche Bank

The topic du jour in banking and semaine and mois. For all the official proclamations that everything is fine we see rumours continue to circle particularly about the derivatives book. Yesterday its share price fell back close to its lows again and whilst it has rallied today the current price of 11.44 compares to a high of 27.98 Euros over the past 12 months. It faces a conundrum where it would like more share capital but that is increasingly difficult due to the low share price. A vicious rather than a virtuous circle is in play as represented by this from Bloomberg.

Leverage ratio — a lender’s capital measured against its assets — at Deutsche Bank lags behind the rest of the world’s major banks, according to data released Tuesday by Federal Deposit Insurance Corp……While it’s not an official scoring by the FDIC, Hoenig’s calculations put more emphasis on derivatives exposure,

There are obvious issue such as the upcoming fine over mortgage miss selling in the US. It is likely to be a fair bit below the US $ 14 billion mooted but none the less Deutsche could do without it right now. Of course it has not actually been bailed out except implicitly but we have to ask how it has such problems 8 years down the road.

Monte dei Paschi

The world’s oldest bank seems like an old friend on here now. It was only a few short weeks ago when we were told that everything was on its way to being fixed and yet yesterday Reuters reported this.

Monte dei Paschi shares fell for eight sessions in a row, shedding 26 percent of their value, after the unexpected resignation of CEO Fabrizio Viola on Sept. 8 added to uncertainty over the lender’s future.

This particularly matters right now because it does this.

a string of losses that have shrunk the bank’s market capitalisation to one ninth of the size of a planned 5 billion euro (4.31 billion pounds) share issue.

You get an idea of the scale of the change as I remember making a mental note that it was one fifth back then as opposed to the one ninth now. Ouch!

If we move to the wider issue of the Italian banking sector it is true that the Non Performing Loans look like they are topping up. The problem is that share prices and hence bank capital have fallen much more quickly.

Comment

As time passes it becomes ever more glaring that many of the banks were not fixed but simply patched-up and told to carry on. It is not just a European issue but that area is making the news right now with Fitch pointing out problems for Portugal earlier today a subject I covered on the 25th of July.

But asset quality is still a major weakness for the banking sector and, in our opinion, makes banks vulnerable to downside risks from the highly indebted Portuguese economy. The unreserved portion of problem assets exceeds 100% of capital at CGD, BCP and Montepio.

Indeed there was not much sign of European solidarity in this reported by Reuters about Italian Prime Minister Renzi on Monday.

Italian Prime Minister Matteo Renzi said on Monday that Germany’s central bank chief Jens Weidmann should concentrate on fixing the problems of his own country’s banks, after Weidmann had urged Italy to cut its huge public debt.

Renzi told reporters in New York that Weidmann needed to solve the problem of German banks which had “hundreds and hundreds and hundreds of billions of euros of derivatives” on their books.

So after all these years the words from Alice In Wonderland sum it up well.

In another moment down went Alice after it, never once considering how in the world she was to get out again.

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