Portugal follows Greece on austerity path

08/03/2010 20:15:50

Portugal became the latest euro zone country to announce austerity measures to rein in a ballooning budget deficit on Monday as debt-stricken Greece urged global action to curb speculation in credit default swaps.

The European Commission said it was prepared to propose the creation of an IMF-style European Monetary Fund to cope with future debt crises in the euro single currency zone. Germany's finance and economics ministers voiced support for the idea but the European Central Bank's chief economist branded it illegal.

EU sources said finance ministers of the 27-nation bloc would discuss ways to dampen speculation in the sovereign CDS market at their next meeting on March 16.

Hedge funds have been accused of aggravating the Greek debt crisis by so-called "naked short selling" -- betting on a default without owning the underlying Greek bonds, hence forcing up Athens' borrowing costs.

Greek Prime Minister George Papandreou, who took draconian austerity measures last week to stem attacks on his country's debt, called credit default swaps a "scourge" that threatened the Greek and global economy and asked the United States to join Europe in action on the issue.

"We need clear rules on shorts, naked shorts and credit default swaps. I hope there will be a positive response from this side of the Atlantic to bring this initiative to the G20," he told the Brookings Institution on a visit to Washington, where he will meet President Barack Obama on Tuesday.

Portugal announced plans to cut its deficit to 2.8 percent of gross domestic product in 2013 from

8.3 percent this year by trimming spending on civil servants and public investment, and raising taxes on high incomes and stock market gains.

The programme is seen as the key to convincing markets that Portugal will tackle its high deficit and debt after coming under scrutiny by investors fearing it may be next in line to have Greek-style fiscal problems.

Under the plan, Portugal's public debt would peak at 90.1 percent of GDP in 2012 and fall thereafter. Greece's debt is set to reach 125 percent of GDP this year.

"This is a bet on reducing the weight of the state in the economy and the weight of public spending," Portuguese Finance Minister Fernandio Teixeira dos Santos said.

SARKOZY CALMS MARKETS

Borrowing costs of the peripheral euro zone countries and the price of insuring their debt against default both fell after French President Nicolas Sarkozy gave the clearest indication so far that firm plans to help Greece were ready if needed.

The premium investors charge to hold Greek debt rather than German benchmark bonds has risen as high as 400 basis points this year, prompting Athens to announce its third and most draconian package of public sector pay cuts, a pensions freeze and sales tax rises last week.

The Greek bond spread fell to 283 bps after Sarkozy told Papandreou on Sunday that the euro zone would stand by Greece. French Finance Minister Christine Lagarde was working with euro zone colleagues "on a certain number of precise measures if Greece needs them," he said.

Analysts said the Portuguese stability programme was more cautious than Greece's in its growth and revenue assumptions, but extra measures might still be required if growth fell short.

"The plan is positive because the largest part of financial improvements comes from the spending side," said Paula Carvalho, economist at BPI. "Maybe the only criticism that can be done is that the economic growth setting might be a bit too optimistic."

Portugal's spread over benchmark 10-year German bunds stood at 109 basis points on Monday, down from a peak of 175 bps on February 4 at the height of the market panic over Greece. Spain's spread was down to 67 bps, the lowest since mid-January.

European Economic and Monetary Affairs Commissioner Olli Rehn said in a newspaper interview that Paris, Berlin and Brussels were working on an EU instrument that could help euro zone states in trouble on "strong conditions."

German Finance Minister Wolfgang Schaeuble, in charge of Europe's biggest economy, and Economics Minister Rainer Bruederle endorsed the idea of a European Monetary Fund.

But ECB chief economist Juergen Stark, an old-school German deficit hawk, said the idea would breach the treaty rules of European economic and monetary union, giving perverse incentives to lax countries at the expense of states with solid finances.

Rehn's spokesman told a news briefing the EU executive was ready to propose setting up a rescue fund for the euro zone, drawing on the lessons from the Greek crisis.

"The Commission is ready to propose such a European instrument for assistance which will require the support of all euro area member states," sp

okesman Amadeu Altafaj Tardio told a briefing in Brussels.

However, he stressed that details of the idea, including whether it would require an amendment to the EU treaty, had yet to be pinned down, and the instrument would not be ready in time to be relevant to the current crisis.

(Additional reporting by Paul Carrel in Berlin, Huw Jones and William James in London and Lesley Wroughton in Washington; writing by Paul Taylor; Editing by Charles Dick)