Portugal bond sale opens way to bailout exit

Portugal has issued €750m of 10-year bonds at its first regular debt auction since succumbing to a joint €78bn eurozone and International Monetary Fund bailout in 2011.

The auction, which came at a better than expected yield of 3.57 per cent, opens the way for Portugal to become the second eurozone country, after Ireland, to exit its three-year bailout programme without the safety net of precautionary EU funding.

The size of the auction was at the very top end of the range indicated by the IGCP debt agency. Despite the maximum size, Wednesday's offer enjoyed a bid-to-cover ratio of 3.47 times, Bloomberg reported, citing the IGCP.

After the auction, the Portuguese 10-year bond yield fell 5.5 basis points to a fresh eight-year low of 3.63 per cent on Wednesday, as investors welcomed the successful issuance. That compares to a 10-year yield peak of 17.39 per cent in early 2012.

Lisbon returned to the bond market last year but through so-called "syndications", or sales arranged by a slew of investment banks. This is the first auction of longer term bonds managed by the country itself since requesting a bailout in April 2011.

Portugal's government will soon announce whether it will exit its bailout programme with or without a precautionary credit line from the European Stability Mechanism - the eurozone's new permanent rescue fund - but the successful auction burnishes its chances of making a clean getaway from the programme. This would be a remarkable turnround from only six months ago, when many investors and EU officials were convinced Lisbon would need a second full bailout when the current programme ends in May.

"There's a 90 per cent probability that the government has already made a decision to go for a clean exit, mainly for international and domestic political reasons," Antonio Roldan, an analyst at the Eurasia Group, said ahead of the auction.

Yields on Greek, Irish, Spanish and Portuguese debt have all fallen recently, partly in expectation that the European Central Bank will embark on large-scale asset buying, or quantitative easing, to fend off deflation.

But the centre-right government of Pedro Passos Coelho, the prime minister, will also be hoping to take some of the credit for what promises to be another successful bond sale for a crisis-hit eurozone economy.

Christian Schulz, a senior economist with Berenberg, said: "Portugal is on track to repeat Germany's successful conversion from the unsustainable sick man of Europe to a competitive and balanced growth champion." He added that he expected Lisbon to exit its bailout programme "without any tensions".

The prime minister insists no decision has yet been taken on whether Portugal will rely solely on market funding after its bailout, which officially ends on May 17, or seek a "precautionary" credit line from the EU on which it could draw if market borrowing costs rose to unsustainable levels.

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"After three years of tough austerity, there is a clear desire on the part of Portugal's creditors to be able to say their policies have worked," says Mr Roldan. "They are also politically adverse to having to commit any more money to a bailed-out country."

Domestically, the two parties that make up the centre-right government have already begun to talk about "regaining sovereignty" from the so-called "troika" of international lenders, which this week began its last quarterly review of Lisbon's compliance with its bailout programme.

Remaining under further surveillance, even over the much lighter conditions attached to a credit line, would be highly damaging for the government parties in the run-up to the European ballot and ahead of a Portuguese general election scheduled for 2015, particularly as the opposition Socialists are hammering home the message that anything other than a clean exit would amount to failure.

Similar to Ireland before its bailout exit, Portugal has built up a sizeable cash buffer of more than €15bn that should cover the government's financing needs for about a year after the bailout ends. This will help reassure investors that Lisbon would be protected from any financial market turbulence in 2014.

However, unlike Ireland, which had posted three consecutive years of economic growth before leaving its adjustment programme, Portugal is only just beginning to emerge from its harshest recession in 40 years.

Although Lisbon's bailout lenders have revised this year's growth forecast from 0.8 per cent to 1.2 per cent, the incipient turnround has not yet made any significant impact on a society that has been deeply scarred by record unemployment, government spending cuts and some of the biggest tax increases in the developed world.

Portugal also differs from Ireland before its bailout exit in having its sovereign debt rated at below investment grade by all three big rating agencies. Mr Schulz says the agencies have been slow to follow markets in rewarding struggling eurozone countries such as Portugal for reforming their economies and eliminating external deficits.

This month Fitch Ratings changed the outlook on its BB plus rating for Portugal from negative to positive, increasing the possibility that Lisbon could regain an investment grade rating relatively soon. But, says Mr Schultz, junk status ratings "could still make Portugal's bailout exit more difficult", creating technical problems for the ECB that he believes "will probably still play a role" in decisions on the exit by both Lisbon and Brussels.

Another risk that sets Portugal apart from Ireland is the lack of a broad cross-party agreement on a fiscal and reform strategy for the post-bailout era. "There's a danger that the removal of external constraints, like the adjustment programme and high borrowing costs, coupled with elections in 2015 will diminish the impetus to reform," says Mr Roldan. "This raises the question of whether Portugal has made enough structural reforms to sustain a sufficient level of growth to meet its big debt and unemployment challenges."

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