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25th Oct 2021

Contagion threat to Portugal, Italy grows

The Bank of Portugal has warned of the "unsustainable" borrowing on the part of domestic financial institutions, who will have difficulty turning over their debt if the government's efforts to impose austerity measures founder.

A report from the central bank on Tuesday (30 November) said that while Portuguese banks face "no intrinsic profitability or solvency problems" as a result of the ongoing European sovereign debt crisis, they have been unable to access international capital markets and have as a result been forced into a "permanent and large-scaled" dependence on the European Central Bank for liquidity, adding that this is "unsustainable."

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  • The Bank of Portugal in Lisbon: dependence on the ECB is 'unsustainable' (Photo: Pieter Musterd)

Any moves on Frankfurt's part to begin to withdraw the lifeline, which the report underlined was "temporary," would put further pressures on the banks.

As the bulk of lending by the banks has been to the government rather than to the private sector, should Lisbon fail in its efforts to impose its draconian restructuring programme, they may have trouble refinancing their debt.

The warning comes atop a move by ratings agency Standard & Poor's on Tuesday to put the country on a credit watch as a result of concerns over the state's solvency.

The same day, the yield on the country's 10-year bonds climbed again, to 7.072 percent from 7.0 on Monday. Meanwhile, Italy, Spain and Belgium are all being hit with record bond spreads compared with German bonds. The Spanish-German spread has climbed to a record 3.0 percent.

The euro also dropped below $1.30 for the first time since September, to $1.2982.

Portuguese opposition leader Pedro Passos Coelho, of the Social Democrats, who are actually conservatives despite their name, also this week admitted that the country may have to seek an EU-IMF bail-out, which would make the country the third eurozone player to do so, alongside Greece and Ireland.

Spanish deputy finance minister Jose Manuel Campa continued to try to inoculate his country against the contagion, insisting that the spike in borrowing costs are temporary and would soon lower once markets began to understand that Madrid has managed to impose reforms.

"We cannot react to fluctuations of one or two days on the market, especially at times when, given the market tensions, there is a perception that liquidity is smaller than in normal market conditions," he said. "These are short-term fluctuations. We are currently in a period of turbulence. What is important is to execute planned policies and the markets will respond."

Rome meanwhile has been disturbed by how quickly Italy has become embroiled in the spreading crisis.

The Financial Times on Wednesday reported that Prime Minister Silvio Berlusconi warned cabinet colleagues of the record bond spreads between 10-year Italian bonds and their German counterparts.

On Tuesday, they hit 2.10 percent over German bonds, the highest since the creation of the euro.

Cabinet undersecretary Gianni Letta also fretted over the situation, saying that investors were attempting to "spread the contagion from Ireland to more solid countries such as Spain and Portugal, and maybe even Italy."

In a conference speech ahead of World Aids Day, Mr Letta took the epidemiological metaphors to an extreme, saying he feared: "euro market shocks that may contaminate other more solid countries like Spain, Portugal and Italy" and that "market turbulences are more infectious than Aids and a vaccine is needed."

He felt that Italy would "remain immune" once the government, which is facing a confidence vote in two weeks, had overcome its current political crisis - a leadership battle between the prime minister and his former ally, the self-styled post-fascist Gianfranco Fini.

Prime Minister Berlusconi however all but threw his Iberian cousins under the bus in his attempt to soothe markets, saying: "Spain has been faring much worse than us."

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