It's been more than 400 years since Portugal's King Sebastian disappeared on the heels of a disastrous military foray he led into Morocco, but the legend lives on: One misty morning, the monarch will return to Portugal and rescue his countrymen in their most desperate hour of need.
Scan the southern horizon. It's a great time for some immortal, kingly intervention to save the day.
Portugal occupies a dubious place in the "who-falls-next" panic being played out in Europe. Invariably lumped together with Greece and Spain and cast as even more troubled than Ireland, Portugal is like the weak bystander who gets trampled by the stampeding mob. This feeling of helplessness leaves the populace wounded and perplexed. While the Portuguese acknowledge their economy has major structural problems, they wonder not only why global markets are running all over them, but what they can do to get out of the way.
"This is a crisis of faith," says a Rocha de Carvalho, a Lisbon-based real estate lawyer. "What we don't see is where the solution will come from in the end."
Portugal's story is different from that of other imperiled European countries. While Greece created a retirement system that is a fool's paradise, Portugal fashioned one of Europe's soundest. While both the Greek and Spanish governments dithered, Lisbon responded to the assault on the euro with stringent budget reductions including cuts to welfare and tax breaks. "Portugal is able and willing to make adjustments when needed. It hasn't happened in Spain. It hasn't happened in Greece," says Pedro Siza Vieira, managing partner and head of finance and projects in Lisbon for law firm Linklaters LLP.
Yet common perception globally makes little distinction between Portugal and Europe's other besieged nations. "International creditors are saying the problem is southern Europe," says Siza Vieira. End of story.
"Everyone assumes we're overheated like Spain and with a level of [government] indebtedness like Greece," Rocha de Carvalho maintains, adding, "Portugal gets a raw deal."
That said, even the most sympathetic voices acknowledge Portugal must work through some serious economic woes. These include an unhealthy dependence on external capital and a highly indebted populace. The evisceration of export markets and a relatively immature private sector that faces increasing problems come on the heels of anemic growth for the past decade, which averaged less than 1% a year.
What really spooked the credit agencies was Portugal's budget deficit, which ballooned last year to 9.4% of GDP, the fifth largest in the EU.
Many economic analysts, however, believe the government of Prime Minister José Sócrates can tame the deficit in relatively short order. According to Cristina Casalinho, chief economist of Portuguese bank Banco BPI SA, government austerity measures already in place should reduce the budget deficit to 7.3% this year and 4.6% in 2011, a two percentage point drop from what the government proposed before the crisis.
Fitch Ratings cut its credit rating of Portugal's sovereign debt on March 24. Fitch questioned whether Portugal's anemic economy can support an assault on the budget deficit. It warned that Portugal's prospects for economic recovery trail those of other EU nations.
Despite a rousing first quarter, in which the GDP grew 1.1% over the previous quarter, Casalinho estimates Portugal will register just a 0.5% GDP increase this year and 0.7% in 2011.
"Most growth factors of the past decade are now in doubt," he says, citing, among other factors, an export market that has largely fallen prey to Asian competition. "It's difficult trying to figure out what kind of sustainable growth engine will enable the Portuguese economy to take off again."
Portugal's private sector is led by large, quasi monopolies formerly owned by the state. Numerically, however, small and midsized companies dominate, and as Rocha de Carvalho explains, "You don't find a lot of strong [private-sector] companies." "Small and medium-sized businesses rely on bank debt," adds Siza Vieira. "Banks are not renewing credit lines. That puts companies into distress."
The strain is showing. Unemployment has spiked to more than 10%, a 15-year high. "Every day, we see that 20, 30 companies are declared insolvent by the courts," says João Maria Pimentel, a Lisbon-based insolvency specialist at law firm Uría Menéndez-Proença de Carvalho. "The number has increased dramatically in the past two years."
Pimentel stresses that the insolvencies to date are overwhelmingly small and midsized companies, often with few assets left at the end. "For the time being, the major companies will survive," he says, adding that banks continue to support their ongoing lending exposure to large clients. But he warns that the situation could deteriorate very rapidly if there's panic in the banking system. One big fear: another ratings agency downgrade. "That would have tremendous impact," he says.
The government already found it must cope with a much higher rate for its debt. On June 9, Portugal paid 5.225% on €816 million ($1 billion) worth of 10-year bonds; a month earlier, it was 4.523%.
The Portuguese unit of German chipmaker Qimonda AG so far has ranked as the country's biggest private-sector insolvency. Qimonda went bust in Germany in January 2009, with more than €2 billion in liabilities and a €2.33 billion loss for the nine months ended June 30, 2008. The insolvency followed the collapse of a €325 million bailout package, €100 million of which was to be provided by the Portuguese government in return for more activity sourced to Portugal.
Once the country's single-largest exporter, Qimonda Portugal filed for insolvency two months later. Most of the company was liquidated; an auction for Qimonda Portugal equipment was announced in March. However, under a reorganization plan in February, Portugal's two largest private banks -- Banco Espírito Santo SA and Banco Comercial Português SA -- combined with an investment arm of the government to bankroll a new company from the debris of Qimonda Portugal called Nanium SA, which makes semiconductor-related testing equipment and packaging and employs almost 400 workers.
The banking system has survived pretty much intact, with only two institutions so far going belly up. One collapse came in April, when Banco de Portugal, Portugal's central bank, announced Banco Privado Português would be wound up and liquidated. This followed an unsuccessful effort by the Finance Ministry to keep the private bank afloat through a government-guaranteed €450 million loan, a process that landed the government in hot water with the European Commission on competition grounds. The bank specialized in asset management for wealthy individuals. At the time of the announcement, the central bank was investigating Banco Privado Português for irregularities. Local media reports say the bank managed €2 billion in assets for some 3,000 customers.
In November 2008, the government nationalized an even smaller institution, Banco Português de Negócios SA, amid fraud allegations. The government says that it will soon invite bids to take the bank private.
One big reason banks did relatively well: Unlike Spain and Ireland, Portugal resisted a real estate bubble fueled by easy credit. "Banks' exposure to real estate is low," says Manuel Puig, a Lisbon-based managing director at Jones Lang LaSalle. Puig says the real estate market, while weakened, remains relatively stable. In part, that's because in Portugal homeownership is far more commonplace and preferable than renting. This means the real estate market continues even during times of economic stress.
According to an April 2009 note by international law firm Mayer Brown LLP, state-run Caixa Geral de Depósitos SA, the country's largest bank, holds one-third of all mortgages in Portugal. Housing values are declining, and home-owners are stretched. So far, at least, banks haven't resorted to large numbers of foreclosures.
Spain's disastrous property bust created collateral damage in Portugal. Spanish developers including Martinsa-Fadesa SA, which went bankrupt in July 2008 with €5.2 billion in liabilities, had sizable operations in Portugal.
Whether Portuguese property developers survive has yet to be played out. Puig is fairly upbeat. While some small and midsized firms have gone bust, only "two or three medium-sized developers are now in trouble."
Pimentel is less sanguine. "Every day we know of small development companies that have been declared insolvent," he says, adding this warning: "There is a danger for big developers. There is a huge risk for a few big ones."
The country reformed its insolvency code in 2004. It gives creditors more clout, puts debtors on a stricter reporting schedule and offers an out-of-court restructuring alternative. In practice, however, the courts are so clogged that insolvency proceedings can stretch out forever. "Insolvency procedures can last 10, 20 years," says António Teles, a Lisbon-based partner at Sérvulo & Associados, with just a touch of hyperbole. "They're full of appeals and technicalities." At the end of the day, "privileged creditors may get 10%. Others get nothing at all."
That makes creditors think long and hard before dragging debtors into court. It provides ample impetus for attempts at out-of-court restructuring, even for companies whose future is grim. Directors themselves are under no legal pressure to file when their companies falter.
"We believe we have many more technically insolvent companies than legally insolvent," says Teles.
Legal insolvency is a death sentence. According to Pimentel, 95% of all in-court insolvencies result in liquidation.
Portugal's financial system may be stable, but that doesn't mean it will sail through the crisis. Portugal is a small country -- a refrain that's heard over and over -- and the level of domestic savings is low. Banks must import capital. When times were good, that wasn't a problem. When the economy turned, it became a huge one.
"Portuguese banks relied so much on wholesale banking," says Siza Vieira. "It's [now] difficult for banks to gain access to funding. The interbank market isn't working as it used to."
Everyone assumes that Portuguese banks avail themselves of the European Central Bank lending window, although, since the ECB refuses to break down its loans, it's very difficult to estimate the degree of dependence.
Total indebtedness is one indicator of euro-zone hot spots. For Portugal, that figure at the end of last year stood at $244 billion, according to the Bank of International Settlements. Greece's debt totaled $206 billion.
The two countries' debt structures are quite different, however. For Greece, public-sector debt is by far the biggest concern. Last year, Portugal's public debt equaled 77.4% of GDP, according to European Commission estimates, which is below the EU average. That works out to about $187 billion.
However, the Portuguese debt profile displays some real weaknesses. Feeding off its euro-zone membership and access to cheap euros, Portugal's household debt ballooned. It now is 135% of disposable income, says Casalinho. That's among the highest in the EU, as the International Monetary Fund highlighted in a recent report. "We've always had this notion that we were living above our means," says Rocha de Carvalho. "We tend to be fatalistic."
An analysis of Portugal's debt reveals two distinct and interwoven characteristics. Almost half of the country's debt came from Spanish banks. Of that $110 billion, $70 billion, or almost two-thirds of the money, was lent to nonbanks. That's good news for those concerned about sovereign debt, not so reassuring for those who believe Portugal's private sector is the weaker link.
Portugal relies on Spain for more than capital. According to the CIA World Factbook, Spain bought over 25% of Portuguese exports, more than double Germany, the next largest market. With Spain's economy reeling, Portugal has a much tougher time selling its port, sardines and garments.
Portuguese companies look elsewhere, including former colonies like Angola. Emerging-markets powerhouse Brazil is one country Portugal's handful of homegrown multinationals appear to be most focused on. Portugal Telecom SGPS SA is now duking it out with Spain's Telefónica SA for control of the Brazilian wireless provider Vivo Participações SA. Portugal's largest retailer, Sonae SGPS SA, announced in March that Sonae Sierra, its shopping malls development joint venture company in Brazil, will launch an initial public offering. Oil and gas concern Galp Energia SGPS SA is part of a consortium that has pledged billions of dollars to extract oil from a major Brazilian offshore field.
Portugal Telecom and Galp Energia are remnants of the country's public-private zigzag. In 1974, a leftist revolution overthrew the decades-old military dictatorship. The new government nationalized companies. By 1980, these public enterprises accounted for anywhere from one-fifth to one-fourth of the economy. The government of Prime Minister Anibal Cavaco Silva reversed course in 1990 and privatized its corporate holdings. "The state used [privatization] to finance the deficit," says Teles. "It wasn't used for productive investment."
That created an open, liberal economy, but also laid the foundations for some of Portugal's current problems. So far, there have been no sightings of Sebastian.