Portugalhas become — following Greece and Ireland — the latest country in the euro zone to ask for financial aid from the European Union (EU) and the International Monetary Fund (IMF). Juan Carlos Martínez Lázaro, professor of economics at the IE Business School, says that move was “inevitable” and that it will relax the market pressure on the “peripheral” countries of the zone. All eyes are now on Spain as the next possible country to fall. According to Martínez Lázaro, whether or not that happens will depend a great deal on Spain's compliance with its deficit reduction goal, and whether it continues to make significant economic reforms.
With the European Central Bank having raised interest rates this month for the first time in three years, the recovery of the euro zone will also slow down, says Mauro Guillén, director of Wharton’s Lauder Institute. That could strike a blow against the weakest countries in the region, which will have more problems because “a decline in real estate will follow, investment will drop and unemployment will not decline as much as it would if rates were lower.” Guillén predicts that the U.S. Federal Reserve’s turn to increase rates will come after the summer.
Following are edited excerpts from the interviews:
Knowledge at Wharton: What does Portugal's request for financial help indicate about the country?
Juan Carlos Martínez Lázaro:What finally occurred is a normalization of the situation. Portugal needed a rescue and the markets demanded that this move take place in order to end the pressure on them. Ultimately, Portugal had to ask for the rescue. I believe that it will be good for Portugal, and also for the euro zone. [Brussels calculates that Portugal will receive some 80 billion euros. While awaiting specifics of the plan, the country will have to carry out a rigorous adjustment plan, including privatization of public enterprises and labor reforms.]
The rescue has a significant positive meaning for the country: [The EU] is loaning it money at a cheaper price than the market, so from the financial viewpoint, it gives security, which is positive. This eliminates the possibility that the government will get to the point where it cannot manage to pay its debt and it has to undertake a restructuring of the debt — which is the main fear of the market.
Mauro Guillén: The rescue serves to clarify what’s on the horizon. This reduces the uncertainty since we already know that Portugal was not going to be able to face up to its obligations.
Knowledge at Wharton: Does the rescue of Portugal remove all the dangers for the euro zone? Will Portugal ultimately have to resort to restructuring the debt? What consequences would that bring?
Martinez Lázaro:The rescues have acted to quiet the markets. In the hypothetical scenario of debt relief, it is very hard to measure the impact for the euro zone. In any case, debt relief would directly affect those who hold the debt. If a restructuring of the Greek debt were to take place, for example, those most affected would be the German and French banks. If the same thing were to occur in Portugal, the Spanish banks would be among those who would suffer the most damage. That is to say, if one of the countries were to fall, the others would be damaged by the blow to their financial systems.
Restructuring of the debt is not a scenario that can be ruled out. But you have to take into account that the key factor for the troubled European markets is their [slow pace of] economic growth. When an economy is growing, the government won’t have problems dealing with the payments it has to make, but when an economy is stagnant, there are going to be problems. The markets have not ruled out the possibility that debt restructurings will take place.
There have been a lot of comments about the danger that the situation poses for the monetary union and the European currency. But there is a lot of misinformation about this subject. For any countries with problems, leaving the euro zone would practically mean suicide because the currency they would adopt would suffer an extremely large depreciation, and it would be even more difficult for them to deal with their debt payments. In addition, if any of the current members of the monetary union were to leave it, that would affect the rest of the countries because they would automatically lose trading partners that are, in many cases, very important for their economies. So if any country were to leave the euro zone, it would have a negative influence on the rest. [Observers] talk a lot about countries possibly leaving [the euro zone], but in the end we are more united than we think we are.
Knowledge at Wharton: Will Portugal be the last country to need aid, or will Spain be the next to fall?
Martínez Lázaro:We depend only on ourselves. Spain has entered that list of countries with problems of its own nature; because of an erroneous and nonsensical economic policy during the period of crisis, it put in place public spending policies that involved incentives to the economy, known as Plan E, which included deductions of 400 euros for all taxpayers. Fortunately, last May things changed because the head of the government shifted the [focus of the] debate toward containing spending and reducing the deficit. But Spain was truly on the brink of an abyss.
The two keys that will determine whether or not Spain falls are, on the one hand, if it continues with the reform process it has begun, such as reforms of its pension system, its labor market and its financial system — focused on its savings banks [known as ‘cajas’]. On the other hand, this means managing to reduce the government deficit and to comply with forecasts for cuts that have been laid out by the government. If it becomes clear that it is not possible to comply with these reforms because the government is not growing at the anticipated pace, it will be necessary to make even more adjustments in spending as well as raise taxes.
I repeat, however, that whether Spain is — or is not — the next country that needs aid depends only on Spain.
Guillén: Spain has a greater capacity to pay than Portugal. Short term, I don’t believe that will be a problem, unless unemployment deteriorates [from the current rate of about 20%], and the economy does not recover. The other concern is over the medium and long term. Spain is not going to grow a great deal if we don’t develop our human capital and devote more of our resources to research.
If Spain ultimately does need help, the way Greece, Ireland and Portugal have needed it, it will cost the European Union dearly. But that is not going to happen.
Knowledge at Wharton: Is there any way that the delicate condition of the euro zone can affect the economies of Latin America?
Martínez Lázaro:Latin America is in marvelous shape, and I believe that the situation will continue to be very good. It has found its particular “El Dorado” in the markets of Asian countries, which have become their largest buyers of primary products, and so I don’t believe that the current economic situation in Europe will affect them.
In any case, and in the specific case of Spain, for example, Latin American countries may be fortunate because Spanish companies, which are aware of the weakness of their country’s internal market, will be searching for ways to expand their businesses in other regions, so they will have an even more positive view of the South American market, and will commit themselves to investing there.
Guillén:I don’t believe that conditions in the euro zone can influence Latin America, since the boom in primary products is helping the entire region, which is also growing a great deal internally.
Knowledge at Wharton: Will the European Central Bank’s move to raise interest rates by a quarter of a point to 1.25% on April 7 put a stop to the recovery of the euro zone?
Martinez Lázaro: The increase in interest rates is not good news for the economy of the region, despite the fact that people knew it was going to happen. It means a return to monetary normalcy, much earlier than the market had anticipated.
Higher interest rates are already leading to an appreciation of the euro that can slow down exports, which are so important in some economies of the euro zone, including Germany. But that is something that the ECB doesn’t often take into account when it is time for it to make decisions. And in this sense, the ECB wanted to demonstrate its independence.
The ECB has staked out its position with this move. It has made it very clear that its goal is to maintain inflation under control at a time when [inflation] is rising strongly, largely because of the higher price of petroleum. It wants, at all cost, to avoid seeing a second round of inflationary effects — that is to say, avoid seeing the upward move in petroleum prices influence prices of other products and even salaries.
Guillén:It is obvious that the rising price of money will slow down the recovery of the euro zone. This decision was determined by the good economic conditions in Germany, but it makes economic growth and job creation harder to achieve.
Knowledge at Wharton: How will higher rates affect the “peripheral” countries in the region, which have more economic problems? That is to say, how will higher rates affect the smaller economies of the euro zone, such as Spain, Portugal, etc.
Martinez Lázaro: It won’t be good for Spain because higher rates will reduce the incomes of its population, and higher rates will make financing, which is already very limited, even more expensive.
Guillén:Real estate will continue its downward path, investment will be reduced, and unemployment will not decline as much as it would if rates were lower.
Knowledge at Wharton: Where do you predict interest rates in the euro zone will be by the end of this year?
Martinez Lázaro:The market is forecasting that rates will be about 1.75% in November or December. This is the most likely scenario, since we expect two new increases of a quarter of a percentage point each.
Guillén:Certainly, [rates will be] 0.25% or 0.50% above the current level [of 1.25%].
Knowledge at Wharton: When do you expect the U.S. Federal Reserve and the Bank of England to make any interest rate moves?
Martinez Lázaro:It is possible that the Bank of England will start to raise interest rates soon, since the British economy is being strongly affected by inflation, which is going to force that institution to feel obliged to speed the path toward increasing rates.
Clearly, the United States is not going to get involved in this now. In coming months, all of the classic economic moves taken in the United States are going to be viewed under a microscope. President Barack Obama is going to be running for re-election next year, and anything that doesn’t help an economic recovery that generates new jobs is going to make it harder for him to win.
The U.S. economy is not being as affected by inflation as Europe’s economy. In addition, with the current depreciation of the dollar, the U.S. administration feels very comfortable. Because of all of these circumstances, changes in [U.S.] monetary policy are not expected during the course of this year.
Guillén:I believe that after the summer, we’ll see rising rates. But everything depends on what happens with inflation as well as the pace of the recovery.