Portugal's problems are high debt and low growth

Bond vigilantes are eyeing Portugal as the next victim of the European sovereign debt crisis.

While it was high public debt that did Greece in and a collapsed banking sector that sunk Ireland, Portugal's problems are low economic growth prospects and high private sector debt.

Portugal's private sector debt is among the highest in the world at almost 240 percent of GDP and its economy's productivity is only two-thirds of the euro zone average, said Marc Chandler, the global head of currency strategy at Brown Brothers Harriman.

Portugal failed to grow following the introduction of the euro, a trend that was clear even before the latest economic crisis. Accordingly, [there are] concerns over…its ability to sustain its current debt stock, said Jacob Kirkegaard, a research fellow at the Peterson Institute.

Starting 10 years ago or more, Portugal and other peripheral European countries lost competitiveness to places with cheaper products like China, Central Europe, and Turkey, added Nouriel Roubini, co-founder of Roubini Global Economics.

Speaking to Portuguese newspaper Diario Economico, Roubini, the famed economist who predicted the global financial crisis, said Portugal also suffers from high debt in general and problems in the private sector that forced the government to intervene.

All these woes, he said, are reaching a critical point.

He recommends that Portugal preventatively ask for an international bailout today and not wait until it is desperate. He warned that things will only get worse for Portugal and that the situation may get out of control without any counteractive measures.

What could happen if Portugal does not follow Roubini's advice?

The obvious danger is that the Portuguese government will not be able to afford the high borrowing costs imposed by the market.

However, as pressure brews on that front, burdens would also be piled on the country's financial system and private sector.

Portuguese banks and corporations, like the government, borrow from international capital markets. Their borrowing cost is that of the government plus a markup, so soaring government borrowing costs pushes it up.

These pressures on the private sector force an acceleration of deleveraging and has inevitable negative effects on the Portuguese economy’s growth prospects over the short and medium term, translating, in turn, into a more intense materialization of credit and market risk, stated a recent report from Portugal's central bank.

Email Hao Li at hao.li@ibtimes.com