A senior eurozone source said on Sunday that Germany, France and other eurozone countries were pushing Portugal to seek an EU-IMF assistance programme, following Greece and Ireland, to prevent contagion spreading to much larger Spain, the fourth biggest economy in the euro area.
The eurozone source said Lisbon would need between 50 billion and 100 billion euros in loans, similar to Ireland, which accepted an 80 billion euro EU-IMF rescue in December after a banking crisis caused by a burst real-estate bubble lumbered the state with huge liabilities.
Portuguese Prime Minister José Sócrates said last Friday his country had no need of outside assistance because it was ahead of schedule in reducing its budget deficit.
Socrates, who heads a minority socialist government, is stubbornly avoiding a bailout, mindful of the traumatic history of Portugal's two International Monetary Fund rescues since its return to democracy in 1974.
The memory of the IMF's involvement, in 1977 and in 1983, is so etched on the Portuguese psyche that the country's media is not even mentioning that it would primarily be the European Union that would finance any bailout this time.
'Little chance of escaping'
German Finance Minister Wolfgang Schaeuble denied Berlin was pushing anyone to seek assistance, but he did say it was defending the euro. A French government official also said it was nonsense to suggest that Paris and Berlin were pressuring Lisbon.
But economists and market analysts believe it is only a matter of time before deficit-laden Portugal, whose stagnant economy has lost competitiveness since joining the euro zone, has to seek aid.
"If market spreads keep rising, Portugal has little chance of escaping a bailout," said Laurence Boone, research director at Barclays Capital in Paris.
Asian powers more generous?
But the European Union is preparing to fight the Portuguese crisis with one hand tied behind its back because Germany continues to block any financial lifeline for a country until it is actually drowning.
Astonishingly China, which pledged last week to buy Spanish government bonds, is doing more to help Madrid than Berlin is.
Japan too announced that it will use its foreign-exchange reserves to buy more than 20% of the bonds released by Europe's financial aid fund in late January to assist Ireland, Bloomberg reported on 11 January.
Japanese Finance Minister Yoshihiko Noda said at a Tokyo news conference that it was "appropriate for Japan to make a contribution as a lending nation to increase trust in the deal".
In a Reuters poll last week, 44 of 51 economists surveyed expected Lisbon would need a bailout, but only seven thought Spain would need outside help, even though most expect Madrid's credit rating to suffer another downgrade soon.
Spain is the euro zone's fourth largest economy and would stretch the capacity of the currency bloc's financial safety net - the 440 billion euro European Financial Stability Facility - to the limit if it had to be rescued.
"Spain has a serious, realistic chance of avoiding a programme because of the government's actions to reduce the fiscal deficit, reduce public borrowing needs, make structural economic reforms and repair the financial sector," a senior EU official said.
After months of denial, Spanish Prime Minister José Luis Rodríguez Zapatero's minority Socialist government has acted to cut public spending, step up privatisation and bring forward long-delayed pension reform.
Nevertheless, bond market pressure is likely to be fierce, with investors fleeing peripheral eurozone sovereigns over worries about their ability to repay their debts as interest rates rise, as well as fears of write-downs for bondholders.
European Union officials are searching for ways to reinforce the euro zone's financial backstop by increasing its effective lending capacity and broadening its scope for action.
German resistance
But German Chancellor Angela Merkel, facing hostile public opinion and fearing a constitutional court veto, has rejected any pre-emptive standby credit line for troubled eurozone countries before they are forced out of capital markets.
Berlin has so far also opposed any increase in the size of the rescue fund and any use of that money to buy sovereign bonds in the secondary market, or help recapitalise troubled banks.
German resistance will be put to the test when eurozone finance ministers meet on 17 January to discuss a comprehensive response to the potentially systemic crisis.
If they are unable to agree on any strengthening of the financial safety net, it could hasten a backlash in the markets.
Indeed, markets are still pricing in a 15-20% marginal possibility of a Spanish default in each of the next five years.
Spain's woes, like Ireland's, result mostly from the bursting of a real estate bubble that was inflated by cheap euro interest rates. Unemployment stands at 20% and the economy is barely growing at all.
Although Spanish public debt is still well below the eurozone average and the two biggest commercial banks, Banco Santander and BBVA, are in good shape, the state faces contingent liabilities from a damaged financial sector.
Madrid's fiscal problems are compounded by the need to recapitalise its unlisted regional savings banks, the cajas, which were merged to 17 from 45 in an overhaul last month and have an unrecognised exposure to bad real estate loans.
Spanish banks also have a large exposure to Portuguese public debt, and would suffer if they could not use Portuguese bonds as collateral in central bank liquidity operations.
Both Spain and Portugal face big funding crunches in April and mid-year. Portugal must repay more than 12 billion euros in the first half of 2011. Spain faces bond redemptions of 15 billion euros in April and another 15 billion in July.
So the euro zone may not have long to build a more effective firewall before the flames start licking around the Iberian peninsula.
(EurActiv with Reuters.)
