The sun glistens off the Douro River in early spring, creating a golden splendor on the ancient banks of Oporto. Like the dark meandering streets of the medieval city, Portugal is a mystery to most investors. Unlike its Iberian cousin, Portugal is thin on glitz and glamour. You never see the fleets of luxury vehicles that grace the promenades of Madrid and Barcelona. Portuguese restaurants and hotels do not reek of opulence. On the contrary, they tend to be smaller and darker venues, which is more in line with the country’s psyche. Portugal is a conservative society, bereft of the flamboyance that is typical of its Hispanic neighbor. Despite the complaints and strikes by the CGTP labor union, Portugal has not seen the level of violence that swept Greece. Indeed, the country’s second largest labor union, the UGT, did not participate in a national strike that was held at the end of March. The turnout for the national day of protest was low, which reflects a general consensus that the government must realign its expenditures to remain within the euro. A closer look at Portugal’s macroeconomic indicators confirms that the situation is nowhere near as dire as Greece, and it is even better than Spain’s. The fiscal austerity measures that were introduced at the end of 2010, including a 2% increase in the VAT, are allowing Lisbon to stay ahead of its target. The shortfall is now expected to finish the year slightly above 4% of GDP—which is much better than Spain’s fiscal performance. The current account shortfall is also on the mend, and it is expected to finish the year slightly below 4% of GDP. Portugal’s stock of debt is high, at 112% of GDP, but the dynamics are favorable. Given the rapid decline in the fiscal and current account deficits, the debt load will peak in 2013 at 115% of GDP. It will then begin to decline rapidly, reaching 80% of GDP by 2030. It was for these reasons that the IMF recently gave the government a good bill of health and released a €5.2 billion tranche from its Standby Facility. It was also the reason why S&P released a report saying that Lisbon would probably avert a debt restructuring. All of these factors suggest that there is good value in Portuguese bonds.
One of the main reasons for the country’s capacity to adjust quickly is its degree of openness. Portugal’s trade (exports + imports) represent 50% of the country’s total output. This is in contrast to Spain, where trade represents only 35%. Ireland’s trade is 78% of GDP, and Germany’s is 64%. Greece is a dismal 25% of GDP. The problem is that the state plays a larger role in closed economies, which aggravates the vicious cycle produced by fiscal adjustments. At the same time, the state plays a reduced roll in smaller open economies, which allows the private sector to adjust more quickly to changes in macroeconomic conditions. This has certainly been the case in Ireland, and it is proving to be true in Portugal. The Portuguese economy is similar in size to Ireland, and it is only a sixth of the size of Spain. This makes it easier to manage and more nimble in its response to stimuli. Although the IMF expects the Portuguese economy to shrink by 3% y/y in 2012, the national statistics agency reported that the level of output fell only 1.3% y/y during the fourth quarter of last year. Some economists are calling for a slight recovery by the end of this year or the beginning of next.
As a seafaring nation, Portugal has a long tradition with foreign trade. Even if it does not have much manufactured goods or commodities to offer, the Portuguese always managed to scour up some goods and services to barter for foreign imports. One of the oldest trade relationships in the world is between England and Portugal. For more than 900 years, the Portuguese exchanged wines from the Douro River Valley for English woolen goods and textiles. The age-old trading relationship became the subject of David Ricardo’s classical treatise on trade and comparative advantage. Like some other countries, such as Chile and Singapore, that are not brimming with a cornucopia of natural resources, the Portuguese always managed to invent new ways to secure their access to foreign goods. Today, Portugal is a major player in Africa, using its former colonies as platforms to penetrate deep into the continent. Likewise, Portugal is opening itself up to its former colonies, bringing in a much-needed deluge of foreign direct investment (FDI) from places such as Angola, Mozambique and Brazil that are providing relief to the country’s balance of payments. Given the semi-inverted nature of the Portuguese yield curve, some of the shorter-dated bonds may provide good value. Portugal is a hidden nook in the rather complex European landscape, but it may have some interesting nuggets of gold to offer.