Portugal’s Prime Minister Jose Socrates resigned on Wednesday after Portugal’s parliament rejected a budget proposal. The austerity measures included in the budget included spending cuts and tax increases and the proposal was widely unpopular. The defeat of the budget is likely to force Portugal to accept a bailout from the European Union (EU) and the International Monetary Fund (IMF), but lack of clear leadership authority in the country may make it difficult for an agreement to be reached. Although EU’s bailout funds are adequate to handle Portugal’s likely financing needs, the greatest concern about a possible bailout of Portugal is that investor fears may shift next to Spain. Spain is the euro zone’s fourth-largest economy and is currently trying to deal with a weak banking system. The situation in Portugal overshadowed a previously scheduled EU summit this weekend. Mr. Socrates has resisted calls for Portugal to accept a bailout and believes that if Portugal accepts a bailout now, the austerity measures that will be a condition of accessing the funds will likely be more restrictive than the austerity measures his government rejected this week. The political turmoil has pushed government borrowing costs to unaffordable levels and ratings agencies have downgraded Portuguese debt.

QUESTIONS FOR DISCUSSION:

1. If Portugal does request a bailout from the EU and the IMF it would be the third euro-zone country to do so in the last year. How much impact would a Portugal bailout likely have on the value of the euro? Have investors become desensitized to euro-zone bailouts?
2. If Portugal does receive a bailout, this is likely to shift investor attention to Spain, which is widely regarded as too big to fail and too big to save. What can the EU do to prevent financial contagion from negatively impacting Spain?
3. One of the challenges the EU faces in its current quest to restructure the emergency bailout program the countries created in May is whether investors should be forced to bear any of the costs of a subsequent EU bailout. What are the advantages and disadvantages that would be created by allowing Portugal to default on its sovereign debt?

SOURCE: Kowsmann, P., & Lewis, J. T. (2011, March 24). New phase in Europe crisis. Wall Street Journal, pp. A1, A12. (Retrievable online at: http://online.wsj.com/article/SB10001424052748704050204576218480566706182.html)

Related video clip: EU Summit Clouded by Portugal Crisis. (Retrievable online at: http://www.youtube.com/watch?v=FFZ_bpusSi4)

Related video clip: Portugal PM Jose Socrates Resigns after Budget Rejected. (Retrievable online at: http://www.bbc.co.uk/news/world-europe-12844020)