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What is the UK's contribution to Portuguese rescue?

Robert Peston | 09:01 UK time, Friday, 8 April 2011

First of all, it does now look as though the implied UK contribution to the Portuguese bailout will be around 4.8bn euros or £4.2bn (in line with what I've been saying).

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That is because European Union finance ministers meeting in Budapest today are working on the assumption that Portugal will ask for 80bn euros of rescue finance, and that this will eventually be provided on a similar basis to the Irish rescue.

So a third of the fund would come from the European Financial Stabilisation Mechanism (EFSM), a third from the European Financial Stability Facility (EFSF) and a third from the IMF.

The UK has no exposure to the EFSF, which is a fund backed only by eurozone members. However we have an exposure of just over 13.5% to the EFSM and of 4.5% to any money provided by the IMF.

Which means that the UK would be on the hook for a little bit less than 5bn euros for the Portuguese rescue.

That said, of this sub 5bn euros exposure, the UK's 3.6bn euros or so participation through the EFSM can be seen as pretty indirect.

Here is why.

The EFSM raises money from investors against the spare capacity in the European Union's budget. So if Portugal were to default on money borrowed from the EFSM, the first loss would fall on the EU's budget - which would only hurt us to the extent that we are a member of the EU and available resources for the whole EU would be depleted.

There would be a direct cost to the UK only if the loss generated by a Portuguese default were to exceed the available resources in the EU. Our contribution, should the EU's budgetary funds be exhausted, would be just over 13.5% of any incremental loss (because our contribution to the EU's budget is just over 13.5%).

I know this is complicated, but it does mean that there would have to be a cascade of accidents before the British taxpayer incurred any direct loss from Portugal's woes. Portugal would have to default. And the cost of that default would have to tip the EU's budget into the red before there was any draw down from the UK exchequer.

Which is certainly not an impossible chain of events. But nor is it a sure thing.

That said, as I mused on the Today Programme this morning, the outrage felt by those Tories who implacably and forever oppose UK membership of the eurozone is understandable.

Their position is that the UK contributes to the EU's budget on the basis that the budget is deployed for the benefit of all the EU - not for the benefit of a subset, those who are members of the eurozone.

They are furious that Alistair Darling when chancellor gave permission for the EU budget to be deployed for eurozone rescues via the EFSM just before the general election. And they are pretty cross with the current chancellor, George Osborne, because they are convinced that as shadow chancellor he gave Mr Darling the nod that this would be okay.

All of which puts the Chancellor, George Osborne, in an awkward spot - even though there is no question of the UK providing bilateral assistance to Portugal, in the way it did for Ireland.

It explains why the Chancellor, George Osborne, hastily re-arranged his schedule to go to Budapest for today's EU finance minister's meeting, after Portugal's caretaker prime minister, Jose Socrates, announced on Wednesday night that his country would be applying for financial help (the Treasury minister Mark Hoban had originally been scheduled to stand in for the chancellor).

There are a couple of other points of a slightly less parochial nature that are worth making.

First, I am told it could take weeks for the details of the Portuguese package to be sorted, because EU finance ministers don't believe that Portugal faces an immediate liquidity crisis. They've been told that Portugal has enough residual cash in its state coffers to meet the 4.2bn euros debt repayment due at the end of next week.

That said, I am informed that the European Commission is doing "due diligence" on the precise state of Portugal's finances, because EU governments were caught on the hop by Mr Socrates's request for emergency aid.

That is not to say the bailout request came out of a clear blue sky (an absurd notion). EU governments have long been expecting that Portugal would require succour. It is just they were surprised it happened at precisely that juncture.

Second, there are economists and analysts who believe Portugal is burdened with too much official debt, that the only way for it to be set on a path of economic recovery is for that debt to be cut in value, for there to be a controlled default, a restructuring or haircut (to use the jargon).

However, for the avoidance of doubt, EU finance ministers are a million miles from being prepared to contemplate that (for reasons spelled out in my post of yesterday).

They could not allow a debt write-off for Portugal without conceding similar debt forgiveness for Ireland and Greece. And EU finance ministers are terrified by the potential consequences of forcing losses on to creditors of those countries (and not least for the strength of their banks), however reckless the creditors may have been in providing loans without due consideration of the risks.

For Portugal, as for Ireland and Greece, what is in contemplation by solvent EU governments is a refinancing - which some will see as temporary fix of the immediate problems of Portugal, Greece and Ireland, not a lasting cure to the underlying disease (which is that, arguably, they have all borrowed far more than they can afford to repay).

Update 12:25: Pals of Mr Osborne insist that he did not give any kind of backing to Alistair Darling's decision, after Labour had lost the election but before the coalition government had been formed, to agree that the EU's budget should be deployable in eurozone bailouts via the EFSM.

They cite, by way of evidence, this statement made in the Commons last December by Mr Darling:

"I discussed with the chancellor what we should do about the financial stability mechanism. He had his reservations and stated very clearly that he was against deploying it, and he asked me whether I should abstain, recognising that the decision was to be taken by qualified majority voting.
 
"Both of us recognised, I think, that if we had abstained the proposal would still have gone through, because everybody else in the room wanted the mechanism to be deployed. I found myself in exactly the same position that he did just a few weeks ago when he was being asked to contribute (to the Irish bailout)".

Mr Darling went on to remind MPs that Mr Osborne actually voted in favour of allowing the EFSM to be used for the Irish rescue because - in the words of Mr Osborne - to have voted against "at this time would, I judge, be very disruptive."

To summarise therefore: Mr Osborne was unhappy about the use of the EU budget for eurozone bailouts via the EFSM, but he wanted Mr Darling to abstain on the issue, rather than vote against. In the end, Mr Darling voted in favour, because there was nothing the UK could do to block the EFSM, even if it had wanted to do so (or so Mr Darling believed).

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