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Q&A: Portugal bail-out

03 June 11 17:17
Portuguese 1 euro coin

Portugal is the third member of the eurozone to obtain outside help for its economic problems.

It followed Greece and the Irish Republic, which both needed an international bail-out in the past year.

What help is it receiving?

The bail-out, worth 78bn euros ($116bn; £70bn), is in the form of loans from other European countries and the International Monetary Fund, which has also been involved with the Irish and Greek deals.

There are two separate European funds that the money is expected to come from.

The biggest is the European Financial Stability Facility, worth up to 440bn euros (£385.7bn; $629bn), which is funded by members of the eurozone.

The second, the European Financial Stabilisation Mechanism, is funded by a wider group of European nations, including the UK. It has 37.5bn euros left in it after the Irish bail-out.

The money will have to be paid back with interest at an agreed rate.

What has gone wrong in Portugal?

There has been no great boom and bust in Portugal.

What has done the damage is a gradual process of loss of competitiveness in the country as wages have risen and tariffs on cheap exports from Asia into Europe have been reduced.

Low growth in the economy has meant that the government has struggled to raise enough money through taxation to fund its spending.

Government spending has been relatively high, partly due to a succession of expensive projects, especially improvements to transport links intended to strengthen competitiveness.

It meant that when the financial crisis came, Portugal had a great deal of debt, which suddenly became more expensive to finance.

Why does it need bailing out?

Portugal has had increasing difficulties managing its debts, with the interest rates it has to pay rising because investors are worried it will be unable to repay its loans.

In order to improve confidence in the economy, Prime Minister Jose Socrates tried to introduce a package of austerity measures to reduce government spending.

They included cuts in welfare payments and increases in taxes and public transport costs.

However, the opposition said that the measures went too far and defeated them in parliament in March.

The prime minister resigned and took a caretaker role until elections on 5 June, but that has meant that confidence in the economy has fallen further, with Finance Minister Fernando Teixeira dos Santos even suggesting that the interim government did not have the authority to ask for a financial rescue package.

Eventually, Portugal ended up having to pay such a lot to borrow money, even for only one year, that the government finally had to accept that it could not afford to pay its debts and ask for help.

Why doesn't Portugal just default on its debt?

If Portugal was not a member of the eurozone, it might be tempted to just default on its debts, which would mean either declining to make interest payments or insisting that creditors agree to accept lower payments and write off some of the debt.

In the case of Portugal, that would present enormous difficulties.

The rate of interest that eurozone governments have to pay have been kept low by the assumption that the European Union and the European Central Bank would provide assistance to eurozone countries to stop them defaulting.

If that turned out not to be the case, the cost of borrowing for many of the smaller EU states, some of which are already struggling to service their debts, would rise significantly.

It means that if Portugal were to default, the Irish Republic and Greece may have to default as well.

A default would also be bad news for the banks that have loaned large amounts of money to the governments of Portugal, the Irish Republic and Greece.

If all of those banks got into trouble, it would seriously test the resources of the European Central Bank, which has loaned large amounts of money to the banks involved and to the countries themselves.

As long as Europe can afford to help countries avoid a default, it is likely to do so.

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