The EU debt crisis: Is Portugal the final chapter?

The following information is based on market circumstances as of the date indicated.

On April 7, 2011, Portugal formally requested bailout funds from the European Union (EU) and the International Monetary Fund (IMF). The news didn't seem to unnerve investors, primarily because the bailout request had been expected for some weeks.

Less than 24 hours later, the European Central Bank (ECB) raised rates by 0.25 percentage points, an action that reflected its sole mandate: to maintain price stability within the euro zone. The tone expressed by the ECB at the time of the announcement (and in subsequent weeks) has apparently validated the market's current discounting of at least two more rate increases later this year.

Here are several points we're keeping in mind in light of Portugal's bailout bid:

  • A sovereign debt crisis is not a new phenomenon. What we feel is unique about today's situation, however, is that it's happening within the confines of a single currency. This straitjacket puts a limit on policy options, leaving governments with few avenues to pursue when resolving debt crises. Given that the euro has recovered to pre-Greek-crisis levels, certain sovereigns are being pressured even more — forcing them to impose massive fiscal austerity on their populations.
  • Portugal's case is different from Greece's and Ireland's. The bailout packages of Greece and Ireland have different dimensions, primarily because the two countries are dealing with different kinds of financial stress. Greece's package is based on the requirement that Greece reform its public sector and pension system while agreeing to additional fiscal measures to reduce its budget deficit dramatically by the end of 2014. Ireland's package, meanwhile, is primarily directed toward recapitalizing and restructuring the country's banking sector. Portugal's circumstance has its own particular variation; economic data suggest the country exhibits a less-competitive economic model, higher costs of production, a current account that is continuously in deficit, and a low savings rate compared with the core European countries.
  • We believe Portugal is not the final chapter of the sovereign debt crises. Spain, for instance, is another country that is under scrutiny. Analysts are concerned about weaknesses that include an undercapitalized banking sector, a rising budget deficit, high unemployment, and weak economic growth. The Spanish government began taking proactive steps last year, including steps to implement social reforms and apply austerity measures. Nonetheless, it would appear that the pressure on Spain is expected to persist in the second half of 2011, as more than 45 billion euros of government debt comes due.

Important update as of May 10, 2011 — The past week has witnessed another leg in the EU crisis, with official recognition that Greece's bailout package will probably not be enough. The massive austerity measures undertaken in Greece have caused public consumption to collapse. This, combined with the cost of financing a debt level that has reached 140% of gross domestic product, is resulting in painful consequences for the country.

Markets are expecting additional EU support of at least 30-60 billion euros to be announced in the very near term. More importantly, financial markets now expect some form of Greek debt restructuring during 2011. The euro has fallen and spreads have widened. A Greek restructuring event, while now largely expected, is likely to have negative implications for spread markets as concern will shift to the sustainability of the EU banking system and other sovereigns like Portugal and Ireland. We remain on alert.

    (Data: Bloomberg.)

The views expressed were current as of May 10, 2011, and are subject to change at any time.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting the fund literature page or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.

IMPORTANT RISK CONSIDERATIONS

Investing involves risk, including the possible loss of principal.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt.

Fixed income securities may also be subject to prepayment risk, the risk that the principal of a fixed income security may be prepaid prior to maturity, potentially forcing an investor to reinvest that money at a lower interest rate.

International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.

Delaware Investments, a member of Macquarie Group, refers to Delaware Management Holdings, Inc. and its subsidiaries. Macquarie Group refers to Macquarie Group Limited and its subsidiaries and affiliates worldwide. Institutional investment management is provided by Delaware Investment Advisers, a series of Delaware Management Business Trust (DMBT). DMBT is a registered investment advisor.

Delaware Investments is not an authorized deposit-taking institution for the purposes of the Banking Act 1959 (Commonwealth of Australia) and Delaware Investments obligations do not represent deposits or other liabilities of Macquarie Bank Limited ABN 46 008 583 542 (MBL). MBL does not guarantee or otherwise provide assurance in respect of the obligations of Delaware Investments, unless noted otherwise.

These materials represent the views and opinions of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Any reproduction of these materials, in whole or in part, or the divulgence of any of the contents thereof, without prior consent of Delaware Investments is prohibited. Certain information contained herein has been obtained from sources that Delaware Investments believes to be reliable as of the date presented; however Delaware Investments cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. Delaware Investments has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. Delaware Investments and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of Delaware Investments or its affiliates.

The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or funds to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or funds for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions.

Conflicts of Interest: Delaware Investments and its affiliates may have investment advisory or other business relationships with the issuers of securities referenced herein. Delaware Investments and its affiliates, officers, directors and employees may from time to time have long or short positions in and buy or sell securities or financial instruments referenced herein. Delaware Investments affiliates may develop and publish research that is independent of, and different than, the information contained herein. Delaware Investments personnel other than the author(s), such as sales, marketing, and trading personnel, may provide oral or written market commentary or ideas to clients of Delaware Investments or prospects or proprietary investment ideas that differ from the views expressed herein. Additional information regarding actual and potential conflicts of interest is available in Part II of Form ADV for Delaware Management Business Trust.


Insights