Tuesday, September 4, 2012

Portugal's biggest risk is Spain

Portugal has been trying to export its way out of the economic mess that it has been in for some time. And it has been doing an amazing job, particularly given its poor export track record and deteriorating economic conditions in the Eurozone. Portugal's exports now make up close to 40% of its GDP vs. 25%  3 years ago. The nation's trade deficit has nearly disappeared in part due to falling domestic demand but also to improved exports.

Source: CS

Unfortunately for Portugal, its main trading partner continues to be Spain. And that presents the greatest risk to Portugal's recovery. Should Spain's recession deepen (for example similar to that of Italy or even worse), Portugal could be in serious trouble.
Credit Suisse: - ... the performance of Portugal is all the more impressive considering its strong economic linkages with its neighbour, Spain. This is really the key risk for Portugal going forward. Indeed, the success of its adjustment relies on the speed at which it adjusts its growth model toward a more export-driven one. The weaker its trade partners, the slower the adjustment.
The markets are beginning to absorb Portugal's recent economic successes (including a number of positive structural changes) as well as the fact that its future prospects for recovery are strongly tied to that of Spain. The spread between sovereign risk premia of the two nations has declined materially. Going forward the CDS spreads of Portugal and Spain will also become increasingly more correlated as shocks to Spain's economic growth will quickly be reflected in Portugal's export-heavy GDP.

Portugal and Spain 5y CDS (Bloomberg)

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