Portugal readies for bailout talks as Spain shrugs off contagion risk

Portugal on Thursday was set to make a formal request to the European Union for financial assistance after the country bowed to the might of the financial markets the previous day and acknowledged the need for help.

Fears of an immediate fallout from Portugal's debt problem on the rest of the euro zone failed to materialize as Spain's borrowing costs fell at a government debt auction, while the reaction to the bailout announcement in the financial markets was benign.

The latest chapter in the euro-zone debt saga took place as the ECB raised interest rates for the first time since July 2008. Although the bank's president Jean-Claude Trichet said the hike was not necessarily the "first of a series," he warned the bank was ready to step in to stem inflationary pressure.

Portuguese government minister Pedro Silva Pereira told a news conference after Thursday's regular Cabinet meeting that he expects a delegation from the European Commission and the ECB to arrive shortly in Lisbon to begin what is likely to be an arduous period of negotiations over the terms of loans Portugal will seek from the IMF and the European Financial Stability Facility (EFSF). Finance Minister Fernando Teixeira dos Santos is due to attend an informal meeting of the Eurogroup in Budapest on Friday.

Trichet said the ECB "welcomed" the decision and would help Portugal "apply the plan." Portugal's request for help is complicated by the fact the country is due to hold general elections on June 5.

The government had previously said it did not have the "legitimacy" to negotiate external assistance in the wake of Prime Minister José Sócrates' resignation on March 23 after parliament had rejected his Socialist administration's latest batch of deficit-reduction measures.

Silva Pereira said the negotiating process needed to "take into account the natural limitations of a caretaker government."

One of the main issues is the size of the loan Portugal needs. Just after Sócrates stepped down, the head of Eurogroup, Luxembourg Prime Minister Jean-Claude Juncker said 75 billion euros would be an "adequate" amount for Portugal to request. However, the Wall Street Journal on Thursday quoted an unnamed minister of a euro-zone member country as saying the figure could be as high as 90 billion euros. Silva Pereira on Thursday did not say how much Portugal plans to ask for.

Portugal is now the third euro-zone member to ask for outside assistance after Greece and Ireland, which also fell foul of the pressure from the financial markets. Greece is paying an interest rate of 3.5 percent for the first three years of its loan but that was before the EFSF was set up. Ireland is paying an average of 5.8 percent, but is currently seeking less onerous terms.

After defiantly rejecting the need for help for months, in a televised address late Wednesday announcing the government's surrender, Sócrates said: "I tried everything but in conscience we have reached a moment when not taking this decision would imply risks that the country should not take." Sócrates took the decision after being forced to pay close to 6 percent to sell one-year Treasury bills at a tender held on Wednesday.

The secretary general of the Paris-based Organization for Economic Cooperation and Development, Ángel Gurria, said Thursday there was a risk of Portugal's liquidity problem turning into a solvency challenge. Portugal faces heavy redemptions this month and in June.

"My impression is that, without losing track of the medium and the long term, there will be emphasis in solving the more short-term maturities," Gurria told reporters in Budapest.

Meanwhile, the Spanish Treasury sold 4.1 billion euros in three-year bonds on Thursday at a cut-off rate of 3.601 percent, slightly down from the 3.609 percent paid at an auction last month. The debt-management agency had been looking to sell up to 4.5 billion euros. Demand for the issue amounted to 7.4 billion euros.

In remarks to Spanish radio station Cadena Ser, Spanish Economy Minister Elena Salgado said she "absolutely ruled out" the risk of any contagion from Portugal. "The markets have been fully differentiating between countries for some time," the minister said. "We have a history of budget surpluses and years of strong growth, and Portugal doesn't have that," she added.

Brussels also gave its backing to Spain, which has embarked on its own deficit-cutting program and has introduced reforms to the labor market and the pension system. "Spain needs to be judged on its own merits. Spain is on track when it comes to fulfilling the objectives that were agreed in terms of deficit reduction for 2010 and for 2011. They are generally on track," EU Commission spokesman Amadeu Altafaj told reporters in Brussels.

"Significant economic reforms have been approved by the Spanish parliament, particularly reform of the labor market. As for the rest, I think you can see market evolution changes as well," he said. "The Spanish economy has significant challenges, but at the moment, as we've said publicly, Spain is living up to its commitments, and we wouldn't draw any parallels or speculations along these lines."