PORTUGAL: FINANCIAL SECTOR MORE STABLE

C O N F I D E N T I A L SECTION 01 OF 02 LISBON 000034

NOFORN
SIPDIS

STATE DEPARTMENT FOR EEB/IFD/OMA, EEB/EPPD.

E.O. 12958: DECL: 01/14/2019
TAGS: ECON EFIN PO
SUBJECT: PORTUGAL: FINANCIAL SECTOR MORE STABLE

REF: 08 LISBON 02666

Classified By: Gary B. Applegarth, Pol-Econ Officer, Reasons 1.4 (b) an
d (d).

SUMMARY
--------------

1. (C) The Portuguese financial market is more stable than
it was in October and November of 2008 but the economy is
still threatened by a negative trade balance, tight liquidity
and rising unemployment. Pedro Penalva of AIG Europe and
Paulo Gray Pereira of Citibank International told us this
week several successful bond offerings by Portuguese banks
totaling 4.25 billion euros demonstrate market confidence in
the Portuguese financial sector, but resources are still
stretched and higher capitalization requirements imposed by
the GOP could trigger additional bank consolidation. Both
financiers support GOP infrastructure investments to
stimulate the economy provided they produce real economic
benefit, and Gray said the GOP should streamline its
operations and improve efficiency. End summary.

FINANCIAL SECTOR CALM BUT MORE BANK CONSOLIDATION POSSIBLE
-------------- --------------

2. (C) PolEconoff met separately with Pedro Penalva of AIG
Europe and Paulo Gray Pereira of Citibank International on
January 12 and 13 to discuss the health of the Portuguese
financial sector, updating impressions provided by the
financiers several months ago (ref A). Both financiers say
the situation has stabilized significantly since October

2008. Penalva said AIG was experiencing modest growth so far
in the first quarter of 2009, a period AIG viewed as critical
because of the large number of annual insurance contract
renewals during that time. Gray stressed that Citi Portugal
was continuing to operate conservatively, discontinuing
aggressive growth programs, targeting new credit cards only
to customers with higher credit ratings and focusing on
collections. Citi has also reduced its workforce modestly.


3. (C) Penalva and Gray both cited recent successful bond
offerings by Banco Comercial Portugues (BCP) for 1.5 billion
euros, Caixa Geral de Depositos (CGD) for 1.25 billion euros,
and Banco Espirito Santo (BES) for 1.5 billion euros as
evidence of investor confidence in the Portuguese financial
sector. All three offerings benefited from the 20 billion
euro bank guarantee program announced by Finance Minister
Teixeira dos Santos in October 2008.


4. (C/NF) Gray said the October 2008 GOP increase of the
minimum Tier 1 capitalization requirement to 8 percent could
result in additional bank consolidation and claimed BCP is
the most vulnerable bank. Gray said BCP, CGD, and BES all
need additional capital to reach the 8 percent level, but
opined that government-operated CGD could "get a check from
the government" to make-up the difference and the strong
shareholders of BES would support their capitalization needs.
Despite BCP's recent bond issue, Gray said BCP lacks the
required capitalization and may have difficulties obtaining
additional funding, leaving the bank vulnerable to
acquisition by another Portuguese bank or, more likely, by a
foreign bank. Gray said consolidations were possible among
smaller banks as well, but he did not identify any particular
targets.

NEGATIVE TRADE BALANCE AND UNEMPLOYMENT ARE MAJOR CONCERNS
-------------- --------------

5. (C) Despite the improved market environment both
financiers cautioned that problems remain. Penalva and Gray
both expressed discomfort with Portugal's negative balance of
trade, since the country's largest trading partners, Spain
and Germany, were much more exposed to overvalued assets than
Portugal, and both have taken heavy losses which could reduce
exports to those markets. Any worsening in the balance of
trade will exacerbate Portugal's need for foreign capital and
further stretch available liquidity.


6. (C) Penalva and Gray also cited rising unemployment as an
ongoing threat to the Portuguese economy. Penalva worried
about the possibility of student unrest over the lack of
employment opportunities in Portugal. Gray's analysis of the
danger from growing unemployment was less dire but he
highlighted the need for improved professional and financial
education to improve the quality of Portuguese workers.

SENSIBLE INFRASTRUCTURE INVESTMENT, EFFICIENT GOVERNMENT
-------------- --------------

7. (C) Both financiers support GOP plans for additional
infrastructure spending to stimulate the economy as long as
the programs make sense. Penalva cited plans to install
fiber-optic internet infrastructure as forward thinking and

LISBON 00000034 002 OF 002


necessary for future growth and competitiveness, but
expressed concern that some programs, such as improved
high-speed rail links within the country, benefit special
business interests and will produce minimal return to the
overall economy. Gray expressed similar skepticism about
proposed highway projects, saying Portuguese roadways are in
much better shape than the cities they connect. Penalva and
Gray both also suggested the country's education system
desperately needs to be overhauled, as the current system is
terribly expensive and produces poor results.


8. (C/NF) Gray said the government should streamline
operations just as the private sector has been doing. He
gave the example of the "competing oversight" of financial
markets by the Central Bank of Portugal (Banco de Portugal)
and the Portuguese Securities Market Commission (CMVM -
Commissao do Mercado de Valores Mobiliarios),claiming
rationalization of their responsibilities could yield
significant public savings while still providing for
effective oversight. Gray said there were other examples of
overlap and waste in the "bloated" government structure that
should be addressed, and that this financial crisis was an
opportunity the government should not miss to take bold steps
that might not otherwise be politically palatable.

COMMENT
--------------

9. (C) The Portuguese financial market continues to weather
the global financial crisis fairly well, and our financial
contacts suggest the long, slow recovery has begun. While we
see little chance for the youth unrest suggested by Penalva,
capital scarcity and increasing unemployment certainly
present daunting challenges requiring skillful economic
leadership. We hope the GOP's competent deficit reduction
foreshadows good future decision making, but the number of
pork barrel projects in the infrastructure stimulus package
tempers our expectations, and we fear more pork is on the way
as domestic politics begins to overshadow structural problems
in the Portuguese economy. End comment.
STEPHENSON