Contagion to Portugal, Spain and Italy

Before you start

Where this sits

Lisbon, spring 2011

On 23 March 2011 Portugal's parliament voted down the government's plan to cut its deficit, the gap between spending and revenue, and the next day the prime minister, José Sócrates, and his government resigned. Governments borrow by selling bonds, promises to repay with interest, and on 6 April the rate on Portugal's two-year bonds passed 10 per cent. The next day Portugal, one of the euro area countries that share the euro, asked the European Union and the International Monetary Fund (IMF), which lends to countries in trouble, for help.

Portugal's economy and its rescue programme

Portugal's economy had grown slowly for more than a decade before the crisis. Since it joined the euro, and leaving aside one-off measures, its government had almost always run a deficit above the ceiling in EU rules: 3 per cent of GDP, the value of everything a country produces in a year. Portugal's banks depended on borrowing from abroad, and in the run-up to the rescue request they were increasingly cut off from it, so they leaned on the euro area's central banks instead.

Portugal agreed a rescue programme in May 2011 of up to 78 billion euros, borrowing from the EU's and the euro area's rescue funds, set up in 2010 to lend to members that could not borrow, and the IMF, a third from each. The money came in stages, in return for deficit cuts, help for the banks and changes to how the economy worked.

From Portugal to Italy and Spain

Lenders did not stop at Portugal. They looked for the same weak points in other euro area governments: slow growth, high debt and weak banks. Italy's economy had been relatively stagnant for most of the 2000s, its banks were struggling, and its government debt had been larger than a year's output for years. Spain's banks had lent heavily into a housing boom that had turned to bust. So in August 2011 lenders turned on both. In October rating agencies, firms that grade how likely a borrower is to repay, downgraded both.

Italy and Spain, 2011

Italy and Spain were the third- and fourth-largest economies in the euro area. The chart shows Italy's ten-year borrowing cost, the yearly interest its government paid to borrow for ten years. It stayed under 5 per cent through 2009 and 2010, then reached 7.06 per cent as a monthly average in November 2011, when Germany paid 1.87 per cent.

When lenders doubt a government, they pay less for its bonds, which is the same as charging it a higher rate. A government repays old bonds by selling new ones, so a higher rate raises the cost of each new loan. Higher costs widen the deficit, and a wider deficit feeds lenders' doubts. By early 2013 Italy's debt was larger than the debts of Greece, Ireland, Portugal and Spain combined. Italy never took a rescue programme, and some feared the rescue funds might not be big enough to rescue it.