Cyprus, Portugal, and possibly other EU countries are insolvent despite EU claims that they are stable, says a new report from French investment bank Natixis SA (EPA:KN) (OTCMKTS:NTXFY). The report claims that the infusion of loans is just a quick fix that denies the reality of the situation and sets these countries up for a harder fall down the line.

Natixis: The IMF rethinks its position on Greece

The report starts by pointing out that in 2009 the Troika (the European Commission, the European Central Bank, and the IMF) approached the Greek crisis under the assumption that finding stabilizing Greece was only a matter of giving the country a sufficiently large loan package, and didn’t address structural problems with the economy. The result was a partial default in 2012 that forced the IMF to reevaluate the way it had dealt with Greece.

Natixis Greece Nominal GDP

But the EU seems not to have learned the same lessons, argues Natixis SA (EPA:KN) (OTCMKTS:NTXFY) economic researcher Patrick Artus. “When looking at the trend in fiscal debts and primary fiscal debts, growth prospects, and the levels of interest rates we can see that in 2013 the following reduction in the fiscal debt (increase in the primary fiscal surplus) would be needed to stabilize the public debt ratio: 17 percentage points in Cyprus, 9.5 percentage points in Portugal,” he argues.

Natixis Public Debt

Natixis Real GDP Growth

Natixis: The EU has a strong interest in averting a banking crisis

The European Commission and the ECB have access to the same data as the IMF, and Artus argues that the reason why they have not revised their approach to fiscal crises in Cyprus or Portugal is because they cannot afford to have either countries’ banking sector to collapse.

“If Europe now declared that Portugal is insolvent, there would be an obvious risk of contagion to other countries with very high public debt,” says Artus. “It is clear that a stabilization mechanism is missing in the euro zone: one that would stop the contagion from one country to the next.”

The problem is that Euro banks have large holdings in sovereign debt, with German and French banks holding onto the lion’s share of government bonds.

If an insolvent country is declared to be solvent, its public debt will continue to rise, as will the risk-premiums it will have to pay to refinance its debt down the road. Eventually a default becomes unavoidable, but the impact is greater and the chances of harming the rest of the euro zone go up.

Natixis Euro sovereign bonds

Productivity and positive migration are important for bailouts to work

Artus argues that bailouts only make sense if a country is able to increase productivity or its tax base (net positive migration) enough to become solvent before the next round of refinancing is necessary. In such a situation the loans act as a painful, but necessary measure to give the country breathing room, but he is skeptical of the idea that either Cyprus or Portugal will avoid a partial default in the long run and believes that EU policies are doing more harm than good.

eurozone productivty and migration