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Thursday 24 July 2014

Axel Bugge: Portuguese politics may spoil European austerity recipe

Published 16/07/2013|15:32

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Portugal's financial markets went into a steep nosedive as the government teetered on the verge of collapse (AP)
Portugal's financial markets went into a steep nosedive as the government teetered on the verge of collapse (AP)

EUROPE hoped Portugal would stick to the austerity prescribed in its financial rescue, graduating next year and following Ireland in a successful recovery from economic slump.

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nstead, a political crisis has knocked the programme off track and Portugal is starting to look more like Greece which only scraped through the latest review of its bailout.

Two senior Portuguese ministers have resigned, creating political turmoil and spending cuts and tax hikes have contributed to the worst economic slump since the 1970s and record high unemployment of 18 percent.

"The hope was that Portugal, by being the second country to exit a programme after Ireland, would show that the cure works, that countries can recover," said Guntram Wolff, director of Bruegel, an influential think tank in Brussels.

"If that doesn't happen, the appetite to do another programme is not very big on all sides."

The crisis started with the resignation of former finance minister Vitor Gaspar, who backed the adjustment plan but said he had no support. Then Foreign Minister Paulo Portas resigned in protest at the austerity, prompting fears he would pull his junior CDS-PP coalition party out of government and rob it of its parliamentary majority.

Portas was angered by the nomination of treasury secretary Maria Luis Albuquerque to replace Gaspar as it implied a continuation of Gaspar's austerity policies. Prime Minister Pedro Passos Coelho then tried to fix the situation by promoting Portas to deputy prime minister and put him in charge of economic policy coordination.

But the crisis took a new twist when President Anibal Cavaco Silva last week refused to accept the premier's plan, instead calling for a broad political agreement between the main political parties to back the bailout until it ends in mid-2014.

SLIPPERY SLOPE

The president wants the main opposition Socialists to be included in the agreement. The three parties have opened talks and promised to conclude them by next Sunday.

"Portuguese politicians from the president down are treating the exit of Mr Gaspar, the architect of the fiscal and structural reforms demanded by the troika, as a green light for a public debate about the bailout programme," said Nicolas Spiro, managing director at Spiro Sovereign Strategy.

"The perception is that Lisbon is turning its back on economic reforms. Portugal is sliding down a slippery slope."

Bond yields surged on Friday after the head of the Socialists said he wanted a renegotiation of the bailout.

The next regular review of the economy by the 'troika' -- the European Commission, the European Central Bank and IMF -- has already been delayed by six weeks because of the crisis.

Portuguese bond yields eased slightly this week, but at 7.32pc for 10-year benchmark paper, are still around their highest levels since December although that is much lower than early 2012's levels of over 17pc.

RELAXED

So far, Brussels and Germany, the largest European creditor, have expressed little worry.

"Portugal's yields can go to 2,000pc. It doesn't change anything. Portugal is not Greece. They are in a programme, they are fully financed and they are not asking us for anything," said a EU official.

Portugal funded itself for all of 2013 when markets were calm earlier this year and yields were near three-year lows.

But analysts say that whatever the outcome of the political discussions -- which could still include damaging snap elections -- the bailout plan may be mortally wounded.

"Looking forward, regardless of what specific political situation emerges, we expect Portugal to seek a renegotiation of the terms of the current program, including an inter-temporal realignment of the austerity path from the short to the medium term," said Marco Protopapa, an analyst at JP Morgan, in a note.

Some analysts also think that when Portugal needs more help from Europe, it is likely to include some element of losses for debt holders, or private sector involvement (PSI), especially as it is set to happen after Germany's election in September.

"Perhaps most importantly, any commitment of new cash from the Eurogroup (to Portugal) will likely have to involve the private sector," said Mujtabe Rahman, an analyst at Eurasia, in a research note.

"The broader Eurozone debate -- as evidenced by developments on banking union post-Cyprus -- has decisively moved towards the involvement of the private sector before taxpayer/public money is committed to finance bailouts. A priori, there is no reason to see why Portugal would buck this trend."

Reuters

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