Portugal's anti-austerity left takes power in watershed moment for the euro
Portugal’s anti-austerity Left has taken power with the support of Communists and radical forces after eight weeks of bitter wrangling, breaking Germany’s grip on economic policy and setting the scene for a bruising fight with Brussels on budget plans.
The triumph of the triple-Left alliance under Socialist leadership is a historic moment for the country and implies a sweeping reversal of austerity cuts imposed by the now-departed EU-IMF Troika.
President Anibal Cavaco Silva warned the Socialists that he will sack the government if it violates Eurozone deficit rules and the Fiscal Compact, or endangers the “external credibility” of the country. “It is an illusion to think that Portugal can dispense with the institutions and creditors,” he said.
Yet his rhetoric cannot disguise the fact that an establishment centre-Left party has, for the first time, defied the prevailing ideology in the Eurozone.
The Germans can no longer count on Lisbon to make the austerity case for them, and to provide political cover. “They have lost their best ally for fiscal discipline,” said Ricardo Amaro, from Oxford Economics.
Portugal’s revolt is not a replay of the Syriza saga in Greece. The country escaped Troika tutelage last year, and is not dependent on money from the Eurozone rescue fund (EMS). “We have no leverage,” said one EU official.
The pro-European Socialist leader, Antonio Costa, has gone out of his way to reassure bankers and business leaders that he will avoid the sort of showdown that brought Greece to its knees. Yields on Portugal’s 10-year bonds have settled down to 2.33pc since spiking earlier this month - though this could change when the Europe Central Bank stops buying its bonds under quantitative easing.
The new finance minister is Mario Centeno, a Harvard-trained labour economist with "Blairite" leanings, deemed to be a cautious team-player. “He is not another Yanis Varoufakis,” said Rui Tavares, a Portuguese commentator.
Yet the picture remains chaotic and fraught with danger. The Socialists are to rule by minority, with no encompassing coalition agreement. The Communists and the Left Bloc reserve the right to dissent, and have made it clear that they will do so. “It could break over Syria, or TTIP (trade deal), or anything,” said Mr Tavares.
Mr Cavaco initially deemed the triple-Left grouping too dangerous for power, warning that there could be no government in Portugal that relied on parties opposed to the euro, the Fiscal Compact or Nato.
He reappointed a Right-wing minority government even though it had lost its parliamentary majority, and openly urged rebel Socialists to switch sides. This gambit failed. The Left held rock solid. He has been forced to back down.
The issues of euro membership, debt restructuring and Nato have been finessed but have not gone away. While the Socialists vow to abide by Eurozone budget rules, their policies are incompatible with the Fiscal Compact and go against the grain of market reforms.
They will reverse wage cuts and a pension freeze for state workers. The minimum wage will be lifted to €600 a month, plus two months’ bonus. Electricity will be subsidized for poor families. VAT be will cut for restaurants. They will halt privatization of the water group EGF and the airline TAP, and suspend plans to open transport in Lisbon and Oporto to private competition.
Societe Generale warned that Portugal will breach the EU’s excessive deficit procedure next year, raising the risk of sanctions. An even bigger crunch looms with the Fiscal Compact, which will force Portugal to cut its public debt – now 128pc of GDP – by 1/20th of the amount above 60pc each year for 20 years, locking in a contractionary trap.
One EU official with close ties to Portugal said the heavily-indebted country is not in better shape fundamentally than Greece. It received lighter treatment from the Troika because EMU leaders deemed it too risky at that time to allow a second disaster. “It was purely a political decision to save Portugal,” he said.
The International Monetary Fund warns that the country has no margin for error, even if private debt has been whittled down from 252pc to 210pc of GDP. The economy has been losing steam and stalled in the third quarter.
While Portugal has eliminated a current account deficit of 12pc of GDP, this is a largely due to a collapse of internal demand. Its export miracle is flattered by re-exports with little value added. “A durable rebalancing of the economy has not taken place,” it said.
Mr Amaro doubts that growth will ever rise above 1.4pc over the next four years. Output will languish below its pre-Lehman peak until 2020, and by then Portugal will be deep into a second "lost decade", with fatal hysteresis effects on labour skills.
Low growth threatens to poison debt dynamics. Mr Amaro says public debt will linger near 130pc of GDP until 2020, leaving the country nakedly exposed when the next global downturn hits.
Portugal has arguably been a greater victim of the unintended effects of monetary union than Greece or Finland. Its net international investment position (NIIP) – the most crucial indicator watched by experts – was positive in the early 1990s before the experiment began. It is now -116pc of GDP and not getting better.
The country has tried to restore viability within EMU by means of an "internal devaluation" and wage cuts, but the election of an anti-austerity front shows the political limits of this strategy. It is, in any case, extremely difficult to deflate a high-debt economy, since the debt ratio rises automatically if nominal GDP growth stalls.
Fitch, Moody’s and Standard & Poor’s all have a junk credit rating on Portugal. The Canadian agency DBRS still has a BBB investment grade rating. This alone allows the ECB to keep buying Portuguese debt under its QE purchase rules.
Mr Costa takes office knowing that his country’s financial security hangs on a single, thin thread.