Portugal Heading for EU Budget Fight

Published: 27th November 2015 08:28 AM  |   Last Updated: 27th November 2015 08:28 AM   |  A+A-

Portugal's anti-austerity Left has taken power with the support of communists and radical forces, breaking Germany's grip on economic policy and laying the ground for a bruising fight with Brussels on budget plans.

The triumph of the triple-Left alliance under Socialist leadership after eight weeks of bitter wrangling is an 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 he would sack the government if it violates eurozone deficit rules or 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. "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. "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 once 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, and 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 Left Bloc reserve the right to dissent. "It could break over Syria, or TTIP [the trade deal], or anything," said Mr Tavares.

President 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.

Mr Cavaco reappointed a Right-wing government even though it had lost its parliamentary majority, and openly urged rebel Socialists to switch sides. The Left held rock solid and he was 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 go up. Electricity will be subsidized for poor families. VAT 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 Portugal will breach the EU's excessive deficit procedure next year, risking sanctions. An even bigger crunch looms with the Fiscal Compact, which will force Portugal to cut public debt - now 128pc of GDP - by 5pc of the amount above 60pc each year for 20 years.

The International Monetary Fund warns the country has no margin for error, even though private debt has been whittled from 252pc to 210pc of GDP. While Portugal has eliminated a current account deficit of 12pc of GDP, this is largely due to a collapse of internal demand. Its export miracle is flattered by re-exports.

Mr Amaro doubts that growth will ever rise above 1.4pc over the next four years. He said public debt would linger near 130pc of GDP until 2020, leaving the country nakedly exposed when the next global downturn hits.

Fitch, Moody's, and Standard & Poor's all have a junk credit rating on Portugal. The Canadian agency DBRS still has a BBB 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.

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