Portugal is Growing So Will It Need More Austerity?

November 24, 2015Portugalby Marc Chandler

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Portugal's importance is greater than its economic size.

A NATO country has shot down a Russian plane.  The refugee influx is threatening to unravel the Schengen Treaty of free movement.  Germany's Merkel celebrated her tenth anniversary as Chancellor this past weekend, but she faces one of the most serious challenges of her tenure.  

Portugal accounts for less than 2% of the Eurozone GDP.  We argue that like Greece, Portugal's importance is greater than the size of its economy.  Among the political challenges Europe faces, the Iberian Peninsula should not be under-estimated. 

Portugal had been heralded as a success of the austerity regime.  When others in southern Europe whined about the counter-productiveness of austerity during an economic downturn, the creditors would point to Portugal to show what was possible.  Portugal completed its assistance program last year.  It has been able to return to the capital markets.  Unemployment has fallen from around 17.5% to below 12%.  

Portugal is growing.  After contracting in 2011-2013, the Portuguese economy expanded by almost 1% last year and it is on track for a little more than 1.5% this year.  The official forecasts call for near 2% growth next year and 2017.

Growth helps ease the debt burden.  However, despite the growth and decline in bond yields, Portugal's growth is less than the average interest rate on its debt.  This means that debt as a percentage of GDP is still rising.  It stands near 130% of GDP.  The EU fiscal rules require country's with debt in excess of 60% of GDP to run budget surpluses to bring the debt levels down.  Even if the fiscal rules are not vigorously enforced, Portugal is facing demands for austerity for years to come.  This is untenable.

The majority center-right government lost its majority in the recent election.  As a minority government, it could not win acceptance of its budget, and the government collapsed.  A loose alliance of the Socialists, Communists, and Left Bloc defeated the minority government, and after a lot of back and forth, the president is allowing the head of the Socialists Costa to form a new government.

Costa and the Socialists are not opposed to all austerity, but rather so much austerity.  In addition, they are interested in redistributing the pain.  The Communists and Left Bloc are more extreme, and in the past have also advocated the withdrawal from NATO.  Costa's work is arduous.  He needs to forge a stable and durable coalition.  Among the government's first tasks is to submit a draft of next year's budget. 

Although Portugal is not on a multilateral assistance program, officials still have leverage.  There is the EU's budget approval process itself.  At the extreme, is the ECB funding.  Through the national central bank, Portuguese banks borrowed almost 24 bln euros from the ECB last month.

Portuguese politics is important because it is part of a growing wave of a push back against austerity, which is not only limited to southern Europe (Greece, Italy, and France).  Corbyn rise to the head of Labour in the UK was partly predicated on his anti-austerity rhetoric.  Canada's Liberal Party promised to turn a small budget surplus into a small budget deficit and against the odds won the recent election.

Why Portuguese Politics Matter is republished with permission from Marc to Market

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