Europe faces second revolt as Portugal's ascendant Socialists spurn austerity
Germany is worried that any concession to Greece will set off political contagion and cause fiscal discipline to collapse across southern Europe
By Ambrose Evans-Pritchard
6:00PM BST 19 May 2015
"We will carry out a reverse policy,” said Antonio Costa, the Socialist leader.
Speaking to journalists in Lisbon as his country prepares for elections - expected in October - he insisted that Portugal must start rebuilding key parts of the public sector following the drastic cuts under the previous EU-IMF Troika regime.
While the Socialist Party insists that it is a different animal from the radical Syriza movement in Greece, there is a striking similarity in some of the pre-electoral language and proposals.
Syriza also pledged to stick to EMU rules, while at the same time campaigning for policies that were bound to provoke a head-on collision with creditors.
Mr Costa accused the Portuguese government of launching a blitz of privatisations in its dying days, signalling that the Socialists will either block or review the sale of the national airline TAP, as well as public transport hubs and water works.
His harshest language was reserved for the International Monetary Fund but this reflects the cultural milieu of the Portuguese Left. In reality the IMF was the junior partner in the Troika missions.
Mr Costa unveiled a package of 55 measures in March, led by a wave of spending on healthcare and education that amounts to a fiscal reflation package. The party would also roll back labour reforms and make it harder for companies to sack workers.
The plan would appear entirely incompatible with the EU’s Fiscal Compact, which requires Portugal to run massive primary surpluses to cut its public debt from 130pc to 60pc of GDP over 20 years under pain of sanctions.
The increasingly fierce attacks on austerity in Lisbon are likely to heighten fears in Berlin that fiscal and reform discipline will break down altogether in southern Europe if Greece’s rebels win concessions. Worry about political "moral hazard" is vastly complicating the search for a solution in Greece.
“Greece is the testing ground and everybody is watching very carefully. That is why the Spanish and Portuguese prime ministers have been so hawkish,” said Vincenzo Scarpetta, from Open Europe.
No deal for Greece is yet in sight. Syriza continues to live from hand to mouth, narrowly putting off default week after week by raiding obscure funds. The country’s finance minster, Yanis Varoufakis, told Greek television on Monday night that “pensions and salaries are sacred” and will take priority if the money runs out. “I would prefer to default to the IMF rather than on salaries,” he said.
Sending out mixed messages, he also said that Greece had no plans for a rupture with Brussels or a “change of currency”.
Portugal is no longer under Troika control. It exited its €78bn bailout programme last year and returned to the markets. It is currently able to borrow money for 10 years at an interest rate of 2.35pc. “We no longer have any direct leverage,” said one EU official.
However, countries remain under “post-programme surveillance”, with two monitoring missions on the ground each year until they have repaid 75pc of the money. Portugal will not be in the clear for a long time.
The legal text stated that the council of EMU ministers can issue “recommendations for corrective actions if necessary and where appropriate”. The EU bail-out funds (ESM and EFSF) have their own “early warning mechanism” to ensure that debtors stay on the right track.
Portugal has weathered the austerity crisis in much better shape than Greece but it remains vulnerable, with higher aggregate debt levels and far lower levels of education than Greece.
Total combined public and private debt is more than 370pc of GDP, the highest in Europe. This leaves the country badly exposed to the effects of debt-deflation and stagnant nominal GDP.
William Buiter, Citigroup’s chief economist, said Portugal has many of the same economic "pathologies" as Greece, and is likely to be first in line for contagion if the sanctity of monetary union is violated by the ejection of Greece.
Citigroup calculates that Portugal’s debt ratios have already gone beyond the point of no return, warning that the country will ultimately need some form of debt-restructuring to wipe the slate clean. This lingering fear in the market leaves Portugal prone to a fresh debt crisis if the eurozone recovery runs out of steam.
The IMF said in its Article IV healthcheck this week that Portugal’s bailout has been a success but warned that the "country remains highly vulnerable".
The “export miracle” is narrowly based and does not yet reflect lasting gains in competitiveness. “A durable rebalancing of the economy has not taken place and the nontradable sector is still dominant,” it said.
While exports have jumped from 30pc to 40pc of GDP since 2010, the picture is far less rosy for "domestic-value added exports", the metric used by the IMF to measure meaningful gains.
The Fund said Portugal is currently benefitting from a “trifecta of record-low interest rates, a weakening euro, and low oil prices” but this cyclical tailwind will fade over time.
“Portugal faces an acute growth challenge. Productivity growth has been declining over the past half-century. Looking forward, Portugal’s working-age population is projected to fall, and the country’s capital stock is contracting because of under-investment,” it said.
This stagnation trap makes it extremely hard for the country to grow its way out of debt, or to overcome external liabilities of 215pc of GDP. “A systemic solution to the problem of excessive leverage is needed. Not only do the banks that keep too much bad credit on their books endanger financial stability, they are also unable to finance the economic recovery,” it said.