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Portugal's austerity reversal may spell budget trouble
January 19, 2016 / 3:36 PM / 2 years ago

Portugal's austerity reversal may spell budget trouble

6 Min Read

LISBON (Reuters) - Relatively calm euro zone debt markets are helping Portugal's new Socialist government deliver on promises to reverse austerity, but the risk of budget slippage could still spook investors and so damage the recovery.

The minority government, under pressure from far-left allies in parliament to reverse the reforms and austerity drive of its predecessor, has dragged its feet presenting a 2016 budget in a possible sign it could struggle to deliver on all its promises.

Prime Minister Antonio Costa has said a budget draft will be ready this week after initial hopes it would emerge at the end of December. Brussels has on various occasions urged Portugal to come up with a draft as soon as possible after Lisbon missed a mid-October deadline due to an election.

Portugal exited a bailout in 2014 after austerity and reform measures and the economic recovery that started then accelerated in 2015. Investors had grown increasingly confident -– foreign direct investment jumped 39 percent in the first half of 2015 -- but a reversal of reforms has since raised concerns.

Samuel da Rocha Lopes, professor at Nova University's business and economics school, said Portugal had "substantially improved its image" with a reform drive of Pedro Passos Coelho during the bailout that had started bearing fruit with an albeit still fragile recovery.

"Now it seems like it wants to reverse everything back to the situation it was in before the rescue," said Rocha Lopes, who is also economics professor at Aarhus University.

"That is not the right image to boost investor confidence."

Costa came to power on Nov. 26 after his party teamed up with the far left Communists and Left Bloc to oust the centre-right administration. The small leftist parties did not formally join the new government, but Costa relies on them for a majority in parliament to pass legislation.

Costa has already passed laws to raise public sector salaries and pensions, raise the minimum wage, reinstate four public holidays and cut an extraordinary income tax introduced during the debt crisis to boost revenues. The government has calculated those changes will cost 1.2 billion euros this year.

At the same time, the prime minister has also promised to reduce the 2016 budget deficit to 2.8 percent of gross domestic product, down from an estimated 4.2 percent last year. His government argues that the boost to family incomes from rolling back austerity will stoke consumption and economic growth.

The government has not yet said how much growth is expected this year after 1.6 percent in 2015. The Bank of Portugal forecasts a modest acceleration to 1.7 percent but notes that depends on the government's budget measures.

Too Optimistic?

Filipe Garcia, head of Informacao de Mercados Financeiros consultants in Porto, said there is a big risk that overly optimistic projections may be used in the budget, making its goals hard to meet. The government has not said how much growth it expects after expansion of an estimated 1.6 percent in 2015.

This year's planned deficit cut is hardly ambitious considering an extraordinary rescue of Banco Banif worth 1.2 percent of GDP last year, while on the other hand, "there is great uncertainty over control of spending," Garcia said.

Last week, in a sign of more pressures on spending controls, public worker unions backed by the far left parties threatened to stage a strike if the working week is not immediately cut to 35 hours from 40. Some privatisations are already going into reverse as in the case of flag carrier TAP.

Portugal's banking sector, which saw two rescues in the past two years, is another cause of concern for investors, especially after senior bond holders were last month called to plug a 2 billion euro hole in state-rescued Novo Banco.

A prospective investor in airline TAP, US-Brazilian aviation tycoon David Neelman, has signalled he would not be interested if TAP were to be state-controlled.

But despite the concerns, Portuguese bond yields have risen only slightly and last week the country sold 4 billion euros in new 10-year bonds, or one-fifth of its 2016 bond issuance plan, with demand reaching 12 billion. Investors are instead focussing on the European Central Bank's bond buying programme.

"If ever there was a time to launch a staunchly left-wing coalition in Portugal, it was now," said Nicholas Spiro of Spiro Sovereign Strategy in London. "Its not facing market pressure and that is emboldening the government."

Apart from the budget, which should spell out more clearly how much rolling back there will be of reforms and austerity, experts from European Commission, ECB and IMF will be in Lisbon next week to evaluate its performance since the bailout and to push for more commitments to improve public finances.

Both events could draw much more attention to potential risks. Analysts say Portugal has huge vulnerabilities because its debt stands at about 130 percent of GDP, one of the highest in the eurozone and well above pre-crisis levels of 84 percent.

"It's a bit like standing on a sunny beach and if a tsunami comes along we could be one of the first to be hit," said Garcia. "We have far less capacity to face a crisis today."

Additional reporting By Sergio Goncalves, editing by Andrei Khalip and Mark John

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