Perspective: Portugal Faces New Economic Challenges

By Grant de Graf

WSJ reports:

Moody's Investors Service issued a two-notch downgrade on Portugal's long-term government bond ratings, citing subdued growth prospects and productivity gains over the near term until structural reforms are enacted.

Apparently, a contributing factor towards the downgrade is "implementation risks for the government's austerity plan, which has faced opposition from the center-right Social Democrats."

Portugal's government is facing political turmoil that threatens to derail its ambition to solve the crisis alone. The nation's Social Democrats are opposed to the minority government's new austerity measures announced Friday that called for further spending cuts and boosted state revenue by further tax increases.

This is the point where I loose it. In summary: with the country facing increasing debt levels, the government initiates austerity measures, in a belt-tightening campaign against public spending. A scheduled program of commitments to repay debt is fast approaching due date, so Portugal successfully issues a series of bond auctions in the open market. Investors are a touch nervous, so interest rates yields are a little higher. Actually, quite a lot higher, about 200 basis points above previous auction levels of 4%.

WSJ elaborates: The nation is at the center of a storm that has already hit Greece and Ireland, as it is struggling with a high budget deficit that must be brought down to 4.6% of gross domestic product this year and 3% in 2012, from around 7% last year.

Interestingly, this is paltry compared to Japan's percentage government deficit to GDP of 200% before the earthquake, Italy's of 120% and France's deficit to GDP of 85% - go figure.

Portugal's Prime Minister Jose Socrates believes that if the new austerity plan was voted down in parliament, his government would likely face early elections and that a "political crisis would inevitably cause the country to request external help."

The point however that needs to be made, is that even if Portugal appeals to the European Central Bank for an extended credit line in a post election scenario, that facility will come with stringent terms, calling for further austerity measures.

This would be no different than the position in which the Irish currently find themselves, with Government officials from Ireland trying to make a case for new terms for their credit line from the ECB, balanced against further demands from the EU for an increase in austerity. Certainly, nothing would really be achieved through an election in Portugal, other than an opportunity for the dog to bite its tail.

The predicament in which Portugal finds itself, is a function of the disparity between fiscal policy and monetary policy that is a challenge for all EU members. It is impossible to fiscally meet the demands of a local electorate, when monetary policy is being dictated centrally in accordance with interests that are very different from local needs. Both Ireland and Portugal may be compelled to opt out the confinement of the Euro, which is inhibiting growth, constraining domestic needs, and reducing political strength.