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Portugal may avoid Greek contagion with austerity plan

Source: Reuters - Thu 29th Apr 2010

Portugal should be able to avoid being the next country after Greece to need an EU bailout as there is a strong likelihood that an austerity plan announced last month will gain parliamentary approval and then be accepted by the population without violent protests.

But with its bonds being hammered by investors, Portugal will have to beef up the plan with unpopular measures like indirect tax hikes, spending cuts and possibly Irish-style wage reductions, or risk a full-blown confidence crisis, analysts say.

"We're in the dynamics of contagion from Greece, which will force the government to widen the existing measures" said Jose Brandao de Brito, an economist at Millennium bcp bank.

"I think there's still time to do so. Portugal needs to control the budget deficit while it's still controllable. New measures should be both on the budget consolidation side and to boost competitiveness by making the job market more flexible" he said.

A day after Standard and Poor's downgraded Portugal's sovereign debt rating two notches to A- citing doubts that Portugal will deliver on its medium-term budget consolidation goals, Portuguese/German bond spreads continued to climb, hitting euro zone lifetime highs of over 320 bps for ten year debt, three times above March levels.

Also, Portugal's credit default swap curve has began to invert in recent few days, as happened to Greece's debt in early April before the European Union and the International Monetary Fund agreed on an aid package for Greece.

The swaps, which are used by investors as insurance against default, are now higher for shorter-term debt than for longer-term, indicating an increased likelihood of a solvency crisis.

The minority Socialist government last month unveiled a plan to cut the budget deficit to 2.8 percent of gross domestic product in 2013 from last year's 9.4 percent. The measures include caps on public sector wages and government spending.

Although considered solid and credible by Brussels, the programme may be insufficient if economic growth falls short of the government's projections.

Socialist Prime Minister Jose Socrates and the leader of the largest opposition party, the centre-right PSD, made a joint statement on Wednesday pledging cooperation to implement the plan.

PSD leader Pedro Passos Coelho also said Socrates had shown "openness to consider additional austerity measures".

Brandao de Brito said he expected an agreement on new measures between the two parties which, together, have the votes to get any necessary legislation through parliament.

He and other economists say Portugal needs at least to raise indirect taxes, such as for fuel and value-added taxes, cut public investment further and make rules for hiring and firing workers more flexible to increase competitiveness.

Diego Iscaro, an economist at IHS-Global Insight in London said the risk of Portugal "being dragged into a vicious circle as happened in Greece" was growing by the day despite Portugal's lower deficit and debt levels and its better fiscal credibility.

"The underlying problems are very similar: two very uncompetitive economies within a common currency area" he said, adding also that the government should unveil more measures in order to ease markets' pressure.

There will be a major test of confidence next month when Portugal will have to redeem five billion euros of Treasury bonds that mature on May 20. The government says there will be no problems.

"We can guarantee that the redemption will be one without difficulties" said Treasury Secretary Carlos Pina on Tuesday.

But it still needs to issue between 11 billion euros and 13 billion euros in bonds this year and demonstrate that it can cope with the current high cost of borrowing.


Professor Joao Cesar das Neves, an economist at the Lisbon Catholic University, said the ideal solution would be to follow the example of Ireland, which last year managed to soothe market fears by coming up with a tough austerity plan complete with salary cuts for public servants.

"The government's big mistake was having too much confidence in the axiom that Portugal is not Greece. They have to come up with tougher measures, cut salaries like Ireland did" he said.

"Nothing happened overnight, Portugal is in the same situation now as it was a month ago, but the market is very nervous and it did not see the kind of soothing measures Ireland produced last year" Cesar das Neves said.

David Schnautz, a bond strategists at Commerzbank in Frankfurt, said Portugal also had to be very careful with its bond issuance programme after hiking it to 20-22 billion euros last month from 18-20 billion euros earlier.

"Another upward revision would almost certainly be a dangerous thing to do. So in order to make sure this is sufficient for 2010, some additional savings, another tranche of austerity measures would certainly help" he said.

He said the country also has to continue showing that it can successfully raise funds in the market to boost sentiment.

"The yield term would not matter much, but just the pure access to market. This would rather help to contain some of the fears that Portugal is experiencing" Schnautz said.

Portugal-based analysts say the risks of not being able to implement austerity measures are quite low as the Portuguese have little stomach for violent protest such as in Greece.

"Internal risks are low. Social unrest is not comparable to Greece. Strikes are generally less intense" said Cesar das Neves.

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