Portugal Bond Yields Ease on Efforts to Defuse Political Crisis

The interest rate on Portugal’s ten-year bonds which moved above 8% on Wednesday on fears of  growing political instability in the country, have eased on news that the prime minister and his junior coalition partner are attempting to defuse the crisis. The stock market has also regained some of its earlier sharp losses.

Portugal’s president, Anibal Cavaco Silva, began crisis talks with political parties and will also meet with the premier, Pedro Passos Coelho. The daily Diario Economico cited a government source who said that Passos Coelho hoped to find a solution that would prevent a snap election and preserve his coalition government. The resignations of finance minister Vitor Gaspar and foreign minister Paulo Portas earlier this week have threatened to deprive the government of a majority in parliament.

The government in Lisbon has been zealous in following the conditions demanded by the European Union (EU) in return for a €78bn bail-out, by cutting spending and implementing reforms since 2011. Portugal has applied some of the fiercest tax rises and budget cuts. In Brussels it was feted as an example of a country doing everything required of it.

However, the austerity drive has triggered increasing resentment among the general populace as Portugal’s unemployment rate has steadily risen to 17.6%. Thousands of graduates are leaving the country and last week Portugal endured another general strike.

Gaspar, architect of the spending cuts and tax hikes required by Portugal’s lenders, resigned as finance minister on Monday, citing an erosion in support for the bailout. Portas resigned a day later in protest at the appointment of treasury secretary Maria Luis Albuquerque to replace Gaspar.

As Portugal’s creditors, the EU and International Monetary Fund (IMF) are scheduled to begin their next review of the country’s economy on 15 July, but the date may now be put back.

Persisting Risks

Fitch Ratings commented that recent developments highlight the political and implementation risks to Portugal’s adjustment programme, which the credit ratings agency (CRA) cited as reasons for maintaining its negative outlook on the country’s BB+ sovereign rating when affirming it last November.

Prolonged political uncertainty that hampered policy formation and execution, or material underperformance of Portugal’s fiscal and external adjustment, would put pressure on the country’s sovereign ratings, said Fitch. “Our base case remains that programme implementation will stay on track.”

It added that the appointment of the new finance minister suggests a desire by Passos Coelho for economic policy continuity. Albuquerque has been a strong advocate of meeting programme targets through the policies of her predecessor, Gaspar.

More significant is the subsequent move by Portas, leader of junior coalition member the CDS party, to offer his resignation in response to Albuquerque’s appointment. Passos Coelho refused to accept Portas’s resignation and reports suggested that the two would meet to discuss securing a “viable solution” for the coalition government. A CDS spokesman was reported as saying that the two other government ministers from the CDS party would not leave the government. Opposition parties have called for early general elections. The final political outcome remains uncertain.

Fitch commented that since last November the Portuguese authorities have kept the country’s EU-IMF programme on track despite significant institutional hurdles, such as April’s constitutional court ruling that elements of the government’s fiscal consolidation plans were unconstitutional. In May the government attempted a further shift towards cutting expenditure, rather than relying on revenue-raising measures, with a four-year package of spending cuts.

Implementing the programme has helped reduce Portugal’s current account deficit and improve external competitiveness. However, the scale of the adjustment needed to maintain primary surpluses and restore fiscal sustainability meant that political disagreement over fiscal and economic policy was always possible. The latest developments increase the risk that programme implementation goes off track, although Fitch added that this is not currently its base case.

More Support Needed

If the government survives, it will have to endure periods of potential instability, for example around local elections due in September, said Fitch

If early elections were called, the resulting government of one or more mainstream parties would be likely to remain engaged with the Troika, although it might seek to renegotiate some elements of the current programme – as also advocated by CDS leader Portas. Both the CDS and the main opposition party, the Socialists, signed up to the original three-year support package in 2011. However, the risk of deviation from programme targets, which may have implications for public finances and therefore potentially for the ratings, would rise.

The political crisis has pushed Portuguese sovereign bond yields higher, upsetting the sovereign’s plan to fully re-enter the bond markets. Fitch concludes by saying its existing assumption, that Portugal will need further official support, remains and its BB+ rating is underpinned by an assumption that this support will be forthcoming. 

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