Portugal, which is entering the last year of a three-year European Union aid program, will likely need further help from Europe at a time when core countries in the region, such as Germany, are fast losing enthusiasm about providing financing to ailing peripheral nations.
The most likely solution to this problem, according to analysts at Credit Suisse, isn’t a second bail-out but instead that European institutions offer Portugal a credit line until the country can make a full return to debt markets.
This is important because the strict budget cuts imposed as part of the EU-IMF aid package have begun to wear on the national psyche, triggering large demonstrations across the country in recent months as unemployment remains high and growth sluggish. Further unrest could spread across the region, fuelling further rebellion against bail-out inspired austerity.
“The credit line is the most appropriate instrument to provide to the country because (Portugal) has one foot in the market (having already refinanced some bonds), and the goal with the credit line is to support a full return to the market,” Credit Suisse analyst Axel Lang told The Financialist.
“It is an instrument that is less costly for the core countries to provide because it’s a precautionary credit line that may or may not be used by Portugal,” said Lang, who said a final decision on the matter isn’t likely until after the German elections in September.
Portugal is expected to face an estimated €12 billion (about $15.8 billion) funding gap in 2014, when its €78 billion bailout ends and as it struggles to pull itself out of a brutal recession. The country’s GDP contracted by 1.8 percent in the last quarter of 2012, and Credit Suisse expects the economy to shrink by 3 percent in 2013. Unemployment remained at 17.5 percent for the third straight month in March, according to Eurostat.
“Domestic demand is really under strong pressure,” Lang said. “At the moment, they rely on external trade, and the export sector is still pretty small for the size of the country…One of the problems is that the main trading partner is Spain, which is also not in great shape.”
European officials have already lowered Portugal’s deficit target for this year from 6 percent of GDP to 5.5 percent. The decision reflects a softening attitude toward deficits that favors a greater focus on implementing structural reforms, which Portugal has done fairly well, Lang said. The country introduced labor market reforms last year, for example, to make it easier for employers to hire and fire workers.
The burden of austerity is still a heavy one, however, and it could get worse. Portugal’s Constitutional Court recently rejected €1.3 billion in scheduled budget cuts for this year. While Lang believes the government will have a fairly easy time filling in the gaps this year, the following years may be more difficult. The government recently pledged cuts of €2.8 billion in 2014, followed by €1.9 billion more over the following two years.
“This will have to be done in a context of weak economic background, continued rising unemployment, social discontent and ultimately, political risks,” Lang wrote in his research note. Portugal’s finance minister has already acknowledged that spending will affect hospitals, schools and other areas.
In response to the growing frustrations about belt-tightening, Portugal’s leaders have been trying harder to foster growth. Recently, officials announced broad measures to cut corporate taxes and provide incentives for foreign companies to set up shop in Portugal.
“They want to have a better environment for firms to operate in because it’s a very small economy,” Lang said “They basically want to replicate the Irish model,” in which a few large companies establishing themselves in Portugal could change the employment outlook and make the country seem like a viable place to do business.
Ultimately, whether Portugal gets a credit line from Europe or not, reversing its status over the past decade as one of the slowest-growing euro-zone economies, is key to the country’s long-term success – and it won’t happen overnight.
Photo of May Day demonstrations in Portugal courtesy of AP – Francisco Seco