Things must be getting serious in Portugal, they just announced a short-selling ban on select banking stocks - how long before capital controls?
Originally posted at Open Europe,
A couple of months ago we asked, ‘Who’s next in line in the eurozone crisis?’. Our top pick was Portugal for a number of political and economic reasons, it now seems that prediction is coming to pass.
Summary: The Portuguese government is on the rocks. The junior coalition partner the People’s Party (CDS-PP) will hold a meeting this afternoon to determine whether to support the government, if it withdraws support in parliament, elections seem inevitable, although they could be delayed for some months. Such a move would seriously hamper Portugal’s economic reform programme, which is already off track. Portugal has only met its deficit targets due to one-off measures while competitiveness adjustments have slowed and contingent liabilities remain a hidden risk. With the country on the cusp of an unsustainable debt burden any delays would likely be the final straw which pushes Portugal into needing some form of further assistance.
Portuguese coalition government fighting to survive
The coalition government in Portugal may well break up. Its position has been eroded by a series of unexpected resignations:
Finance Minister Vitor Gaspar – He resigned on Monday citing the protests against austerity and the decisions by the Portuguese Constitutional Court to overturn some of the government’s reforms. Said he felt his credibility was undermined by Portugal missing numerous reform targets.
Foreign Minister Paulo Portas (also Head of the junior coalition partner the CDS-PP) – resigned yesterday following the resignation of Gaspar. His resignation has been rejected by Portuguese Prime Minister Pedro Passos Coelho, who is fighting to keep the coalition together. The two remaining CDS-PP ministers have suggested they will also resign in the near future, which would bring an end to the coalition.
The coalition government (Social Democrat and the People's Party) currently controls 132 seats out of 230 in the Portuguese Parliament. Without the CDS-PP this would drop by 24 to 108, meaning Passos Coelho’s Social Democratic Party would no longer command a majority.
What happens next?
The leadership of the CDS-PP meets this afternoon to decide the next moves. The Portuguese media expects all ministers and undersecretaries from the party to resign immediately after the meeting. Meanwhile, Portuguese President Aníbal Cavaco Silva is due to hold talks with Passos Coelho and all the political parties holding seats in parliament tomorrow.
The key aspect is not whether CDS-PP ministers pull out of government, but whether the party withdraws its support in parliament.
CDS-PP pulls out of government, but maintains its support in parliament. Passos Coelho’s government can stay in office with the same majority, after a cabinet reshuffle. However, this would be a tenuous arrangement given the significant austerity which still needs to be implemented. It is of course possible that Portas’s move was a tactical one, looking to secure more influence as his electoral support falls ahead of this weekend’s party conference.
CDS-PP withdraws its support in parliament. The government would lose its majority. Passos Coelho could then decide to either go ahead with a minority government or step down. It is not entirely unusual for Portugal to have minority governments. The government led by former Socialist Prime Minister José Socrates after the 2009 elections was a minority government, for instance – but was forced to an early resignation after parliament rejected an austerity package in March 2011. Another Socialist Prime Minister, António Guterres, uniquely managed to lead a minority government through an entire four-year parliamentary term between 1995 and 1999. That said, the situation is much tougher now given the crisis, and keeping a stable minority government will be a very difficult proposition.
What does it take for the government to fall?
Prime Minister Passos Coelho chooses to resign. He said yesterday he does not want to, but could be forced to quit at some point if he loses his majority in parliament.
A no-confidence motion is adopted by the parliament. The key would again be how CDS-PP votes. If the party abstained, Passos Coelho’s party would have enough votes to win. Interestingly, opposition parties in Portugal can only submit one no-confidence motion per parliamentary year. The new parliamentary year starts on 15 September. The Socialist Party, the Communist Party and the Left Bloc have already submitted a joint motion earlier this year, but the Greens have not. This government has already survived four no-confidence votes since it took office in 2011, five may be a step too far.
Passos Coelho requests a vote of confidence and loses it. The Prime Minister could decide to test his majority. However, he would have no chance of winning the vote if CDS-PP votes against him.
What happens after the government falls?
The Portuguese President Aníbal Cavaco Silva holds talks with the political parties holding seats in parliament. After that, he can either try to appoint a new Prime Minister or dissolve parliament and call new elections. Under Portuguese law, new elections must take place at least 55 days after parliament is dissolved. In the meantime, Passos Coelho’s government would stay on as caretaker.
Who would win if elections were held?
The Socialist party has opened a large lead by all accounts, up to 12% in some polls. However, it still looks short of the majority needed to govern alone – in the previous elections the Social Democratic Party secured 38% of the vote but only 108 seats (although as noted above a minority government is difficult but not impossible). However, despite initially supporting the reform programme the Socialist Party has become increasingly vocal against austerity and it is unclear if they would stick to the reform programme, if they came into power. This would throw up serious problems, breaking the fragile cash-for-reform bargain which has been in place over the past few years in Portugal and in the eurozone more widely.
What is the most likely outcome?
Ultimately, it depends on today’s meeting of the CDS-PP and whether it decides to continue supporting the government. At the moment this seems unlikely, suggesting new elections could be on the way at some point (although Passos Coelho could drag this out by trying to run a minority government).
The Portuguese economy cannot afford further delays
Under the optimistic scenario forecast by the EU/IMF/ECB Troika, Portuguese debt is still expected to peak at 124% of GDP in 2014. Any delays will likely see this rise quickly, especially with growth already underperforming.
Portuguese ten year borrowing costs have already shot up a staggering 1.5% since Gaspar’s resignation, reaching close to 8%. This highlights the fragility of the economic situation. Only a month ago, there was widespread talk of Portugal returning to the markets ahead of schedule – now it is difficult to see how it will exit its bailout programme in spring 2014 without any further assistance (the ECB’s bond buying programme, the OMT, still remains the most likely candidate).
Deficit reduction already off-track
Over the past two years, the government has been reliant on one-off measures to meet its deficit targets. In 2011 these amounted to almost 3% of GDP (allowing the deficit to fall from 7.4% to 4.4% of GDP). In 2012, they amounted to 1.7% of GDP (pulling the deficit down from 6.4% to 4.7%). In the first quarter of 2013, this has already increased to 7.1% of GDP (although the deficit for the first quarter alone reached 10.6%).
This year’s deficit target has already been revised upwards to 5.5% of GDP, but even that looks a stretch from the current position. Further delays would make it very difficult to reach.
Export-led growth shows positive signs but may not be enough
Although exports have picked up in recent years, they still represent too small a share to offset the falls in other drivers of GDP (and therefore economic growth). As Graph 1 below shows, domestic demand has collapsed, while government spending and investment have also been falling. Exports may be growing, but they are unlikely to grow quickly enough to offset this collapse, or far enough to restore the decline in GDP seen in recent times.
Gaps in competitiveness between Portugal and Germany increasing again
As we noted in our previous briefing (and as Graph 2 above shows), the adjustment to unit labour costs has been thrown significantly off track by the Portuguese Constitutional Court ruling (which overturned some cuts to public sector spending), the increasing protests against austerity and the lack of buy-in from the private sector. This may eventually harm the export led growth mentioned above.
Contingent liabilities are significant
In many countries, the long-term burden of contingent liabilities such as pensions and healthcare are well known but in Portugal there are more immediate problems. The contingent liabilities of State Owned Enterprises (SOEs) total 9% of GDP but are excluded from government debt levels despite these companies coming under serious pressure. Many have significant debt overhangs and could be forced to turn to the government for assistance if financing conditions worsen once again. Total contingent liabilities could run as high as 15% of GDP according to the IMF. Furthermore, the stock of government arrears is around 2.6% of GDP (€4.3bn) and is owed to domestic firms meaning it remains a drag on growth.
Easing the reform programme is an option but may help little
Portugal has already seen its targets eased as well as the maturities of its loans extended and the interest rates reduced. There may still be scope to do this further, but not much. It is unlikely the eurozone would agree to such a move until a stable government is once again in control. Furthermore, with maturities and rates already extended and cut almost as far as is feasible further action seems unlikely. Delaying targets may give more room to breathe but Portuguese debt continues to look unsustainable.
So will Portugal need further financial assistance?
Any delays would likely be tantamount to pushing Portugal towards further assistance, be it OMT or some form of debt restructuring, and consigning the country to another few years of tough austerity – which would be both politically and legally difficult to implement. As we previously noted, further assistance always seemed possible – Portugal will now have to work very hard to avoid needing it.
For more information please contact the office on 0044 (0)207 197 2333, Raoul Ruparel on 0044 (0)757 696 5823 or Vincenzo Scarpetta on 0044 (0)796 924 0642.
 We covered the resignation and the reasons behind it in more detail on our blog, see: http://www.openeuropeblog.blogspot.co.uk/2013/07/portugals-finance-minister-resigns-bolt.html
 Público, ‘Ministros e secretários de Estado do CDS preparam cartas de demissão’, 2 July 2013 http://www.publico.pt/politica/noticia/ministros-e-secretarios-de-estado-do-cds-preparam-cartas-de-demissao-1599053
 RTP, ‘Governantes do CDS vão apresentar demissão’, 3 July 2013 http://www.rtp.pt/noticias/index.php?article=663706&tm=9&layout=123&visual=61
 Cited by FT Alphaville, ‘Portuguese turmoil’, 3 July 2013: http://ftalphaville.ft.com/2013/07/03/1554872/portuguese-turmoil/
 Cited by Reuters, http://www.reuters.com/article/2013/03/01/us-portugal-minister-idUSBRE9200VZ20130301
 For a more detailed discussion on this see the Open Europe blog: http://openeuropeblog.blogspot.co.uk/2011/11/securing-portugals-deficit.html
 Figures are taken from the IMF’s Seventh Review of the Portuguese economic adjustment programme published in June.
 Portuguese Statistics office, first quarter 2013 press release on government lending: http://www.ine.pt/xportal/xmain?xpid=INE&xpgid=ine_destaques&DESTAQUESdest_boui=152049611&DESTAQUESmodo=2
 Open Europe, ‘Who is next in line in the eurozone crisis? Portugal and Slovenia are the prime candidates’, 11 April 2013: http://www.openeurope.org.uk/Content/Documents/Pdfs/2013Whosnextinline.pdf. In graph 2 the dotted line shows the desired path of adjustment needed to close the competitiveness gap to a sustainable level.