A political crisis has suddenly erupted in Portugal, spurred by deep divisions in the government of Prime Minister Pedro Passos Coelho, aggravated by years of austerity and bleak economic forecasts. The political turmoil has rattled financial markets and raised doubts about Portugal's ability to recover from its long slump.
Yet deteriorating economic fundamentals in Portugal did not cause this crisis. Political maneuvering did. Undoubtedly, a degree of austerity fatigue has arrived in Portugal, as growth forecasts have been revised down and unemployment has increased. Indeed, these revisions were highlighted by former finance minister Vitor Gaspar in his resignation letter on July 1, when he stated that such disappointments had undermined his credibility as finance minister.
The basic political calculus for the current Portuguese coalition government has been to swallow hard and hope for economic recovery before the next elections, which must be held by mid- or late 2015. The coalition understood that an early election would hand victory to the opposition center-left Socialists. The "Troika" of the European Commission, European Central Bank, and the International Monetary Fund were also hoping for the government to last. But as the economic recovery disappears into the future, more pressing political concerns take precedent.
Prime Minister Coelho's Social Democratic Party (PSD) would no doubt follow the Troika route to the end. But the junior coalition partner, the Democratic and Social Center Party (CDS)—led by Portas—has gotten cold feet, fearing losses in local elections planned for September. The annual CDS party congress is to take place this weekend. As a result, Portas demanded a political sacrifice from Coelho, which came in the form of Gaspar's resignation.
Coelho appointed Secretary of State for Treasury Maria Luis Albuquerque as the new finance minister, a choice praised by the euro group partners and EU Commissioner Olli Rehn, as representing continuity. Unfortunately, this very continuity rendered Gaspar's resignation politically worthless for the CDS.
Portas then offered his own resignation, which Coelho has so far not accepted. Portas has not withdrawn his party from the coalition government, however, indicating that he also has no interest in early elections. Rather he wants concessions from Coelho, making more political maneuvering inevitable.
Coelho will likely accommodate Portas' demands. The CDS might even get the post of finance minister. The PSD could also continue as a minority government, with CDS supporting it on a case-by-case basis. This latter option would be similar to the political maneuvering in Greece, where the junior coalition member has also left the government but supports it case-by-case. The political backgrounds in Greece and Portugal are similar, with a junior coalition wanting to appear opposed to Troika policies while avoiding early elections.
Coelho has powerful allies—in the Troika and also in the financial markets, where Portuguese yields have once again shot above 7 percent. In reality, Portas is negotiating economic policies not with Coelho, but with the Troika, which will be in no mood to offer Portugal any relief from its austerity and structural reform homework. The basic economic fact remains that Portugal is broke. But so much of its government debt is domestically held that threatening to default or restructure is not a credible threat. It is a country so riddled with structural economic defects that it failed to grow even before the crisis. There was less than 1 percent annual real economic growth from 1999–2008. Structural adjustment and crisis cannot be avoided. Portas' political maneuvering and the CDS' opportunism will not change these fundamentals.
In Portugal, it is the president who has the power to dissolve parliament and call new elections. President Aníbal Cavaco Silva is an experienced politician in Portugal and in Europe. He was prime minister from 1985 to 1895 and has a PhD in economics. He has a keen understanding of the situation. It is doubtful he will take the country to new elections, which, according to current polls, are unlikely to lead to an outright majority for the opposition center-left Socialists, while not producing major gains for populist parties. Voting would merely prolong the uncertainty without producing a credible new government.
As the horse trading takes place, the Troika will grant Portugal limited economic latitude to change policies. Little change should be expected in the economic outlook, apart from further short-term deterioration in the markets.