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Portugal's Risky Experiment



Portugal is heading into politically unchartered territory with the fall of its center-right government on November 10 in the face of protests and defections by anti-austerity lawmakers. A new Socialist government led by Antonio Costa is expected to take power with two other leftist parties, the Left Bloc (BE) and the Unitary Democratic Coalition (CDU), both of which have been excluded from political influence in the past. If such a new government reverses Portugal's fiscal and structural policies, it could set up a confrontation with the European Central Bank (ECB), whose lifeline to Portugal has kept interest rates from spiking on its huge burden of debt.

Until now, Portugal's mainstream politics have been resilient in the face of poor growth performance. Real GDP in 2013 was up less than 5 percent from 1999 levels, a record worse than that of Greece. Recent parliamentary elections produced no collapse of the traditional centrist parties in favor of more radical alternatives. The governing center-right coalition Portugal à Frente (PaF) won 38.6 percent and the center-left Socialist Party (PS) 32.3 percent. The two smaller leftist anti-austerity, anti-NATO, and anti-euro parties increased their combined support from 13.1 to 18.5 percent of the vote, however.

Most other European countries with such close votes in recent years have been run by grand coalition-type governments, as the two mainstream centrist parties join forces to share blame for tough but necessary decisions without the participation of more radical protest parties. Not so, however, in Portugal today.

But a government led by the Socialists and the two smaller leftist parties will find it hard to last long. Distrust between the far left and more moderate Socialists historically runs deep, even if Costa manages to steer clear of fundamental disagreements over Portugal's NATO and euro area memberships.

The potential economic platform of a leftist governing majority would roll back many of the spending cuts and market liberalizations introduced under Portugal's program from 2011–14, which was overseen by the so-called Troika of the European Commission, the ECB, and the International Monetary Fund. But because of the previous government's austerity policies, the new government might be able to stay within the program's fiscal targets, at least in the first year. But the Socialists have also called for unfreezing public pensions, changes to the tax system, stopping privatization of state-owned enterprises, and restoring various public holidays. Such steps would aggravate Portugal's rising structural deficit.1 For these proposals to be sustainable, Portugal would have to experience substantially higher economic growth, which the left heroically assumes would flow from the extra spending.

For a country that only recently exited its reform program and has experienced only a partial recovery from its deep structural growth crises, rolling back unfinished reforms is a risky bet. Unless Portugal more fully enables firms to negotiate wages and working conditions with their own workers, reforms its public pension system, and completes the divestments of state-owned enterprises, Portugal's potential growth rate—among the lowest in the European Union—will not likely improve, dampening market confidence in its creditworthiness. Increased financial market pressures and rising government interest rates in Portugal hence seem likely under a Socialist-leftist government.

A quick market rout is not in the offing, however. The ECB buys over €1 billion a month of Portuguese government debt under the Public Sector Purchase Program (PSPP).2 But how long will the ECB do so if Lisbon walks away from budget discipline? The ECB demands that the bonds it purchases have an investment grade rating. It currently relies on the opinions of four different external credit assessment institutions (ECAIs)—Moodys, Fitch, Standard & Poor's, and DBRS. However, the first three all rate Portugal's credit at below investment grade. Only DBRS's BBB (low) assessment lets the ECB purchase Portuguese bonds, and this DBRS rating is under review. Were Portugal to lose this rating, the ECB would have to stop its quantitative easing purchases, unsettling financial markets.

No doubt the ECB would have no choice but to take this step, even at the risk of restarting an economic crisis in Portugal. The rules of the PSPP are clear. The European Court of Justice would step in if the central bank wavered. It would be clear, moreover, that a new crisis was precipitated by Portuguese backsliding, making it easy for most members of the ECB's governing council to condemn Portugal to the fate of the markets in the event of a downgrade. Especially, as Frankfurt—as normal and appropriate for an independent central bank in a supranational currency area—will have managed to have someone else, a credit rating agency, pull the public trigger for its actions against a euro area government.

Ultimately, any new leftist Portuguese government would find that its most important constituents reside not in Portugal but in the credit analysis department of DBRS, located in either Toronto, New York, or Chicago (and owned by a consortium led by the Carlyle Group and Warburg Pincus). Assuming a new government went ahead with implementing the policy platform previously announced by the PS, it seems implausible that a downgrade would not eventually emerge during its term. This would mean that any such government would have to face the Portuguese electorate the next time having prematurely lost the support of the ECB—a scenario probably not conducive for its reelection prospects.

Certainly, the real world influences of credit rating agencies are alive and well in the euro area in 2015.


1. Portugal's structural deficit is estimated (based on trend GDP) to rise from 2 to 2.7 percent of GDP during 2015–17. Data from the European Commission's annual macroeconomic (AMECO) database.

2. Since the program was started, the ECB has bought on average €1.184 billion per month and a total of about €9 billion of Portuguese debt. See ECB data

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