Portugal: Avoiding Past Mistakes

Published on October 31, 2013

Ireland will return to markets at the end of this year as the first success story of the European fiscal crisis to emerge from a Troika program. But questions continue to linger over Portugal, the other hoped for success story, as it struggles on, mired in a deeper recession and facing continued political and social challenges.

*** Despite continued brawls within the government, however, which needed a marathon 13-hour long negotiation before coming out with a draft budget two weeks ago, signals from Portugal in fact point to a very lean budgetary process that has been negotiated closely with the Troika. ***

*** And in that process, the populist Paulo Portas, Vice-Prime Minister responsible for the budget and head of the minority CDS-PP coalition party, has quietly and wisely backed off of his grand promises of seeking another deficit target adjustment from the Troika and European Commission. ***

*** With the budgetary process well underway – it will still need to pass parliament but should do so easily – markets and analysts are now concerned about a repeat of the Portuguese Constitutional Court challenge to the budget that shocked investors and creditors alike so much back in April of this year. And ironically, a court challenge and judgment could come at the worst possible time, in the spring or summer of 2014, right when Portugal’s current program will be rolling off and Lisbon will be gearing to return to markets. ***

*** This time around, however, the government has gone out of its way to take steps to mitigate those risks. Specifically, we have been told that the government has learned from its mistakes, and next year’s budgetary measures are designed to be much less controversial for the courts, focusing more on a “revenue-based” approach than on wage and benefits cuts. Also, a former European Court of Justice¬† Advocate General and Constitutional expert, Poiares Maduro, has been enlisted to help draft the measures in a way that at least minimizes, even if it does not eliminate, any Court challenge. ***

We expect Portugal’s attempts to return to market in the middle of next year to be successful, especially if enhanced by an ESM credit line, even if the process is not entirely smooth.

Politics and that Pesky Constitutional Court

The Portuguese Constitution is widely seen as very left-leaning, despite continuous amendments to try and make it fit the needs of a more modern, market-based country. Due to its construction, as explained to us by political sources in Lisbon, it is much more difficult for the government to approve spending cuts than it is to raise taxes.

That, of course, did not stop the current center-right government of Prime Minster Pedro Passos Coelho (PSD) from trying to do just that and institute much needed wage and pension reforms, leading to last year’s bad experience with the courts. This year’s budget, however, leans much more towards new revenues than it does towards spending cuts.

Nevertheless, the 2014 budget does require some cuts for public employees, a circumstance that has triggered public demonstrations, including last week. Controversial provisions also include cuts in the so-called “survivors’ pensions,”¬†a measure that is widely considered “retroactive” and which therefore could in fact be sanctioned by the Court.

Timing wise, the President of the Republic, Annibal Cavaco Silva (also PSD), once the budget is approved by the Parliament – and we believe it will be by the end of November even though neither of the coalition parties is happy with it – is compelled to send the budget to the Constitutional Court if he believes there are elements of it that could be judged unconstitutional. If he does not do that, a number of MPs could and will request it formally.

Last year, we hear the government tried to convince the Court to be milder in its ruling, arguing behind the scenes that this was a “specially sensitive” time. In fact, from what we understand, the President apparently even sent the budget law to the Constitutional Court with some remarks of his own added on the side (throwing his political weight even further behind the evaluation).

That did not sit well with the Court, who rebutted with its commitment to upholding the fundamental law of the country, and refused to give the budget legislation “a political eye.” We have been told that this year the President will prudently refrain from applying such overt political pressure.

The Coalition: Litigious, but Solid

Perhaps of lesser immediate concern, but of concern nevertheless, is a return to the political infighting and instability that rocked Portuguese markets last July.

Back then, the Passos-Coelho government almost collapsed when the fiercely ambitious Portas, claiming the country needed to take a tougher stance in negotiating with the Troika, threatened to withdraw from the coalition if he were not put in charge of the “Euro-bailout” portfolio.

While Coelho did fold and give him the desired powers, Portas since then has been unable to really score any substantial points, and has come out of the latest 8th and 9th Troika reviews clearly rebuffed, forced to announce to the Portuguese public that despite doing everything in his powers, the Troika would not budge from its targeted 4% deficit number.

There is also a slow but real rift growing between the two government coalition parties. Evidence of that is in the recent “survivors’ pensions” scandal. That was a measure agreed to cut pensions of the survivor who benefited from a double treatment that amounted to more than 2100 Euros. Any mention of that was conveniently left out by Portas during a press conference three weeks ago (when he had to present the results of his agreement with the Troika). The measure had to later be leaked to the press, supposedly by a PSD member of the government.

These rifts, however, are not big enough to lead to any near term future shock.

The PP-CDS, Portas’ party, will hold its congress next year in February. Although his position with the voters has weakened and although the incapacity to negotiate has negatively affected his reputation, Portas leads his party with a Machiavellian grip, and will therefore most likely not face any real challenge.

The larger PSD party itself is not in such good shape. While the PP-CDS normally enjoys strong ideological support from its members, the PSD is more subject to the mood swings of the electorate. Look to the upcoming European parliamentary elections in May of 2014 for further signs of PSD weakness and Socialist gains.

Passos-Coelho also faces a challenge from within his own party from the former mayor of Porto, Rui Fernando Rio. That, however, is unlikely to materialize by the next party congress.

A 2014 Return to Market?

The question still remains whether Portugal will be able to return to markets in the middle of next year when its first bailout program expires? We suspect it will, especially if the global market environment remains benign, and that there will be good demand for new Portuguese bonds and paper.

Those prospects could be further enhanced if Lisbon agrees to seek a credit line backstop as a guarantee from the ESM as it exits its program – just in case.

There was some chatter in Brussels recently that European leaders could be more inclined to deal with a possible “ECCL” (Enhanced Conditions Credit Line) type facility, or in worst case the possibility of a second bailout, before the end of the year, in order not to carry the issue close to the European parliamentary elections next May.

But there were no signs that Portugal was actually in need of any imminent help or in danger, and this chatter has since died down – at least for now. There was, however, a frank admission by the Portuguese Prime Minister that the country would ask for a line when and if “it felt like it needed it.”

Ireland looks to be foregoing such support as it returns to markets, mainly to avoid any unnecessary conditionality, because it can now stand on its own two feet, and to prove just that to markets and to its population.

Portugal may need just a little bit more help as it flies out of the Troika’s nest.

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