The financial press and analysts are, not surprisingly, ringing alarm bells again over the latest spat between the very liberal Constitutional Court of Portugal and the center-right government of Prime Minister Pedro Passos Coelho – namely over the Court’s rejection last night of elements of the 2014 budget on constitutional grounds.
We warned, however, that a partial rejection of pension cuts was possible, and in fact expected, and that the government of Coelho had in anticipation taken pains to try and limit the fallout from any such ruling (see SGH 10/31/13, “Portugal: Avoiding Past Mistakes”).
*** While not to underestimate their disappointment at the decision, it is now essentially back to the drawing board for Coelho for what will be a quick, albeit yes, maybe not ideal, fix. ***
*** And our expectation was and continues to be that this will not derail Portugal’s return to bond markets in mid-2014, most likely with the announcement in January of a request for a Precautionary Credit Line as a backstop credit enhancer. ***
After all, the ultimate determinant of Portugal’s return to markets will be the broader, big picture direction of its fiscal policy and economic prospects, and the market’s appetite to buy its bonds, and not what portion of its budget is derived from taxes or pension cuts.
Budgeting Under Pressure
Bitten before by the Constitutional Court, the Coelho government went to some pains this time around to try and draft a budget that would be as insulated as possible from a negative court ruling, including going so far as to hire a former European Court of Justice constitutional expert for advice (see again SGH, “Avoiding Past Mistakes”).
And indeed, last night’s court ruling is against just 10% of the budget, on roughly 388 million Euros of pension cuts out of a budget of 3.9 billion Euros. While certainly not insignificant, especially given the tightness of the budget already, sources in Lisbon fully expect the gap to be filled.
What will happen next is that the government will look to find money elsewhere – and it seems like they are only looking at tax hikes to play it safe – even if the pension cuts can actually be re-drafted in a more legally viable way.
The Court has given the government the option to come back with pensions that have a longer transitional period, and are applied equally between the private and public sectors. But the government, from what we understand, is concerned that re-working the pension cuts at this juncture would be too unwieldy, rushed, and risky of an experiment given the goal of returning to markets by mid-2014.
Interesting enough, it was precisely the lack of time to put together the original budget that is being cited to us as the reason for making even these constitutional mistakes by members of Coelho’s coalition: the government has had to cut quickly and brutally and under pressure. While there is certainly a bit of defensiveness in that argument against Brussels and the EU, we do sympathize a bit.
Politically, the judgment is expected to be no more than a bit of a vacation-spoiler for the government in Lisbon, and it won’t significantly weaken it.
The state secretary responsible for drafting the measures (Helder Rosalino) did have to be thrown under the bus, and resigned. Rosalino was close to (ex-Finance Minister) Vitor Gaspar – of the so-called “Bank of Portugal group” – and his resignation has been widely criticized by the news. But there is no real threat to the coalition over this ruling.
All in all, we do not believe this ruling to mark the difference between Portugal returning to the market or not.
The speedy referral of the budget to the Constitutional Court in fact may have been a brilliant move by President Cavaco Silva, who belongs to Coelho’s party, in that it helps bring the decision earlier and gives the government time to react, and for markets to settle before the mid 2014 target for returning to markets.
But what this ruling may well do is, to the government’s disappointment, move the bar that much closer towards seeking a Precautionary Credit Line – with some conditionality attached – to ease Portugal off the full bailout and back to the private sector.
That is something we have been sort of expecting all along anyway.