Fears of Euro Zone Domino Effect Will Greek Contagion Bring Portugal Down?

Will the Greek malaise spread to Portugal? Fears of a national bankruptcy are now also growing in Lisbon, even though the country is capable of getting its debt under control by itself. The problem is that markets no longer have faith in the Portuguese to fix their own affairs.



"Fear defeats more people than any other one thing in the world," wrote the American philosopher Ralph Waldo Emerson. The current crisis in Greece shows that the fear of failure can also bring countries to their knees. Greece's precarious financial situation has brought the state to the brink of bankruptcy in record time.

Portugal could be next. The country is under pressure due to fears that it could be sucked into the Greek maelstrom. In the past few days, the government in Lisbon has experienced the power of international markets. On Wednesday, the rating agency Standard & Poor's announced it would downgrade Portugal's credit rating to A- and warned that further downgrades were possible.

The devaluation was partly based on technical reasons. As a result of the Greek crisis, nervousness spread on the bond markets. This increased the interest premiums on Portuguese government bonds. Standard & Poor's reacted by giving the country a lower rating. But this only accelerates the downward spiral: Investors become even more nervous, the interest rates on Portugal's bonds rise rapidly and new downgrades become more likely.

This panic mechanism has been influencing the bond markets for months, significantly exacerbating the debt problem in countries such as Portugal. In the case of Portugal, however, the fears are hardly justified. Economically and financially, the country is far better off than Greece:

  • Although Portugal's budget deficit skyrocketed up to 9.4 percent of gross domestic product during the global economic crisis, its national debt, at 77 percent of annual economic output, is only slightly higher than Germany's. Greece's debt, in contrast, is about 125 percent of GDP.
  • The government in Lisbon will not need very much fresh money in the foreseeable future. In May, they need to refinance around €7 billion ($9.3 billion), with a total of about €21 billion for the whole of 2010. Under normal circumstances, those sums could be raised in the markets.
  • Even Standard & Poor's had a different opinion about Portugal just a few weeks ago. As recently as March 29, the rating agency decided that it did not need to downgrade Portugal's credit rating. That raises the question of what is supposed to have changed about Portugal's economic situation since then, apart from the fact that interest rates on government bonds have increased as a result of unrest in the market.

Government Effective Despite Minority in Parliament

Indeed, the crisis that Portugal is facing is mainly a political one. "Early elections and postponed reforms have seriously shaken confidence in the government's ability to act," says Pedro Tadeu of the newspaper Diário de Notícias. In addition, Prime Minister José Socrates of the Socialist Party (PS) is head of a minority government, meaning that the opposition can block its reforms at any time.

Currently, however, the government and the largest opposition party, the conservative PSD, are demonstrating unity and determination. On Wednesday, Socrates and opposition leader Pedro Passos Coelho stood side by side at an appearance in the Sao Bento Palace in Lisbon, the seat of the Portuguese parliament, and promised decisive action against the "unjustified speculative attacks."

To achieve that end, Socrates' "Program for Stability and Growth" (PEC) will be changed. Austerity measures that were originally planned for the coming years will now be introduced in 2010. Tax increases are also planned. The tax rate on incomes of more than €150,000 will be increased to 45 percent, which will bring the state an extra €1.3 billion by 2012, according to the business newspaper Jornal de Negocios. In addition, the government plans to introduce a stock market tax and new highway tolls, and cut back unemployment benefits, before the end of 2010.

Support from the Opposition

The chances of Socrates' savings package being implemented are good. Opposition leader Passos Coelho, who has only been in office for a few weeks, said his party would support the legislation in parliament. He is generally regarded as more cooperative than his predecessor, Manuela Ferreira Leite, who for a long time refused to cooperate with Socrates' savings plans. In February, she even supported a regional finance bill, against the will of the government, that allows the autonomous regions of Madeira and the Azores to accumulate up to €400 million in new debt over the next four years.

On March 25, however, the PSD finally approved Socrates' austerity package. After the rating agency Fitch downgraded Portugal's credit rating, the PSD supported the goals of the program indirectly by abstaining in a parliamentary vote.

Socrates and Passos Coelho want to avoid such wrangling this time around. The government's new savings efforts are expected to be approved by parliament in the next few days. The legislation is considered certain to pass, given that the PS and PSD between them have an almost two-thirds majority in the Portuguese parliament.


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