Court Ruling Threatens Reform Progress
On Friday April 5, Portugal's Constitutional Court overruled four out of nine contested austerity measures put forth by this year's government budget. The rejected measures would have resulted in an estimated EUR900mn-EUR1.35bn in savings and revenue (0.8% of GDP) by slashing pensions, public servant salaries and employee benefits. We see several important implications of this ruling, which we highlight below.
Bailout Negotiations in Question
In light of the court's ruling, uncertainty once again surrounds the future course of Portugal's bailout negotiations with the troika (European Commission, International Monetary Fund, European Central Bank). While a meeting of eurozone finance ministers this week was expected to result in an extension of bailout programme loan maturities, this is now unlikely until Portugal can produce a concrete alternative plan to make up for the revenue shortfall. The troika previously envisaged this extension as aiding Portugal's full return to public bond markets by year's end, which now seems increasingly unlikely as well considering the spike in borrowing costs likely to follow. Relatively shallow reliance on bond markets means public finances are largely shielded from rising yields in the short term, although a return to markets in the original time frame no longer seems possible.
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While the troika has shown leniency to Portugal in the past by extending deficit targets following sharp downward revisions to forecast GDP growth, we do not take it as given that adjustments to the program will continue indefinitely as the economic and political outlook continues to deteriorate. Given Prime Minister Pedro Passos Coelho's stated intention to cut current government expenditure to make up for the court ruling, another downward revision of forecast GDP growth for this year and next would most likely be in order should this plan go forward. Furthermore, we believe that finding the full EUR1.35bn of tenable alternative expenditure cuts will be difficult given the court's protection of pensions and salaries, making a need for further adjustment to fiscal targets probable. As court challenges to austerity become more likely given the precedent set in Portugal, the troika might be wary of granting further leniency, instead opting to pressure the government to come up with a solution. In either case, a challenging road lies ahead for Portugal.
Coalition Intact, For Now
Despite bailout uncertainty, Portugal enjoys a stable political outlook in the near-term which mitigates the risk to reform progress. The Prime Minister acted quickly in an attempt to assure the continuity of Portugal's bailout programme, declaring that the revenue shortfall caused by the court's ruling would be compensated for by further, as of yet unspecified, expenditure cuts. Coelho's party enjoys a comfortable majority in parliament and this current setback is not expected to weaken the internal cohesion of his coalition, whose demonstrated commitment to meeting deficit targets and avoiding a second rescue leads us to believe that determined efforts will be made to make up for the shortfall. However, as the popularity of the opposition Socialist party grows, and considering the large scale popular protests that erupted this year for the first time since the implementation of austerity, this setback is likely indicative of the increasing difficulty the government will face in implementing further reform, especially now that legal precedents limit their options.