Portugal
Protests in Lisbon, Portugal against austerity measures implemented by the Government

Portugal’s Constitutional Court in a Friday ruling rejected parts of the austerity package for 2013 standing for 0.8% of GDP out of a total projected effort of 3.0% of GDP, on grounds of equality of treatment (the Court found that civil servants, pensioners and unemployed were disproportionately hit). The final impact on the fiscal adjustment is not what is at stake here, since the government announced on Sunday night that it would redistribute the litigious 0.8% on legally safer spending cut measures.

Last week the government easily won a confidence vote in parliament, which suggests that the Prime Minister still has the kind of control over his majority that the alteration to the initial budget bill will require. This should allow the Troika to authorise the disbursement of the next tranche (EUR 2bn) of the program in May, as per the statement on the 7th review released on 15 March.

The medium term political consequences matter more, since the Court ruling marks another step on “adjustment fatigue” in a country which had initially been one of the Troika’s “model pupils”.

The conflict between the President of the Republic Cavaco Silva and the Prime Minister Passos Coelho (although they both belong to centre-right PSD) is at the root of the legal case, since it is the President himself who decided to defer the budget bill to the Court. This has triggered a general shift to the left – and to anti-adjustment rhetoric – in Portuguese politics.

Indeed, the main opposition socialist party could not be seen as taking a more moderate stance as a centre-right President, especially since it has to deal with the competition of a sizeable radical left (more than 20% in voting intentions). While it is a socialist administration which had initially requested and negotiated the bailout, this party is now officially calling for a renegotiation of the MoU, and is calling on Passos Coelho to resign, which would trigger early elections.

The coalition (PSD and CDS-PP, a more conservative party as a junior partner) was in talks over the weekend. There were some speculations in the local press on Saturday morning that Passos Coelho would decide to trigger early elections to try to lock-in another full democratic mandate to reform. In his TV statement on Sunday his implicit message was that he wanted to continue under the current set-up. The President of Portugal also cooled the minds by stating that in his views the government was still meeting the “right conditions to rule”.

Deutsche Bank (DB) does not think ‘early elections as a very rational move’. The polls suggest that the coalition and the socialists are already neck and neck, and even if Passos Coelho wins his junior partner is likely to make significant progress which would force a redistribution in cabinet jobs detrimental to PSD and to Passos Coelho’s own authority. Besides, early elections in Portugal would create market uncertainty at a time when the sovereign is trying to re-issue more regularly to qualify for ECB support via OMT.

Deutsche Bank believes that Portugal’s Passos Coelho will continue – with a diminished authority and standing in Europe – with the current set-up, focusing on technical solutions to make up for the 0.8% of GDP, which means that no immediate crisis flaring up from Portugal. However, the Court ruling, together with the change in the general political mood in Portugal will embolden the unions in resisting any further austerity/structural reform measures.

The Europeans have just given the country another year to achieve their fiscal targets (the return to a deficit below 3% of GDP has been postponed to 2015). However, given the deteriorated economic situation and political developments, it may well be that further leeway will have to be given.

The view Deutsche Bank has been holding since the beginning of the Portuguese bailout was that it was too hastily conceived and predicated on overly-ambitious fiscal targets, while the full financial support (ending this September) was too short.