Portugal, like much of southern Europe, is recovering from the global recession but still weak on its feet. The government has agreed to meet troika demands for deficit reduction, household debt continues to fall, and GDP growth is expected to be positive in 2014 if still low. But the private sector continues to leverage, even as consumer confidence is low and consumption is expected to stay flat.

“We consider that the corporate sector is far from having completed its adjustment, which will compound the impact of persistent fiscal austerity to drag on domestic demand,” writes Deutsche Bank economist Gilles Moec. “We expect only subdued GDP growth next year.”

Portugal tax increases

The problem is that companies are taking on more debt, but investment has fallen even when compared to Spain. Consumer spending has increased for the first time in three years, but only by 0.4 percent in 2Q13. There may be a one-off correction as Portuguese households saved a lot ahead of a tax increase that shaved 3 percent off disposable income, but the overall trend is one of households deleveraging.

portugal spain business leverage

portugal spain HH debt

Small companies are taking on new debt even more readily. Lombard Street Research’s Jamie Dannhauser doesn’t think that the Portuguese debt situation can be handled as long as the Eurozone exists in its current form, and one part of his argument is the astounding increase in debt among small non-financial Portuguese firms, which can’t even be measured on the same axis as other distressed Eurozone countries.

net debt ratio small NFCs

Spain and Portugal’s debt

“Debt burdens in a handful of countries are extreme, an immediate threat to banking sector solvency and probably unresolvable – e.g. in Spain and Portugal,” writes Dannhauser. There’s no doubt that he is bearish on the Eurozone in general, but it’s hard to argue against such high levels of debt being a drag on growth. Stricter austerity measures in the face of personal deleveraging and companies that must be reaching the limits of their ability to borrow will eventually become unpopular.

Portugal continues to receive ECB support because it is implementing difficult austerity measures, but the combination of decreased government spending, increased taxes, households trying to save money, and businesses awash in debt isn’t a great recipe for growth.