The problem with Portugal

In extremely difficult circumstances, the government of Prime Minister Pedro Passos Coelho deserves fulsome praise for the gusto it has displayed in attempting to rectify the gaping hole in Portugal’s national balance sheet. With an electoral mandate based on austerity, he has implemented measures that are expected to reduce the budget deficit to around 4.5% of GDP this year, after it reached almost 10% back in 2010. Having received bailout assistance of EUR 78bln last year from the troika, Portugal is essentially fully funded until late next year.

However, despite its best endeavours the government is still likely to fall short in terms of placing Portugal back onto a more sustainable financial footing. Based on rather questionable assumptions, the EC has calculated that debt/GDP will stabilise next year at 113%. This projection will certainly be proved wrong. Even if the government succeeds in delivering a fiscal deficit of only 4.5% of GDP this year, and 3% next year, debt will grow relative to GDP because the denominator will be falling. Nominal GDP in Portugal has declined in the past four years, with another deep recession likely in 2012.

Although Portugal is no Greece, nevertheless there are justifiable concerns. Without significant structural reform and a substantial internal devaluation, the economy simply lacks the necessary wealth creation to underpin a meaningful recovery. Despite yesterday’s vehement denials from the Finance Ministry, a significant debt restructuring is highly likely at some point in the next couple of years.