Portugal takes its punishment with fresh taxes

Friday, May 14, 2010
By Paul Martin

Portugal is to impose fresh austerity measures to cut the budget deficit and regain the confidence of bond markets, becoming the fourth country on the eurozone periphery to tighten fiscal policy before a durable recovery is underway.

By Ambrose Evans-Pritchard
TelegraphUK

Socialist premier Jose Socrates aims to cut the deficit by an extra 1pc of GDP to 7.3pc this year and 4.6pc next year, but has refused to follow yesterday’s move by Spain for broad-based cuts in public wages owing to constitutional constraints.

The package relies on revenues, including a rise in VAT to 21pc, higher income tax, and a range of corporate levies. “I ask my countrymen to make this sacrifice to defend Portugal, defend the single currency, and defend Europe,” he said.

Paul Portas, leader of the free market conservatives, said the mix of policies amounted to a “fiscal bombardment of the economy” that would crush wealth creation and fail to put the country on a viable path back to recovery.

The austerity plan follows a dramatic crisis last week when yields on 10-year Portuguese bonds surged to over 6pc, above the level that led Greece to request an EU-IMF bail-out.

Escalating distress in Portugal – and the risk of contagion to Spanish banks that hold €86bn of Portuguese debt – is what forced EU leaders to put together a combined package of €720bn to defend EMU over the weekend. The European Central Bank has been buying Portugal’s bonds on the open market to force down spreads.

The quid pro quo was a pledge by Mr Socrates for further belt-tightening, no easy task for the leader of a minority government. Opposition leader Pedro Cassos Coelho said his party would back the measures since the country faces a “state of emergency”.

The combined austerity packages in Greece, Ireland, Spain, and Portugal cover a substantial part of the eurozone and may have broader ramifications. Italy is also considering a public sector wage freeze.

“This Club Med tightening is deeply worrying,” said Charles Dumas from Lombard Street Research. “Some of these economies are going to be contracting at an annualized rate of 4pc by the end of this year and that is going to spill back into Germany.”

Southern Europe is having to squeeze fiscal policy without offsetting stimulus from monetary policy or the exchange rate. Deutsche Bank said membership of EMU had deprived these states of all key instruments of economic management This is not what political leaders expected in embracing the euro.

There is a risk of populist backlash if citizens start to think that they are powerless, with no clear way out of a deflation trap.

Fernando Texeira dos Santos, the finance minister, said he expected “violent episodes” comparable to those in Greece but insisted that there was no other option.

The CGTP trade union federation vowed to mobilize its forces. “Either we come up with a very strong reaction or we will be reduced to bread and water,” he said.

While Portugal’s public debt is average for EMU states at around 84pc of GDP this year, the private sector is heavily indebted and reliant on external funding. Fresh EU data shows that Portugal’s total debt is 331pc of GDP, compared to 224pc for Greece. The IMF said Portugal’s labour market is the most rigid in Western Europe.

Brian Coulton, director of Fitch Ratings, said the new measures are a great improvement on the “underwhelming” plan put forward earlier this year. The agency has a rating of AA- on Portuguese debt with a negative outlook.

“The country has already made substantial progress on spending cuts over the last four years and is replacing every two civil servants who retire with just one, so it make sense to rely on taxes to raise revenue quickly,” he said.

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