Portugal Pushed Closer to EU Bailout After Socrates Budget Cuts Defeated

Portugal moved closer to an international bailout as Prime Minister Jose Socrates’s offer to resign left his government in limbo on the eve of a European Union summit to address the region’s debt crisis.

Two-year Portuguese bond yields reached the highest since 1999 before today’s summit of EU leaders in Brussels to sign off on measures aimed at drawing a line under the sovereign-debt crisis. The government of Socrates, who will attend the meeting, retains its powers for now before President Anibal Cavaco Silva meets tomorrow with the main parties to resolve the political crisis or call elections.

German Chancellor Angela Merkel praised Socrates today for putting “far-reaching” austerity measures to parliament, which rejected the package last night. The vote prompted him to tender his resignation and moved the nation closer to following Greece and Ireland in requiring a bailout, which Royal Bank of Scotland Group Plc estimates at about 80 billion euros ($113 billion).

“It’s pretty inevitable” that Portugal will need a rescue, said Jacques Cailloux, a London-based economist at RBS. “The market will deteriorate in the absence of other measures going through. There is obviously the risk of further downgrades, which will become anticipated by the markets and be a self-fulfilling prophecy.”

Yield Jumps

The yield on Portuguese two-year notes jumped as much as 29 basis points to 6.89 percent at 6:34 a.m. in New York, the highest level since the euro’s inception. The cost of insuring against a default on Portuguese sovereign debt advanced, with credit-default swaps on the nation climbing 7.5 basis points to 542, near the record of 555 reached Jan. 10, according to CMA.

Portugal has already raised taxes and implemented the deepest spending cuts in more than three decades to convince investors it can reduce its budget shortfall. Additional cuts, announced on March 11, prompted a political backlash and failed to persuade investors.

“I regret that there wasn’t a parliamentary majority for it,” Merkel said today, outlining her stance before the two-day summit. The proposed Portuguese cuts had been supported by the EU and European Central Bank, she said.

The spread between Portuguese and German 10-year bond yields widened 15 basis points to 439 basis points yesterday after reaching a euro-era record of 484 on Nov. 11. It was at 448 basis points today.

Bad Timing

“This crisis occurs in the worst possible moment for Portugal,” Socrates said last night. Greece and Ireland were forced to seek bailouts last year.

“Clearly the near-term problem is that Portugal has no one with the authority to commit to a bailout,” said Paul Donovan, a global economist at UBS AG in London. “This makes any negotiations uncertain, and will disappoint market hopes for a solution by this weekend.”

The spotlight now falls on President Cavaco Silva, with JPMorgan Chase & Co. economist Nicola Mai saying his statement stresses that Socrates still holds power as he heads into the summit that starts later today.

It “could open the door for a possible negotiation of an international bailout package as soon as this week,” said Mai in an e-mailed note. He said further options include calling an election, which could take more than two months; asking the parties to form a coalition; or appointing an “independent technical government.”

Parliament’s Rejection

Opposition parties united to reject the additional cuts that were the equivalent of 4.5 percent of gross domestic product over three years. The package included a reduction in pensions of more than 1,500 euros ($2,114) a month and further cuts in tax benefits.

The government said the extra measures were needed to trim the deficit to 4.6 percent of GDP this year and within the EU’s 3 percent limit in 2012.

Socrates warned on March 15 that parliament rejecting the cuts would cause “a worsening of the financing risks of our economy and would lead Portugal to request external intervention.”

Socrates, who first came to power in 2005, leads a minority government. The Social Democrats, the biggest opposition group, had allowed the government’s earlier batch of austerity measures to pass with this year’s budget plan. They say they still support efforts to reduce the budget gap, while voting against the current package.

Poll Results

The Social Democrats would defeat the Socialists if elections were held today, polls indicate. In a Feb. 25 survey published by Diario Economico, 48 percent said they supported the Social Democrats with 29 percent backing the Socialists.

“The country has faced very difficult times before and has always been able to overcome them,” Pedro Passos Coelho, the leader of the Social Democrats, said in Lisbon last night after Socrates announced his resignation.

The political crisis comes as Portugal braces for its first bond maturities of the year. Portugal faces redemptions in April and June worth about 9 billion euros in total. It also faces bill maturities in July, August, September, October and November. The country intends to sell as much as 20 billion euros of bonds this year to finance its budget and cover maturing debt.

“Portugal faces heavy redemptions in April and June and difficult and costly access to the primary market, which makes it hard to roll over the debt,” Tullia Bucco, an economist at UniCredit SpA in Milan, said in an e-mailed note to investors.

Rating Cut

Concern about Portugal’s finances also led to a decline in its creditworthiness. Portugal’s credit rating was cut two steps by Moody’s Investors Service on March 15 to A3, four steps from so-called junk status, with the outlook on the grade “negative.”

Portugal should continue to finance itself in the market at present, Finance Minister Fernando Teixeira dos Santos said on March 16, though “it’s obvious that current market conditions are unsustainable in the medium to long term.”

The ECB has prevented those yields from rising further by buying Portuguese debt in secondary markets to shore up demand. The ECB has bought about 20 billion euros of Portuguese debt since last May, Barclays Capital estimates.

“In a situation of political void, cutting a deal with the IMF and the EU to trigger financial support would be particularly cumbersome,” Gilles Moec, an economist at Deutsche Bank AG in London, said in a research note yesterday. “In the meantime, ECB intervention may be required.”

To contact the reporters on this story: Joao Lima in Lisbon at jlima1@bloomberg.net; Anabela Reis in Lisbon at areis1@bloomberg.net.

To contact the editor responsible for this story: Tim Quinson at tquinson@bloomberg.net.

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