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Portugal Passes Budget in ‘the Start’ of Deficit Fight

Portugal’s parliament approved the 2011 budget today, starting the Socialist government’s battle to implement the deepest budget cuts in three decades without choking the economic recovery.

Parliament backed the plan with abstentions from the opposition Social Democrats, who agreed on Oct. 29 to let the fiscal blueprint through.

“The vote is just the start, then you have to implement these measures,” said Luigi Speranza, an economist at BNP Paribas SA in London. “The market is probably pricing in most of the good news and the focus is now on the feasibility of the adjustment.”

Portugal, whose central government budget gap continued to widen through September, is trying to prove it can rein in the deficit and avoid following Greece in seeking an international bailout. The extra yield on its debt compared with Germany’s surged to a three-week high today, wider than the spread on Greek debt 10 days before it sought a European aid on April 23.

Highlighting the challenges facing the government, Portugal’s borrowing costs rose and demand fell at an auction of 1.03 billion euros ($1.5 billion) of three- and 12-month bills today.

“We need to see spending actually being reined in and this has to be demonstrated quite fast,” said Gilles Moec, an economist at Deutsche Bank AG in London. “We need to see things changing in the first months of 2011 to be fully reassured.”

Wage Cuts

The government plans to cut its total wage bill by 5 percent, freeze hiring and raise value-added tax by 2 percentage points to 23 percent. After talks with the Social Democrats, Prime Minister Jose Socrates’s minority government also agreed to reconsider some public works projects.

Miguel Macedo, a Social Democrat lawmaker, said yesterday his party agreed to let the budget through as “the alternative would have meant the country’s bankruptcy.” Finance Minister Fernando Teixeira Dos Santos has said the country doesn’t need to tap the European Union’s 750 billion-euro ($1 trillion) rescue fund.

The Portuguese vote came as the extra yield demanded to hold Irish and Portuguese debt surged after German Chancellor Angela Merkel stepped up demands for private investors to “make a contribution” to resolving future European debt crises, rather than leaving European taxpayers “on the hook.” German Finance Minister Wolfgang Schaeuble said the euro’s stability depends on making investors responsible, underscoring Merkel’s comments.

Risk to Growth

The budget cuts, the biggest since the 1970s, will be a “massive” drag on gross domestic product, particularly in the absence of structural measures to spur growth, Speranza said.

Portugal’s economic growth, which has averaged less than 1 percent a year in the past decade, will slow to 0.2 percent next year from an estimated 1.3 percent in 2010, according to the government’s forecasts. Standard & Poor’s, which has cut its rating on the country three times in the past two years to A-, said on Oct. 4 it expects the Portuguese economy to shrink 1.8 percent next year and stagnate in 2012.

The nation’s budget gap reached 9.3 percent of GDP last year, the highest in the euro region after Ireland, Greece and Spain. The government aims to lower the shortfall to 7.3 percent this year, 4.6 percent in 2011 and meet the EU’s 3 percent limit in 2012. Still, in the first nine months of the year, its central government budget deficit widened 2.3 percent from a year earlier to 9.32 billion euros, the Finance Ministry said on Oct. 20.

Socrates’s government is betting on exports to spur the recovery. About a quarter of the country’s foreign sales go to Spain, which is struggling to emerge from the worst recession in six decades as it implements its own measures to cut the budget deficit by half in two years. More than 70 percent of exports go to the European Union.

“If core Europe slows down, which I think it could into next year, then we’re going to be looking at the problem of what do the small peripheral economies do with a deceleration in their main trading partners,” said Guillaume Menuet, senior European economist at Bank of America Merrill Lynch in London. “It’s a pretty tough environment.”

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