Bond Market Reminds Junk Portugal It's Tough to Please Everyone

  • Socialist government to hand in 2016 budget proposal on Friday
  • European Commission still has to give its opinion on the plan

Portugal’s new government is facing an old quandary for the euro region: How to appease voters, European budget regulators and the bond market at the same time.

Socialist Prime Minister Antonio Costa is juggling external demands for continued fiscal discipline with pledges at home to ease spending cuts. With the premium Portugal pays to borrow compared with Germany widening to the most in 18 months, it’ll be hard for Costa to ignore the 223 billion-euro ($250 billion) government debt pile towering over a country still considered non-investment grade by the three major ratings companies.

While the last government completed Portugal’s rescue program, the challenge for Costa, 54, is to show he can stay on track after coming to power in November following weeks of political stalemate. The country may not be given much room for maneuver as Spain next door also finds itself in a post-election impasse with budget targets in question.

“Portugal did need an international bailout and there is a new left-wing government so European institutions will want to make sure there is no slippage going forward or temptation to go back to old habits,” said Owen Callan, a fixed-income strategist at Cantor Fitzgerald LP in Dublin. “The push for austerity is more toned down now, but the EU’s toughness also helps send a message to Spain that it won’t be lenient.”

Turning a Page

Even with the backstop from the European Central Bank, Portuguese bonds fell again this week, with the 10-year yield rising 21 basis points to 3.09 percent. The spread over bunds widened to 279 basis points, the most since August 2014.

The budget plans to “turn the page on austerity,” Costa said on Wednesday. Measures include reversing salary cuts made during the bailout program for state workers and shrinking their working week. Family incomes will also be boosted, while on the revenue side, taxes on consumer loans and fuel will increase.

The deficit will remain within the EU limit of 3 percent of gross domestic product through 2019 and debt will be steadily reduced, Costa has said.

The proposals are also designed to get support for his minority government in parliament from the Left Bloc, Communists and Greens. Those parties haven’t followed the Socialists in backing EU budget rules in the past.

Varying Math

Discussions on the 2016 budget are still ongoing and the European Commission will present an opinion on Friday, European Economics Commissioner Pierre Moscovici said. Costa also meets German Chancellor Angela Merkel in Berlin the same day, before European finance ministers gather in Brussels on Feb. 11.

The numbers from Lisbon at the moment look at odds with those coming from Brussels. Portugal predicts a budget deficit of 2.6 percent of GDP this year, while the European Commission says it will be 3.4 percent.

Portugal is counting on a faster pickup in the economy. The government sees growth of 2.1 percent in 2016, more than the commission’s 1.6 percent forecast.

In the background, the country faces bond redemptions of 6.6 billion euros this year, and almost 9 billion euros each in 2017 and 2018, according to the debt agency.

The effort to reduce the structural budget deficit needs to be “significantly” increased, the Commission and the European Central Bank said in a joint statement. “Financial markets have become more volatile, making financing the high levels of sovereign debt more of a challenge for the government.”

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