Portugal’s Socratic Method

Story Highlights:

• Portugal’s parliament rejected new austerity measures Wednesday.
• Prime Minister José Sócrates followed through on his earlier promise to step down, necessitating elections in the next 55 days.
• While Portugal’s unfolding political drama may impact interest rates in the near term, it needn’t tip off a wider debt contagion.
• But it does highlight the need to finalize a workable eurozone framework.

In a widely expected move, Portugal’s parliament voted Wednesday to reject the latest austerity package—a measure that would have reduced social security spending, cut unemployment benefits, and increased public transportation prices in an attempt to reassure markets of Portugal’s creditworthiness. While Portugal’s austerity measures (had they passed) likely wouldn’t have made a tremendous dent (nor done much to stave off a bailout), their failure certainly won’t help either. But markets have expected a Portuguese bailout for awhile—even notoriously late-to-the-party credit rating agencies have downgraded Portugal several times in the last year.

More than just the spending cuts’ fate hung in the balance: Portuguese Prime Minister José Sócrates said he would resign if the plan failed to receive parliamentary support—a promise he followed through on late Wednesday. Which highlights an interesting Portuguese subplot: Portugal’s government doesn’t technically require parliamentary approval in order to implement the new austerity measures, raising questions about the motives behind Sócrates’ promise and subsequent departure. Some speculate there’s a political game afoot to avoid taking the blame for requesting a bailout package. (Understandable, given Greek and Irish protests that erupted in the wake of similar austerity measures passed in those countries.) The main opposition Social Democrats (PSD) lead polls by over 20 points. The new government will in all likelihood end up making essentially the same cuts in order to secure a bailout! However, they get the benefit of blaming Sócrates for the economic mess, get bills paid via a rescue package, can blame the European Union/International Monetary Fund for more cuts, and start off the new government with a favorable public perception.

That may be good for PSD politicians, but the political drama’s timing is not terrific, considering Portugal faces €4.23 billion of maturing debt in the next month—incidentally, likely before the elections which must be held within 55 days. Whatever the endgame, this political version of hot potato could easily impact Portuguese bond rates in the near term.

But before extrapolating from the political and fiscal issues facing Portugal to broader eurozone contagion, consider that recent debt auctions haven’t even revealed Iberian contagion. Spain’s most recent debt auction was successful on strong demand—bid-to-cover was more than four times for three-month debt and more than five times for six-month debt. Plus, the resulting yields were lower than similar auctions a month ago—the opposite direction of Portugal’s yields recently—showing improving confidence in Spain’s ability to tackle its own debt issues for now.

While Portugal seems unlikely to contribute to wider contagion, a snap election adds more uncertainty to the ongoing effort to finalize the European Stability Mechanism (ESM)—which could indeed impact longer-term rates. (Read more on pre- and post-EFSF rates here.) Add to that questions about financing structuring(who contributes what), Ireland’s fight to maintain its low corporate tax rate, Finnish elections in April, and Germans becoming seemingly more conservative in their willingness to backstop those countries facing debt troubles. But amid the uncertainty, one thing’s clear: Portugal’s budget battle underscores the need for a finalized eurozone framework.