It is not at all clear where things in Portugal are headed. The economy is in a deep depression. Yet, sovereign bond yields have come down considerably. The Troika is even relaxing Portugal’s austerity target, hoping this will drive yields down further. Will the strategy work though?
If you recall, as the year began, the Troika was demanding even more austerity from Portugal despite the fact that its austerity budget called for the highest tax increases in Portuguese history. The problem was that Portugal had a 4 billion euro fiscal gap to close and it was coming to the end of the life of its existing bailout program. This year, being a year of general elections in Germany, the prospect of more bailouts created huge problems for Germany’s ruling coalition. Just yesterday, Wolfgang Munchau wrote a cogent analysis of the German situation for Der Spiegel, noting that German Chancellor Angela Merkel’s strategy is to delay any and all unpopular decisions until after the elections.
When the IMF call for more cuts came in January, the IMF had just done a mea culpa on its aggressive austerity dogma, Chief Economist Olivier Blanchard announcing that their analysis showed the fiscal drag from cuts was much greater than anticipated. His calculus at the time however was that austerity itself per se was not the problem. Rather, front-loading austerity was the problem. So the plan was to continue austerity now that the front-loading mistake had already been made – and in some cases dial back the austerity if necessary. In January, the plan was to continue – and even press harder – in Portugal.
This has now changed. The previous Portuguese targets were deficits of 4.5% in 2013, 2.5% in 2014 and 2% in 2015. This has now officially been pulled back to 5.5% in 2013, 4% in 2014 and 2.5% in 2015. (Le Figaro has an analysis in French, if you’re interested.) Now clearly, this is in part Europe acceding to the facts on the ground and Portugal’s 6.6% deficit in 2012. This was well over target due to the economic contraction and tax revenue shortfall. There was no chance that Portugal would hit a 4.5% target this year given the projected economic contraction there. However, at the same time, I have been saying to you that the fiscal problems are everywhere: Spain, France, and the Netherlands. And it is the problems in those three countries – in the Netherlands in particular – which have made it clear that targets would need to be relaxed.
This is a good thing. But Europe is still in big trouble. The economic malaise seemingly has no end. My question now goes to how Portugal is going to roll over its bailout program commitments into an OMT-style program with its economy in the tank, unemployment sky high and yields in nosebleed territory. The country is nowhere near where Ireland is on this front. How long will Europe be able to dodge this question? At some point in the year, the OMT question for Portugal will come up and there won’t be any answers.