The mess in Portugal is negative for debt sustainability

Portugal’s election on 4 October was inconclusive, without any party winning an absolute majority of the votes. The President of the country, a former Prime Minister, allowed his own party, led by incumbent Prime Minister Pedro Passos Coelho to form a new minority government as has been done in the past. However, the way he has gone about doing so has created a controversy, which has made Portugal the new focal point of the still virulent European sovereign debt crisis. While I don’t think this is a coup as some are saying, by any stretch, I do think Portugal has a tough road ahead regarding debt sustainability.

Here’s a brief history of the individuals and parties involved and why what has occurred is controversial.

In the legislative election on 4 October, the incumbent coalition called “Portugal Ahead” (PàF) consisting of the Prime Minister’s Social Democratic Party and the junior People’s Party won only a plurality of parliamentary seats with 107 of 230. They failed to garner the absolute majority with which they had previously ruled when they held 132 seats after the parliamentary legislative elections of 2011. In a very real sense, PàF did not actually win the election then, though they got the most seats in parliament.

Immediately after the election, it was clear though that a minority government was likely. Here is the Guardian on 5 Oct for example:

Yet any objective reading of Portugal’s election would soon conclude that the coalition government was not just a winner but also a big loser on Sunday. Portugal Ahead’s 38% share of the vote is hardly a ringing endorsement when it is recalled that the same parties captured 51% in the last elections in 2011. Its projected total of 100 seats in the new parliament compares badly with the 132 seats it commanded before the election. From being able to govern as a majority, Portugal Ahead now faces minority status, dependent in large part on an agreement with the Socialist party to get its programme, or a moderate version of its programme, through parliament. As victories go, it is a very fragile one.

Eventually, a minority government is what we got… but not without controversy. The President, Aníbal Cavaco Silva, who also previously governed as the longest-serving post-coup Prime Minister from 1985 to 1995, is a member of the same party as the incumbent Prime Minister Passos Coelho. And in allowing the minority government to come into being, he stated the following– more in opposition to anti-Euro opposition parties than in support of a new minority coalition:

In 40 years of democracy, no government in Portugal has ever depended on the support of anti-European forces, that is to say forces that campaigned to abrogate the Lisbon Treaty, the Fiscal Compact, the Growth and Stability Pact, as well as to dismantle monetary union and take Portugal out of the euro, in addition to wanting the dissolution of NATO.

Now Ambrose Evans-Pritchard of the Telegraph says this statement shows the President “deemed it too risky to let the Left Bloc or the Communists come close to power, insisting that conservatives should soldier on as a minority in order to satisfy Brussels and appease foreign financial markets.” I differ somewhat with his characterization of the issue. Parliamentary process says the parties with the largest number of seats get to form a government, even if it is a minority government unless other parties can present a formal governing coalition alternative to the President. In this case, we didn’t have that alternative simply because the blocking majority leftist parties – who have been ideologically at odds in the past – never presented one.

Here’s the Wall Street Journal from 20 Oct on this issue:

Left Bloc leader Catarina Martins confirmed that her party, an ally of Greece’s ruling Syriza party, was ready to support a Socialist-led administration with its votes in parliament. But she indicated that the Left Bloc wouldn’t be part of the government itself.

“The Left Bloc can guarantee a government solution that protects people,” she said, without disclosing details of her party’s agreement with the Socialists.

Communist leaders withheld comment. Mr. Cavaco Silva was scheduled to meet with them on Wednesday and in the coming days announce a decision on who will lead the next government.

There is no indication here that, two weeks after the election, these parties would formally agree to ally as part of governing coalition. Thus, it seems the President won’t allow the anti-euro leftist coalition to occur not just because of his ideological opposition to them but also because they have not been able to muster a formal coalition alternative. Instead, we will see a weak minority and pro-austerity government that will face a vote of no confidence and potentially collapse. We may see serious political turmoil there very soon as a result.

The fact is the parties on the left do have a blocking majority in Parliament even if they cannot form a government. They have even said they will force the vote of no confidence as the first order of business. That makes the present government doomed to failure.

Two things here. First on the politics, this looks bad. The President’s statements have to be seen in the European context because they smack of status quo forces doing anything they can to prevent political change in Europe. The eurozone is poorly constructed from an institutional perspective and soldiering on in its present form with the current macro policies will eventually lead to the breakup of the euro and perhaps of the EU.

Second, Portugal has a government debt burden, which is only sustainable in the narrow context of ECB support via quantitative easing and OMT. This is a country that had a deficit in excess of 7% in 2014, with public debt well over 120% of GDP, external debt over 200% of GDP and total public and private debt of 370%. In a recession, these figures go higher. For Portugal’s debt to be sustainable given the present institutional framework and economic paradigm, austerity must bring the deficit down and nominal GDP must then grow over several decades at rates above government bond yields, all while receiving the implicit support of the ECB.

The potential is high for debt sustainability to diminish significantly going forward. And then we will have “a second Greece” on our hands. I was in Greece for the recent parliamentary elections. And I said then after the election that Greece would cease to be a source of contagion for the sovereign debt crisis.  And I continue to believe this. I see Greece now as isolated, a “special case” if you will. But the significance of what is happening now in Portugal makes Greece less of a special case and more of a harbinger of what is to come elsewhere. And this is negative for debt sustainability and thus for risk and government bond spreads everywhere in the periphery.