Yesterday, Portuguese political opposition parties united to defeat Prime Minister Jose Socrates’ latest austerity measures in a parliamentary vote. Though it is one of the 17-nation eurozone’s smallest governments and has only 10.6 million people citizens, the financial world is focused on Portugal. Fears that this vote could re-ignite market anxiety about the financial soundness are warranted, as it shows a continued challenge the European Union faces as many of its members are struggling with sovereign debt issues.
The economic situation in Portugal is severe; last year it had a public sector deficit of 6.8%, over the past decade its economy has grown at a rate of less than 1 percent a year, it maintains a record 11.2% unemployment rate, and Moody’s recently downgraded its credit rating.
In order to combat this fiscal crisis, Prime Minister Socrates put forward an austerity package yesterday in which taxes would be hiked and pay cuts would be implemented. These measures were sought in order to bring the Portuguese public sector deficit down to 4.6% of GDP in 2011 and to 3% in 2012, in line with European Union guidelines.
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Socrates warned in a statement if this package was defeated, it would make it impossible for him and his government to ensure Portugal’s economic future and he would resign. A man of his word, after the austerity measures were blocked yesterday afternoon, Socrates quit.
Critics of Socrates’ austerity plan argued that the measures would unfairly hurt lower-income citizens through a freeze in pensions. The package also included cuts to the welfare system, raised public transportation fees, and hiked personal income and corporate taxes. In a country where there is already a 22% value-added sales tax on many goods, I can understand the people’s dismay.
However, what could come to pass could be worse for the Portuguese people. Without increased austerity measures, Portugal could need a bailout from the European Union and IMF, just like we saw in Ireland and Greece. Portuguese Finance Minister Fernando Teixeira dos Santos said, “Rejecting (this plan) will worsen financial market conditions, bringing additional difficulties for the country’s financing which I doubt we will be able to bear on our own.”
Foreign financial assistance comes with strings attached, including a role for the International Monetary Fund which strips away government control of key fiscal policies for years, making it a last resort for cash-strapped countries.
Each time there is a bailout for one of these European countries, it weakens the European Union. Not only does it cost the EU billions of dollars, it also diminishes the global confidence of the EU’s strength. Many people believe that Portugal is just the third country in a longer line of countries that will need a bailout. If that happens, and larger European economies like Belgium, Italy, and Spain require financial assistance, there won’t be enough money in the EU’s bailout fund to rescue them. If that ever happened, the EU would collapse and so would its currency, the euro. The result could be similar to that of the global financial collapse of 2008.
Understand that this issue could take years to play out and nothing overly dramatic will probably happen this week. To assess how seriously the markets are taking this news out of Portugal, look for a strengthening of the US dollar verse the euro in the coming days. Also, we could see a pull back in the global stock markets and in commodities.
What do you think? Do you think that this issue in Portugal is a significant worry to the stability of the European Union? Do you think these fears are overblown? Leave your thoughts below.
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