As the dust settles on the Cyprus bailout, a recent court ruling places the so-called Troika—the European Central Bank (ECB), European Commission (EC), and International Monetary Fund (IMF)—back into the headlines as it finds itself at odds with another Eurozone country.
After months of deliberation, on April 5th the Constitutional Court of Portugal struck down four of nine proposed budget cuts that would have raised 4 billion euros over three years as part of payment plan for a 78-billion-euro bailout.
This includes a ruling against the government’s plan to eliminate one of two extra “bonus” months in the summer and its decision in January to cut sickness and unemployment benefits. This court decision will cost Portugal around 1.2 billion euros in savings.
Following the court’s ruling, foreign creditors decided to withhold further loan payments until the situation resolved itself. In order to qualify for the next loan installment, Prime Minister Pedro Passos Coelho must convince the European Union and the IMF that he can raise the funds lost by the court’s ruling through other means.
The IMF has continued to call for a reduction in state-provided health services and state pensions based on its determination that these sectors resulted in the largest increases in government spending. The IMF also found that there is “excess employment” in the education and security sectors. In order to meet this demand, Coelho has requested that the constitution be revised to shrink the state, thus allowing the originally prescribed cuts.
The opposition Socialist Party has resisted this move, making it unlikely that Coelho will secure the necessary two-thirds majority in parliament to amend Portugal’s constitution. Instead the Socialist Party has called for an early election, convinced it would gain control of the country despite failing to oust Coelho’s center-right government through an earlier vote of no confidence. Once in power the party could then begin negotiations for a new bailout.
Possible Respite
In a surprising show of leniency, the European Union finance ministers agreed to extend the maturity dates of Portugal’s loans by an average of seven years. This decision grants Portugal enough flexibility to issue a 10 year-bond, a move that will once again grant the country access to European bond markets.
However, the plan was still conditional upon approval from the Troika. The ruling by the constitutional court and the subsequent Portuguese scramble to secure funds has caused concern for the Troika. Because of fears that Portugal might not be able to bring its budget back in line, the Troika delayed their approval pending further discussions with the Portuguese government.
Prime Minister Coelho has announced that while he will not raise taxes, he will institute new spending cuts totaling 1.2 billion euros. Although he did not reveal the specifics, Coelho did announce that half would still come from the health and education sectors, cuts in social security and pension benefits, and cuts in other government offered services. The other half would come from cuts in ministries’ budgets.
The Portuguese government met with the Troika on Monday April 13th to discuss the specific cuts it plans to make to meet its 2013 budget. After this meeting Coelho announced that the government plans to raise the retirement age and make public sector employees work an extra hour daily. The government also plans to lay off around 30,000 government workers. The Troika returned to Lisbon this week to determine if this latest round of proposed cuts are enough to once again disburse rescue funds.
The Troika has somewhat relented during the early days of these meetings, granting Portugal permission to sell its 10-year bond. Thus far bond sales have raised around 3 billion euros. However, negotiations to see if the Troika will once again begin to disburse bailout payments are still ongoing.
Underlying Problems
Up until this point Portugal had been an obedient pupil in the Troika’s austerity regime. The Center Right Party was able to push through tax hikes and cuts in social services. Unlike other struggling eurozone countries such as Greece, Ireland, and Cyprus, Portugal merely suffered from years of low growth and private sector investment—not questionable fiscal policies.
And there were brief signs of improvement following structural reforms, at least by the Troika’s standards. For example, unit labor costs have fallen, exports have risen, and the current account balance is moving in the right direction.
However, other economic indicators tell quite a different story. The budget deficit has widened from 4.4 percent of GDP in 2011 to 6.4 percent in 2012, the economy shrank by 3.2 percent, and unemployment is expected to reach 19 percent.
Augusto Praca, international relations advisor for Portugal’s largest trade union confederation, the CGTP, emphasizes that “most of our economy has disappeared. Companies are going bankrupt. There is no investment, and the government is only interested in paying back our loans.” And similar to Cyprus there is a youth brain drain, with one in 10 graduates now leaving Portugal for Brazil. This is not surprising considering how hard young people have been hit in Portugal; the jobless rate for those aged 15 to 24 is 42.1 percent.
Even if the Troika agrees to Portugal’s proposed 2013 budget, most economists and many European officials agree a second bailout may still be necessary.
So what are the implications for the rest of the Eurozone now that one of its star pupils has stumbled? However unlikely it may be, hopefully the situation in Portugal serves as a wake-up call for the Troika. Unless it begins to focus on policies that stimulate demand throughout the entire Eurozone, Portugal may not be the only country lining up for another bailout.
Bryan Cenko is an intern at the Institute for Policy Studies.