Portugal growth poses dilemma on pace of further budget cuts

Portugal’s emergence from its long recession is a sign that the European austerity recipe may work, but it also poses a dilemma for Lisbon and its lenders as a new dose of planned budget cuts may kill a fragile revival.

As a result, many economists expect the government to negotiate a new easing of the budget deficit targets during a bailout review next month with its European and IMF lenders, who could in return demand longer-term commitments on spending cuts.

With less than a year before the mid-2014 end of the bailout, some experts suggest a second, possibly less stringent, lending programme could help Portugal spread further cuts over a longer time without compromising fledgling growth or stirring additional resistance to austerity at home.

A sharper-than-expected 1.1 per cent second-quarter growth from the previous quarter cut short 2½ years of recession, but the economy still shrank 2 per cent year-on-year and is expected to contract about 2 per cent for the whole of 2013.

The flash GDP estimate did not provide a breakdown, but analysts say domestic demand likely fell again under the weight of huge tax hikes applied from early 2013.

"This growth shows that they are on the right path, even though it's not an easy path," said Commerzbank economist Ralph Solveen.

He did not rule out further GDP drops this year as Portugal’s economic dynamics remained volatile and hinged on how much more austerity is to be applied over the coming months.

Giada Giani, a Citi economist in London, said that despite “some positive shifting in exports and less bad domestic demand, the underlying climate is still very weak and I think we should see much lower growth in the coming quarters”.

Exports
With domestic demand depressed by austerity measures, much of Portugal's recovery has been on the back of stronger exports, from shoes and olive oil to fuel and cars, but there are questions over how long the export momentum will continue.

Exports in the quarter were also boosted by a new diesel unit of oil firm Galp’s Sines refinery that made Portugal a net diesel exporter. But the unit is already working flat out.

The government expects next year to be the first full year of economic growth since 2009, but Ms Giani said that “if they go ahead with all the planned cuts, growth will certainly be negative again next year”.

In question are €4.7 billion in spending cuts that Lisbon needs to enact mainly next year to hit a budget deficit goal of 4 per cent of GDP. This year the deficit needs to be reduced to 5.5 per cent from last year’s 6.4 per cent.

Without these deficit reductions designed to alleviate its debt burden, Portugal is unlikely to regain enough investor confidence to fully return to market financing by mid-2014 as planned, which would require some sort of further European aid. Just one quarter of growth is unlikely to change that.

New commitments
"It could be a precautionary package or another full package," Ms Giani said.

“But there’s no such thing as a free lunch and Europe will demand new commitments for budget cuts as their main goal is to make Portugal’s debt sustainable.”