28 January 2016

European Commission sends Portugal a warning over 2016 budget

Portugal’s new Finance Minister Mário Centeno yesterday received a letter co-signed by European Commission Vice-President Valdis Dombrovskis and EU Economic Affairs Commissioner Pierre Moscovici, asking for explanations as to why the Portuguese government is planning to cut structural deficit by only 0.2% of GDP in 2016 – which, the Commission notes, is “well below” the recommended target of 0.6% of GDP.

Portuguese Prime Minister António Costa has tried to play down the significance of the letter, arguing that the Commission is only seeking “technical clarifications” and that his government has “good economic arguments” to pursue a smaller reduction of structural deficit this year. However, the next step could be a request from Brussels for a revised draft budget – similar to what happened to Spain a couple of months ago.

Costa could be heading for a clash – either in Brussels or in Lisbon

Should such a request materialise, Portugal’s fragile ruling alliance – a Socialist minority government with ad hoc support from the Communist Party, the Greens and the Left Bloc – would face its first real EU-related test.

Prime Minister Costa would find himself in a pretty uncomfortable situation. He could resist calls for further adjustment and pick up a fight with the Commission in Brussels. Or he could agree to go back to the drawing board and make the additional cuts – potentially triggering a row with his leftist allies in Lisbon.

As I previously noted on this blog, economic policy and the stance vis-à-vis Eurozone fiscal rules can be major flashpoints – in particular between Costa’s Socialist Party and the openly anti-euro Communist Party.

The cracks were almost exposed at the end of last year, with the decision to offer a taxpayer-backed bail-out to Banif – one of the country’s largest lenders. While that dispute seems to have died down, I suspect this one would be tougher to overcome.

A familiar dilemma

The Portuguese government has until tomorrow to provide its clarifications. The Commission is then expected to make a decision early next month. Generally speaking, this episode is yet another illustration of a familiar dilemma in the Eurozone periphery. Political leaders who fought successful election campaigns on a ‘Yes to the euro, No to austerity’ platform inevitably face a reality check after they enter office.

Compared to Alexis Tsipras in Greece, Costa’s rhetoric was far less inflammatory – but his pledge to “turn the page on austerity” in Portugal was just as unequivocal. The Commission’s letter was the first reminder to the new Portuguese government that Eurozone membership and austerity are not easily separable. I am pretty sure that it is not going to be the last.