Portugal’s government collapsed Wednesday after the parliament rejected a budget-cutting plan, pushing the country closer to an international bailout and triggering another test of Europe’s ability to deal with an ongoing public debt crisis.
The developments occurred in advance of a summit Thursday at which European leaders were expected to approve an economic program they hope will convince world markets that the 17 nations that share the euro will stand behind each other, better coordinate economic policies, and guarantee that none will default on their loans.
Instead, the European leaders will meet amid a new round of uncertainty. Strapped for cash and mired in slow economic growth, Portugal must raise $6 billion or more next month, and it faces high interest rates demanded by investors who are not confident in the government’s ability to pay. After the resignation Wednesday of Socialist Party Prime Minister Jose Socrates, the country will be forced to go to the market in the middle of an election campaign — with no guarantee that an incoming government will make the reforms likely to be demanded by the International Monetary Fund or other European governments in return for financial help.
Interest rates on Portugal’s 10-year bonds have increased nearly 50 percent since autumn to an unaffordable 7.6 percent as of Wednesday. Analysts say the country is increasingly likely to become the third eurozone nation to need a bailout in the past year, after Greece last spring and Ireland in the fall.
“Portugal is essentially doomed,” said Jacob Kirkegaard, an analyst at the Peterson Institute for International Economics who has followed the European debt crisis. “They cannot finance themselves.”
Portugal’s economy is small, and it does not have the extensive banking system or other global ties that would make its crisis an immediate cause for broader concern. But the resolution of Portugal’s problems will be important in determining whether the euro area puts a lingering debt crisis behind it and adds to the world recovery with a stronger outlook for growth, or whether it remains under a cloud of possible sovereign default.
More significant European economies such as Spain, Belgium and Italy also have high levels of public debt. Although analysts say it is unlikely that any will need international help, the situation is volatile. Spanish banks have about $100 billion at risk in Portugal, the type of transnational “exposure” that could allow problems in Portugal to spill beyond its borders.
The outlook is murky for Greece and Ireland, despite the rescue packages provided by the IMF and other eurozone countries. Nearly a year into its IMF program, Greece is behind on some of its economic restructuring targets, and some analysts say the country might default on its debts. Ireland says it needs lower interest rates on the loans that other European countries provided last year, but it has refused conditions they want to impose, including an increase in the country’s regionally low corporate tax rate.
If Portugal needs a bailout, “there is going to be a lot of stress,” Angel Gurria, secretary-general of the Organization for Economic Cooperation and Development, said Wednesday in Washington. He characterized Europe’s economy as “fragile.”
The pact being debated in Brussels on Thursday and Friday is meant to strengthen the entire system. Designed around what has been called a “grand bargain,” it includes a promise by the euro area’s strongest economies, most importantly Germany, to keep weaker countries solvent by establishing a permanent loan fund that could also buy a country’s bonds. In return, all eurozone countries would commit to more tightly controlled government spending and economic reform.
But public opposition to government austerity measures has been growing in Portugal and prompted the opposition party to vote against the latest round of cuts. With elections not scheduled until at least May, Portugal, Europe and the IMF will have to find a way to meet the country’s short-term need for cash, even as its politicians turn against the conditions likely attached to any aid.
As in other European countries, the changes proposed in Portugal include public-sector wage cuts and hiring restrictions, pension reform and increases in public fees. Thousands marched in Lisbon against the cuts this month, and a social networking movement has taken root around the “Precarious Generation Manifesto,” a statement of concern about the economy from the “unemployed . . . underpaid workers, disguised slaves . . . intermittent workers, trainees, scholarship holders, working students, students, mothers, fathers and sons of Portugal.” Transit workers walked off the job Wednesday, ahead of the parliamentary vote.
The latest round of uncertainty may further undercut a European program that some analysts say fell short of what was needed. Although agreement on the new program is considered an important step for the eurozone’s monetary union, there’s no guarantee it will end market speculation about problems in places such as Spain and Belgium or ease concern that banks, pension funds and other large bondholders might see the value of their holdings cut if governments decide they cannot afford the payments.