Junior party in Portuguese coalition aims to save gov't, but investor confidence is jolted

  • Article by: BARRY HATTON , Associated Press
  • Updated: July 3, 2013 - 2:05 PM

LISBON, Portugal — Portugal pitched European financial markets into turmoil Wednesday as the coalition government came close to collapse in a dispute over austerity measures before stepping back from the brink, reminding investors that the eurozone's debt crisis is not over.

The two governing parties found common ground late in the day when the junior coalition party, the Popular Party, agreed to hold urgent talks with the senior Social Democratic Party to resolve their differences and save the government.

But the spat reignited concerns over whether Europe can find an end to its prolonged financial crisis before more damage is done — a worry that has haunted investors. And the imminent threat of the Portuguese government's disintegration underscored the political perils of austerity, which is increasingly contested as a long-term solution because it chokes growth.

Popular Party official Luis Queiro announced in an evening statement after a day of tension that his party's two members of Cabinet will stay in their jobs "so as not to make it harder for us to overcome this crisis."

Popular Party leader Paulo Portas, whose resignation as foreign minister Tuesday threw the coalition into disarray, will meet personally with Prime Minister Pedro Passos Coelho to seek "a viable solution for the government of Portugal," Queiro said.

However, he warned his party will carefully examine future spending cuts.

The market turmoil was a reminder of the delicate path bailed-out countries like Portugal must tread to get their finances back on an even keel and the dangers they face.

The country's main PSI 20 stock index fell 5.3 percent to close at 5,236 before the junior party's announcement. Bank shares fell up to 13 percent. Stock indexes across the rest of Europe also dropped on what was happening in Portugal, with Germany's DAX down 1 percent and Spain's IBEX off 1.6 percent.

Another indicator of investor wariness, the interest rate on Portugal's benchmark 10-year bond, jumped 0.85 percentage points to 7.31 percent. The rate, which is what Portugal would pay to borrow 10-year money, is far above the 5.23 percent rate it hit in May but still lower than the 9.77 percent it was at this time last year.

"The initial reaction of the markets shows the obvious risk that the financial credibility recently built up by Portugal could be jeopardized by the current political instability," the European Commission, the European Union's executive arm, said in a statement.

Passos Coelho, the prime minister, defied calls to resign but spent some tense hours trying to convince his coalition partners to stay the course.

If the governing coalition collapsed, the ruling party would not have enough votes in parliament to pursue the reforms required to keep accessing the international bailout loans it depends on to avoid bankruptcy.

Portugal agreed on its 78 billion euro ($102 billion) bailout program with its fellow euro countries, the European Central Bank and the International Monetary Fund two years ago when it could no longer afford to pay its way on the international debt markets. In return for the loans, and to keep debt under control, Portugal had to agree to a series of harsh cuts and reforms.

Any failure to stick to an austerity program once the loans end would exclude Portugal from the ECB's offer to buy the bonds of countries struggling with high borrowing costs. To qualify for the ECB program, the mere promise of which has already helped out Spain and Italy maintain their debts, a country must promise to reform their finances.

The country also has to keep a grip on its finances so that it is able to return to the international debt markets once the current bailout loans run out in June 2014. It aims to reduce the budget deficit from 6.4 percent last year to 5.5 percent in 2013.

If investors feel that Portugal is a risky bet and therefore charge sky-high rates to buy the country's bonds, the government will be forced to ask for another bailout loan. Worse still, it could also be forced out of the eurozone.

Though the rise in Portugal's government bond rates is not an imminent threat — since the government is not relying on bond markets but surviving on bailout loans — they reflect concerns the country will be unable to get back on its feet once the program ends.

Portugal's austerity program has already proved a massive drag on its economy, eroded standards of living and drawn criticism from trade unions and business leaders. Unemployment is at 17.6 percent, with more than 42 percent of young people out of a job.

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