RaboResearch - Economic Research

Portugal: Continuing down the road of fiscal consolidation

Economic Report

  • Prime Minister Costa’s Socialist Party (PS) is expected to win the October 6 election by a wide margin
  • The most likely scenario is a minority Socialist-led government with outright backing of the Greens or other left-wing parties
  • We do not expect major changes to the policy-agenda focus of further reducing public debt, support for low incomes and increasing public investment
  • To meet fiscal targets Costa will be dependent on continuing economic growth
  • However, economic growth may find it hard to maintain momentum as the US-China trade war gets into full swing and the euro area economy slows
  • Whilst the Portuguese economy is projected to grow faster than that of the eurozone as a whole, a sharper than expected global (and European) downturn would expose the persistent underlying macroeconomic imbalances
  • Assuming that none of these risks materialize, we expect the Portuguese economy to slow but grow faster than the euro area as a whole
  • All in all, we expect growth to be 1.7 percent in 2019 and 1.2 percent in 2020

Portuguese voters approve of Costa’s balanced approach

Figure 1: Polls (September 23 – 30, 2019)
Figure 1: Polls (September 23 – 30, 2019)Source: Jornal de Notícias

Prime Minister Costa’s center-left Socialist Party (PS) is expected to win the upcoming Portuguese elections (October 6) by a wide margin. Current polling puts PS at 38 percent, which is a commanding lead over the center-right Social Democratic Party (PSD) (Figure 1). Despite having lost to PSD in 2015 elections, Costa rose to power by forming a minority government with outright backing from the far-left parties Left Bloc and the Portuguese Communists. In the years that followed, the Socialist Party gained appeal across the political spectrum as they combined fiscal conservatism with left-wing policies, such as increasing pensions and public sector wages. Costa and his popular fellow party member Centeno (Minister of Finance and president of the Eurogroup) continue to emphasize fiscal rigor, which has made them popular among the centrist part of Portugal’s electorate. Meanwhile, right-wing parties are calling for tax cuts to alleviate the relatively high tax burden and for increasing public investments to tackle the recent breakdowns in public services. However, Portuguese voters seem to prefer Costa’s more fiscally responsible approach and the Socialist Party is expected to gain at the expense of right-wing parties whose support has been dwindling.

Costa will need backing from other parties

Although an outright majority for PS is a distinct possibility, the most likely scenario is a Socialist-led minority government with Costa and Centeno serving another term. Due to Portugal’s electoral system, Costa will obtain an even larger advantage in parliament as the method for seat allocation favors the largest party. Based on current polling numbers, the Socialists will fall short of an outright majority and may need to rely again on the outright support of other left-wing parties. This may prove more problematic than many anticipate as Costa’s focus on budgetary rigor is starting to run into opposition from the left-wing parties that kept him in office. A strong election result could induce Left Bloc to demand a larger role in government and a more expansionary fiscal stance, which Costa will be reluctant to accept. However, the probability of a Spanish-style deadlock looks slight as the emergence of the Peoples-Animals-Nature (PAN) party offers the Socialists a way out. The Green party has already expressed its willingness to back Costa in exchange for a commitment to battling climate change.

Fiscal prudence will remain the cornerstone of government policy

Since PS is likely to remain the dominant force in a future Portuguese government, we expect a broadly unchanged policy agenda as Costa maintains his balanced approach and continues down the path of fiscal consolidation. He has pledged to increase public investments in infrastructure, education and hospitals and any extra fiscal room will be spent on supporting workers at the low end of the income distribution to prevent the re-emergence of social unrest witnessed earlier this year. However, if the far-left parties are excluded from government, the incidence of unrest might increase if these parties decide to support workers demanding a share in the spoils of the economic recovery.

Although Costa and Centeno are frequently praised for their outstanding management of Portugal’s public finances, the substantial improvement in Portugal’s debt metrics would have not been possible without the strong cyclical upswing (Figure 2). While the Socialists were in office, the budget deficit declined from 5.5 percent of GDP in 2015 to 1.7 percent of GDP in 2018. This is also reflected in a declining public debt ratio (Figure 3). As a result of this progress, the government’s target of a 0.2% deficit in 2019 and a balanced budget in 2020 looks realistic. Although the fiscal rigor has probably shaved something off economic growth in recent years, it does provide the government with more fiscal space to counteract a downturn.

Figure 2: The economy has flourished under Costa’s watch
Figure 2: The economy has flourished under Costa’s watchSource: Eurostat
Figure 3: Costa administration has presided over fiscal consolidation
Figure 3: Costa administration has presided over fiscal consolidationSource: AMECO

Vital to keep the growth momentum going

If Costa wants to meet fiscal targets and keep the sky-high public debt ratio on a firm downward trajectory he will be dependent on the economic recovery maintaining momentum. Given the recent social unrest and criticism about public under-investment, the demand for higher public expenditures and investments is already rising. Costa’s ability to meet deficit reduction targets will therefore primarily rely on GDP expansion and continuing low bond yields. While bond yields are expected to remain low for the foreseeable future, economic growth may not be able to maintain momentum given that the US-China trade war is in full swing and other eurozone economies are slowing.

What’s more the Portuguese economy is still relatively vulnerable to a negative economic shock. As is explained in more depth here, the Portuguese economy is still troubled by serious imbalances including the relatively weak quality of bank assets and the high level of private and public sector indebtedness. Also, the household savings ratio is among the lowest in the eurozone meaning that consumer spending may react heavily to a change in economic fortune. With substantial downside risks looming, such as a disorderly Brexit and the US potentially re-focusing its trade war towards Europe, there is serious potential for shocks hitting the Portuguese economy. High indebtedness and an already troubled banking sector give Portugal less wiggle room to counteract the negative impact of such a shock.

Economy held up relatively well, but is expected to slow

Figure 4: Confidence is becoming downbeat in Portugal, but is deteriorating less quickly than in the euro area as a whole
Figure 4: Confidence is becoming downbeat in Portugal, but is deteriorating less quickly than in the euro area as a wholeNote: The Economic Sentiment Indicator (ESI) is measured as net balance + 100. Net balance refers to the amount of positive responses minus the amount of negative responses.
Source: European Commission

That said, the Portuguese economy has held up relatively well so far. In the first two quarters of 2019 economic growth remained at a decent 0.5% (q-o-q), which could even be classed as buoyant when viewed from a eurozone-wide perspective. The unemployment rate is still coming down at a time when jobs are being added. However, the pace of job creation is slowing. There are signs that sentiment is becoming more downbeat in Portugal but is deteriorating less quickly than in Germany and the eurozone as a whole (Figure 4). Assuming an orderly Brexit and no US import tariffs on European cars, we expect the Portuguese economy to slow but grow slightly faster than the eurozone as a whole. All in all, we forecast growth to be 1.7 percent in 2019 and 1.2 percent in 2020.

Michiel van der Veen
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 6 8313 4616

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