Last updated: August 31, 2011 4:58 pm

Portugal promises biggest cuts in decades

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Portugal has announced new austerity measures designed to cut its budget deficit to almost zero in under five years, promising the biggest cuts in government spending for more than 50 years.

Vítor Gaspar, finance minister, said on Wednesday the planned reduction in public expenditure by 2015 – by 7 percentage points to 43.5 per cent of gross domestic product – was “without precedent” in recent Portuguese history.

The strategy outlines how the centre-right coalition government aims to meet ambitious deficit-reduction targets set out in Portugal’s €78bn bail-out agreement with the European Union and International Monetary Fund.

Mr Gaspar announced a special “solidarity tax” on the highest family and corporate incomes, a measure similar to wealth tax proposals that have caused controversy in other eurozone countries.

Other moves included extending a public sector wage freeze to 2012 and 2013, accelerating planned reductions in the number of state workers, and reducing welfare payments by 0.6 per cent of GDP.

The measures are the latest in a series of tough austerity packages that Portugal has introduced over the past two years. Details of ministerial spending cuts, however, will not be released until the government presents its 2012 budget in mid-October

Pedro Passos Coelho, prime minister, has warned that the need to cut the deficit amid a deep recession will be the toughest test that Portugal has faced since democracy was introduced in 1974. Speaking in Madrid, he said efforts to cut the deficit had been €2bn off target in the first half of this year.

Mr Gaspar said the extra measures were required to cover this shortfall and meet the deficit targets agreed with the EU and IMF. The strategy aims to cut the budget deficit from 9.1 per cent of GDP last year to 0.5 per cent in 2015.

Two-thirds of the fiscal adjustment would be achieved by spending cuts and the remainder through increased revenue, he added.

However, some economists fear years of harsh austerity could take a heavier toll on growth than official forecasts, making it difficult for the government to generate extra revenue. Nicholas Spiro, a London-based analyst who specialises in sovereign credit risk, said Portugal was “at the sharp end” of a reassessment of the eurozone debt crisis caused by growing fears over the European and US economies.

“Bond market investors are now realising that without growth, fiscal consolidation can quickly become self-defeating,” he said. Portugal was “extremely vulnerable” because it had no “fiscal wriggle room”, while the global slowdown would make its recession “deeper and longer than forecast”.

Mr Gaspar predicted that Portugal would return to growth in 2013 after its economy shrank by a total of 4 per cent in 2011 and 2012. Public debt would peak in 2013 at 106.8 of GDP, he added.

The government, which took office in June, also said it would talk with opposition parties on the possibility of introducing constitutional limits on the budget deficit and public debt, a measure that would be welcomed by Portugal’s European partners.

Fitch, the rating agency, said, in a report on Tuesday, that Portugal “should be able to avoid a default or restructuring of its debt” but it was unlikely that investors would regain confidence in the country in the short term. The consolidation of public finances posed “significant risks” to the Portuguese banking system, which would need “recapitalisation and increased emergency liquidity provision” from the European Central Bank.

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