Portugal struggles to restore confidence in its economy (Feature)

By Sinikka Tarvainen and Emilio Rappold Oct 12, 2010, 3:07 GMT

Lisbon - Portuguese Prime Minister Jose Socrates is facing a major challenge this week as parliament prepares to vote this week on an austerity budget in line with recommendations from international watchdogs seeking to restore the country's financial credibility.

Portugal's lethargic growth and high debts have sparked concern that it might need an international bailout similar to the one that rescued the Greek economy earlier this year.

The main opposition conservative Social Democratic Party (PSD), which earlier backed Socrates' Socialists' attempts to cut the gaping budget deficit, has criticized tax hikes and other measures that were expected to form part of the budget.

If Socrates' minority government fails to win sufficient support for its austerity policies, that would not only undermine market confidence in Portugal and the euro, but would threaten the stability of the government itself, analysts say.

Political leaders were expected to comment on the budget before the vote takes place.

Portugal's economy is deemed to be among the weakest in the 16-member eurozone alongside Greece, Spain and Ireland.

The government expects growth of at least 0.5 per cent this and next year, after the economy shrank 2.7 per cent in 2009.

International analysts, however, have been more pessimistic, with the ratings agency Standard & Poor's predicting a contraction of 1.8 per cent in 2011 and stagnation in 2012.

The budget deficit of 9.3 per cent of gross domestic product (GDP) is one of the highest in the European Union, and public debt has soared to more than 85 per cent of GDP.

Unemployment is running at the record level of 10 per cent, and social care organizations say poverty has increased alarmingly in recent years.

But analysts do not just attribute the problems to the global crisis, but point out that Portugal's growth has been sluggish for a decade.

The stagnation is blamed on low productivity, an excessive dependence on labour-intensive sectors such as construction or tourism, insufficient private investment and innovation, as well as a rigid labour market.

The structural weaknesses of the economy have become evident as Asian competition has increased in sectors such as textiles and shoes, and eastern European countries have joined the EU, vying with Portugal industrially and for EU subsidies.

Portugal's difficulties are exacerbated by a subdued economic outlook also for neighbouring Spain, Portugal's main trading partner, which receives about a quarter of its exports.

Losses of thousands of jobs at northern Portuguese electronics and other factories in recent months, as well as the state needing to rescue a string of banks during the global crisis, have contributed to concern about the economic situation.

Some leftist politicians and even conservative economists have suggested that the only way out was abandoning the euro, which is seen as having eroded Portugal's competitivity.

'No fragile country can have a strong currency which it does not control,' the weekly Expresso wrote.

Meanwhile, the EU, OECD and ratings agencies have stepped up pressure on Portugal.

The government has announced three austerity packages this year in attempts to shore up the economy and cut the budget deficit to below the EU threshold of 3 per cent by 2013.

The latest measures include slashing public sector wages by an average of 5 per cent, freezing pension payments, cuts in social spending and public investments, and raising value added tax.

Critics fear the austerity policies will erode spending power to the point of paralysing the economy.

EU experts, on the other hand, say the measures presented by the government so far are likely to be insufficient to put the economy on the right track.

President Anibal Cavaco Silva has tried to mediate between the government and the opposition to find a consensus on economic policy. His efforts are expected to be successful.

'To topple the government at this critical time ... when the country does not have any margin of manoeuvre, would be the worst we could do,' PSD representative Jose Pacheco Pereira said, advising party leader Pedro Passos Coelho not to block the budget.

Yet even if the government wins parliamentary support for its belt-tightening policies, it is expected to face growing labour unrest. The country's top trade union confederations CGTP and UGT have called a general strike for November 24.