ANALYSIS: Portugal's political crisis casts shadow over eurozone

By Sinikka Tarvainen and Emilio Rappold Mar 24, 2011, 16:25 GMT

Lisbon - Portugal was facing a deep political crisis after Parliament failed to endorse the government's latest austerity package and Prime Minister Jose Socrates resigned.

The collapse of the government was expected to affect the stability of the entire eurozone by sparking fresh market jitters and making it increasingly likely that Portugal will seek a bailout from the European Union and the International Monetary Fund (IMF).

The crisis erupted just before a key EU summit was due to discuss beefing up the bloc's rescue fund after 2013 and other steps to restore investor confidence in the eurozone's weakest members, including Portugal.

The austerity package rejected by Parliament was the fourth adopted by the government within 11 months. Socrates had been trying to slash the budget deficit to 4.6 per cent this year, down from 7.3 per cent in 2010 and from 9.4 per cent in 2009.

Socrates' tough spending cuts won praise from the EU but put a heavy burden on Portuguese citizens.

The 2011 budget cut public-sector salaries by 5 per cent, froze pensions and raised the value-added tax. Meanwhile, unemployment has soared past 11 per cent.

Portugal's Catholic Church and aid organizations have warned about the increase of poverty, while trade unions have staged a string of strikes protesting the government's spending cuts.

'How can we feed our families?' an elderly woman asked on television Wednesday while an engine drivers' strike brought most trains to a standstill in the morning hours.

The latest austerity package contained further cuts in pensions, as well as in health and education, while imposing more tax hikes and postponing infrastructure projects.

The package made the main opposition conservative Social Democratic Party (PSD) turn against the government, after supporting its earlier austerity measures.

'You cannot put an entire country on bread and water,' PSD leader Pedro Passos Coelho said.

The austerity is seen as paralysing consumption and contributing to the country sliding back into recession. The government on Monday revised its economic forecast from 0.2-per-cent growth to 0.9-per- cent contraction in 2011.

Not only does Portugal have high debt levels, but it also suffers from other problems such as slow growth, low productivity, an excessive reliance on labour-intensive sectors, red tape and a rigid labour market.

The Socrates government has pledged structural reforms, but that did not dissuade the ratings agency Moody's from downgrading Portugal's credit rating earlier this month.

'A country cannot rise from the debt crisis without economic growth,' said the PSD's 'Iron Lady,' former finance minister Manuela Ferreira Leite.

Socrates' resignation was expected to bring snap elections within two months. In the meantime, President Anibal Cavaco Silva could place the country in the hands of a caretaker government.

In such an unstable situation, Portugal would find it increasingly difficult to ward off the international bailout it has been avoiding for months, Finance Minister Fernando Teixeira dos Santos warned earlier this week.

There has long been speculation that Portugal could be the next country to be rescued, after Greece and Ireland last year.

Signs of growing market pressure were in the air as Portugal's borrowing costs continued to soar on Wednesday.

In neighbouring Spain, a senior official said the effects of the political crisis would be limited to Portugal, but the opposition was concerned that they could spill over the border.

'Uncertainty in Portugal is not good for Spain, because there are such close relations between the two countries,' Jose Eugenio Azpiroz of Spain's conservative People's Party told Portuguese media, before Socrates announced his resignation.

'Only a strong government will allow (Portugal) to emerge from the crisis,' said Joao Vieira Lopes from the National Trade Association.

Passos Coelho, whose party leads in polls, announced his willingness to form the next government.

Despite the party's criticism of Socrates' spending cuts, it was expected to stay the austerity course while trying to ground it in a broad government coalition.