Country's debts amount to 124 percent of its gross domestic product (GDP). Since private investors were hardly willing to lend Portugal money after the global financial crisis, the European Union, euro-zone countries and the International Monetary Fund (IMF) granted Lisbon a €78 billion ($103 billion) loan two years ago.
Since then Portugal, more than any of the other debt-ridden Southern European countries, has adhered meticulously to the requirements dictated by the so-called troika, consisting of the European Commission, the IMF and the European Central Bank (ECB). By cutting pensions, trimming the public-sector workforce and making the labor market more flexible, the government has held out the prospect of a return to the international financial markets next year.
But, in the third year of the recession, there are growing doubts that Portugal will then be able to refinance itself under its own steam and eventually reduce its debt to a tolerable level. And now the political stability the country has maintained for so long is also in jeopardy.
Finance Minister Vítor Gaspar, a political independent and the man who had been viewed as a guarantor of Portugal's course of austerity measures, plunged the country into a crisis when he resigned two weeks ago. Since the government headed by liberal-conservative Social Democrat Pedro Passos Coelho came into office in June 2011, Gaspar had been in charge of implementing the troika reforms. One of the reasons he decided to resign is that he had lost popular support. In addition, labor unions and, more recently, employer associations have been rebelling against the austerity measures.
Now President Aníbal Cavaco Silva has called upon the government and the main opposition party, the Socialists, to develop a sort of national emergency plan that includes the continuation of the reforms stipulated by the troika. He has also proposed new elections after the aid program expires next summer. The parties are in an uproar, and the new troika mission to review the austerity policy has been postponed until at least the end of August. Investors fear that the reform process could become derailed.
Portugal does have some initial successes to show for itself. Exports are up, especially to countries outside the EU, and the trade deficit is shrinking. But the country has deep-seated structural problems, and change will be slow in the making. The substantial debts and an 18 percent unemployment rate are paralyzing consumption and investment. At the same time, dozens of the small companies that employ fewer than 10 people and have made up 95 percent of Portuguese businesses until now are shutting down every day. This raises the question of whether the country can get back on its feet without a debt haircut.
Some economists argue that the euro is more of a curse than a blessing for Portugal. The common currency is too strong for Portugal, which makes the products it exports too expensive. As a result, there has been too much investment in recent years in consumer products and retail companies and too little in manufacturing industries, which has left the structure of the economy "distorted."
The problems began long before the financial crisis. The EU's expansion into Eastern Europe and China's accession to the World Trade Organization adversely affected Portugal's textile and shoe industries. The manufacturing sector shrank from 18 percent of economic output in the 1990s to 14 percent most recently. The economy has been stagnating for more than a decade.
Portugal reacted incorrectly to external challenges. It turned inward, focusing on largely isolated industries, such as energy and telecommunications, and the economy came to depend on consumption. Private households, companies and the public sector took on more debt. But when interest rates rose during the financial crisis, the model collapsed.
Now the troika is trying to solve several problems at once, problems which cannot be solved at once. Reducing both the current account deficit, which had been high for years, and private household debt necessitated a decline in domestic consumption. But this led to a sharp drop in tax revenues and the expansion of the budget deficit.
The crisis has since divided people from Portugal. Some are convinced that only a withdrawal from the euro and the devaluation of the escudo, the country's readopted old currency, can reverse the trend, stimulate exports and get investments and consumption back on track.
Others argue that withdrawal from the euro could isolate Portugal politically and throw it back to a time when the country was caught in a vortex of strong economic growth, inflation and downturns. "An exit from the euro is out of the question," says Minister of Economy Álvaro Santos Pereira. He feels that the main problem lies not in the strong euro, but in the excessively high interest rates Portuguese companies are forced to pay.
Pereira imagines that the establishment of a development bank, a European banking union and, last but not least, the ECB will help ease the credit crunch. Nevertheless, he adds, it is essential that Portugal continue its austerity programs.
Since President Cavaco Silva called into question plans to reshuffle the cabinet, it has been unclear who will actually be setting the direction on economic and fiscal policy in the future. The cabinet reshuffle was Prime Minister Passos Coelho's attempt to satisfy his coalition partner, the conservative Democratic and Social Centre - People's Party (CDS-PP). Its leader, Paulo Portas, had also threatened to step down after Gaspar's resignation.
Now the president wants the major parties to commit to his government's reform programs. But the socialist opposition is demanding a renegotiation of the conditions of such a commitment. If Portugal has to secure its own financing in the markets next year, without the troika's support and at much higher interest rates, its debts will be "clearly unsustainable," and there is no way around some form of debt restructuring.
By Guylain Gustave Moke
World Affairs Analyst
Photo-Credit: AFP: Portugal President Aníbal Cavaco Silva