Portugal: growth, fiscal momentum at risk as snap elections end six years of political stability

Snap elections come at a sensitive time and a delayed budget will likely hold some adverse repercussions as concerns the country’s post-pandemic recovery plans on top of the impact from increased political uncertainty.

The time needed to form a new government could impede Lisbon’s efforts in implementation of reform and deployment of crucial investment outlined in the country’s recovery plan, despite the government’s strong record as regards improving Portugal’s long-run growth and government finances.

Recent opinion polls suggest the Socialist Party could come out on top in an early election but again fall short of a parliamentary majority, indicating any new government is expected to be tricky to form. Strained relations with left-wing parties, which have so far granted external support to Prime Minister Antonio Costa’s minority government, may increase risk of permanent political instability.

Complex coalition politics could ultimately dent Portugal’s record of fiscal prudence

Portugal’s dependence upon more complex coalition politics in formation of governments, while increasingly common in European capitals, might ultimately dent authorities’ records as concerns prudent fiscal policy and commitment to fiscal consolidation, and hinder gradual unwinding of structural economic imbalances, including reduction of elevated structural unemployment.

Economic stagnation is a key risk for Portugal given modest growth potential, which we estimate at only 1.5%.

The proposed budget from the Socialist-led minority government, voted down by two left-wing allies, would have trimmed the budget deficit to 3.2% of GDP in 2022 from 4.3% in 2021, confirming commitment to fiscal stabilisation.

Fiscal discipline has become the norm in Portugal’s policy making, with the government’s debt-to-GDP ratio declining 14pps between 2015 and 2019, supported by elevated primary surpluses combined with robust growth.

The economy has become better positioned for sustained growth

The economy has become increasingly better positioned for sustained growth since 2014 as banks rebuilt capital buffers and liquidity, while households and corporates have started belatedly deleveraging. The public debt-to-GDP ratio rose sharply to around 134% of GDP in 2020 due to the pandemic crisis, from 117% in 2019. However, the government retains a sizeable cash buffer, equivalent to around 12% of GDP as of 2020, providing some flexibility in funding plans.

We expect the public debt ratio to resume a downward trend in 2021 despite primary deficits of around 2% of GDP in 2021 and 1% in 2022. Low interest rates and robust growth expectations, underpinned by Portugal’s EUR 17bn recovery and resilience programme, pave the way for post-crisis public debt reduction.

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Giulia Branz is Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH. Jakob Suwalski, primary sovereign analyst of Portugal at Scope Ratings, contributed to writing this commentary.