March 22, 2016 / 7:55 AM / 4 years ago

Portugal rolls back austerity, how far can it go?

LISBON (Reuters) - Portugal’s left-leaning government has set out to reverse its predecessor’s austerity policies, aiming to grow its way out of trouble by boosting demand and set an example for other post-bailout euro zone countries.

A woman walks in front of the Portuguese parliament in Lisbon, Portugal, March 21, 2016. REUTERS/Rafael Marchante

But European authorities have responded by raising pressure for budget deficit cuts, which tepid economic growth alone is unlikely to deliver despite Lisbon’s assurances. Any increase in purchasing power may be too slight to fuel the desired economic take-off, setting up a clash with Brussels soon.

Parliament’s approval of the 2016 budget last week marked the most explicit attempt so far by a euro zone country to roll back reforms and spending cuts imposed during an EU/IMF bailout.

It came after social democratic leaders from around Europe, hosted by French President Francois Hollande, agreed at a March 12 Paris meeting to push back against German-driven austerity policies and press for more EU initiatives to revive growth.

The Portuguese budget assumes growth of 1.8 percent this year but many analysts doubt even this reduced forecast will be achieved after 1.5 percent in 2015.

The shaky alliance of a minority Socialist government and its leftist allies in parliament - the Communists and Left Bloc - has started to deliver on promises to restore public sector wages and pensions to levels before the 2010 debt crisis.

They have raised the minimum wage, cut crisis-time tax surcharges and reintroduced four public holidays.

Other peripheral euro zone countries have also begun to chip away at austerity. In Spain, the center-right government restored before elections in December part of an annual 13th month bonus paid to civil servants canceled in 2012.

Italian Prime Minister Matteo Renzi, whose country avoided a bailout but has the highest debt ratio of any euro zone state except Greece, is also pushing for more fiscal leeway from Brussels to stimulate the economy.

Ireland called time on seven years of severe austerity in its 2015 budget and continued to use the spoils of a booming economy this year to further reduce income taxes, reverse unpopular bailout cuts and raise public sector wages.

But while Ireland’s phenomenal 7.8 percent growth meant its 2015 deficit of 1.5 percent of gross domestic product was far below the EU limit of 3 percent, Spain and Portugal both missed their deficit targets last year.

“RIDICULOUS AMOUNT”

In Portugal, the big question is whether gradual reversals in pay cuts will make the heavily-indebted Portuguese spend more, boosting the economy as the government hopes.

Fabio Cavaleiro, a 30-year old male nurse, says the changes to his pay so far reached just 10 or 15 euros per month.

“Not that they don’t come in handy, but I think this is a ridiculous amount,” said Cavaleiro who earns about 1,100 euros by working extra night shifts, without which his salary would be close to the minimum wage, now 530 euros per month.

In the last few years Cavaleiro and his girlfriend, who is also a nurse, lost around 400 euros in monthly income.

Since the Socialists teamed up with the far left in the autumn to oust a center-right administration, the economy has shown some signs of worsening. Unemployment, which had fallen since mid-2013, rose in the fourth quarter to 12.2 percent from 11.9 percent in the third.

Investment and business confidence fell, spelling challenges ahead, while quarterly growth practically stalled.

Political analyst Adelino Maltes says cohesion between the government and its leftist allies, which Prime Minister Antonio Costa needs for support in parliament, hinges on the economy.

“How the economy reacts is the secret of the continuation of Costa’s bargaining,” he said. “Everything depends on the economy. Change could happen quickly.”

Alexandra Silva, 43, an unemployed graphic designer and a mother of two living on the outskirts of Lisbon, was laid off in early 2014 and since then has seen her unemployment benefits halved to around 420 euros a month.

“I’ve been constantly looking for a job all this time, signed up at the jobs center, but there are no jobs and life has not gotten better at all, much worse actually,” she said. “Whoever is in government, they don’t give us much hope.”

She makes some money on the side selling sweets at craft fairs around Lisbon, but says that business has gone downhill.

The European Commission has already made Lisbon take extra fiscal measures worth nearly 1 billion euros in higher indirect taxes - mainly on petrol - in this year’s budget, reducing the impact of higher wages. Brussels may well demand more cost cutting in May if, as it has suggested, Portugal fails to comply with the EU fiscal rules.

“Let’s not delude ourselves. The pressures from the European Commission are today the biggest risk to the implementation of this project,” senior Left Bloc lawmaker Mariana Mortagua told parliament last week, calling demands for cuts “stratospheric”.

Complicating matters for the moderate Socialists, both far-left parties have revived talk of a debt renegotiation, arguing that the burden is unsustainable. The government says that at 130 percent of GDP the debt is manageable and can be reduced via budget controls and growth.

Such tensions could very well put Costa in a bind if there is a showdown with Brussels, or a potential economic shock such as a downgrade of the country’s debt rating by agency DBRS, which holds the only investment grade mark on Portugal.

Slideshow (4 Images)

A cut into junk territory “would be catastrophic” since Portugal could then be shut out of the European Central Bank’s bond-buying program, said political scientist Viriato Soromenho-Marques. Conversely, he does not think the EU watchdog will be tough on Portugal since countries like France and Italy are in a worse fiscal position.

The biggest risk is that the economy only limps along, undermining the government’s rosy revenue and growth forecasts.

Business leaders have warned that fuel tax hikes and the interruption of corporate tax cuts initiated by the previous government will hurt investment and growth, undoing competitiveness gains of the past few years.

Editing by Paul Taylor

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