Can Portugal Remain the Eurozone's Anomaly?

7 MINS READOct 16, 2019 | 09:00 GMT
In this photo, Portuguese Prime Minister Antonio Costa speaks to the press after meeting with President Marcelo Rebelo de Sousa in Lisbon on Oct. 8, 2019.

Portuguese Prime Minister Antonio Costa speaks to the press in Lisbon on Oct. 8, 2019, two days after his Socialist Party won the most seats in Portugal's parliamentary elections, but fell just short of a majority.

(HORACIO VILLALOBOS/Corbis/Getty Images)
  • Portugal's economy will continue to grow in the coming years, but at a slower rate.
  • The reelected government's left-wing allies will push for the reversal of some austerity measures, which could make the country less attractive to investors.
  • Spain's economic slowdown, along with rising U.S.-EU trade tensions and a potential no-deal Brexit in the weeks ahead, also risks creating headwinds for Portuguese exporters.

In the wake of the eurozone financial crisis in the early 2010s, an informal alliance of left-wing forces in Portugal unexpectedly managed to not only stabilize the country's battered economy, but also to make it more attractive to foreign investors. And Portugal's Oct. 6 general election has since confirmed its place as a European anomaly, with the government winning reelection on a continent where nationalist and right-wing parties are on the rise.

After receiving almost 37 percent of the vote, Prime Minister Antonio Costa and his Socialist Party are now seeking support from smaller left-wing parties to form a new government. But despite Portugal's strong economic performance in recent years, public and private debt remain high. And this, combined with an influx of global trade uncertainty and domestic pressure to roll back some of the business-friendly policies implemented during the crisis, will challenge Lisbon's ability to sustain its robust growth in the years ahead.

The Big Picture

The Portuguese economy is in far better shape than it was during the peak of the European financial crisis, which saw Lisbon request an $86 billion bailout from the European Union and the International Monetary Fund in 2011. But Portugal continues to struggle with high debt and labor market issues that, along with mounting global uncertainty, risk cooling its recent economic expansion.

An Economic Oddity

After Portugal's 2015 general election, Costa's Socialist Party led a minority government that relied on support from three left-wing forces in parliament: the Left Bloc, the Portuguese Communist Party and the Green Party. At the time, many were skeptical about the sustainability of this heterogeneous political alliance, while others worried that a left-leaning government would result in a higher fiscal deficit and a worse business environment.

But despite these initial concerns, Portugal beat the odds and became one of the best performing economies in Western Europe, growing every year since 2015. Unemployment, meanwhile, fell from roughly 13 percent of the active population to 6 percent between 2015 and 2018. Costa's government has also taken Portugal's fiscal deficit to only 0.5 percent of GDP in 2018 — a striking reduction from the country's 11 percent deficit in 2011.

This graphic shows Portugal's GDP growth since 2009 compared with the rest of the eurozone.

Portugal's fiscal discipline in recent years is the result of a policy that combines modest public spending with high taxes. This, along with increased political and financial stability, has helped the country become a more attractive destination for foreign direct investment. Portugal’s strong economic performance can also be attributed to a generally positive economic environment in the eurozone. Portugal's exports to Spain, its main trade partner, rose from roughly $15 billion to $19 billion between 2015 and 2018, as Madrid also experienced strong economic growth after years of crisis. The European Central Bank's intervention in debt markets over the past four years have helped Lisbon issue debt at low interest rates as well, allowing the Portuguese government to finance itself at a manageable cost.

Internal Challenges Ahead

But despite its recent prosperity, Costa's reelected government will face significant challenges in the coming years. While unemployment is much lower than where it was at the peak of the economic crisis, many Portuguese workers are finding only low-paying temporary jobs. Today, roughly 22 percent of Portuguese workers are under temporary contracts — the second-highest rate in the European Union after Spain. Portugal also has one of the lowest minimum wages in Western Europe at roughly 700 euros (or about $770) per month; Spain's minimum wage, in comparison, is roughly 1,000 euros per month (or about $1,100).

This combination of low wages and temporary contracts means a significant portion of the Portuguese workforce struggles to make ends meet and does not qualify for credit, thus depriving the Portuguese economy of one of the main drivers of growth. Indeed, not everybody in Portugal is feeling the positive impact of their country's recent economic "miracle," evidenced most recently by the influx of teachers who have taken to the streets to demand higher salaries.

Despite reelecting the Socialist Party, many voters have thus grown tired of its austerity measures over the past decade, which will make it harder for the new government to stick to the current path of structural reform. In exchange for their support, some of Costa's potential coalition partners, such as the Left Bloc, are also likely to demand labor reforms that increase protection for workers, in addition to higher pensions and greater public spending. And this could threaten Portugal's newfound fiscal balance and reduce the country's overall appeal to foreign investors.

This graphic shows Portugal's debt burden as a percentage of GDP compared with Greece and Italy.

Portugal will also remain under the heavy burden of its large public and private debt for years to come. At roughly 120 percent of GDP, Portugal's public debt is the third-highest in the eurozone after Greece and Italy. This a less urgent problem for Lisbon, as the European Central Bank's current policies have kept borrowing costs low for eurozone governments, enabling Lisbon to finance itself at a manageable cost. But the eurozone remains vulnerable to market shocks that could lead to higher borrowing costs for its member states down the line. And Portugal's slowing economy will also reduce the speed at which it can grow out of its public debt. In addition, household debt in Portugal (including mortgage loans and consumer credit) exceeds 130 percent of net household disposable income, which is higher than other Southern European countries such as Spain and Italy.

Nonperforming loans (NPLs), meanwhile, still represent roughly 9 percent of all loans in Portuguese banks. While down from the roughly 13 percent recorded just two years ago, this NPL rate is still double the eurozone's average. In recent years, the country's improving economy allowed some debtors to pay back debts originally considered to be lost. Portugal's biggest banks have also managed to reduce their stock of NPLs by selling bad loan portfolios to investors and by reaching agreements with debtors. But a slowing economy at home could make it harder for Portuguese banks to scale back their ratio of NPLs.

Global Instability Looms

Costa's reelected government will have to reckon with these internal challenges at a time when global economic risks are also on the rise. The U.S.-China trade war and Brexit-related uncertainty, along with various domestic factors, have caused most economies in the eurozone to slow down. For Portugal, Spain's cooling economy is of particular concern, as it could result in a contraction of vital Portuguese exports to the country. Madrid saw its weakest growth in five years during the second quarter of 2019. And the Spanish economy is now expected to slow further from 2.6 percent in 2018 to 2 percent in 2019.

Portugal also faces risks related to the European Union's trade disputes with the United States, which represents roughly five percent of Portugal's exports. As part of its punitive measures against Brussels, Washington has so far excluded some of Portugal's main exports such as olive oil and wine. But escalating trade tensions between the European Union and the White House could eventually lead to higher U.S. tariffs for Portuguese exports, further damaging the country's economy.

A looming Brexit could yield additional headwinds for Lisbon as well. The reintroduction of trade barriers between London and the European Union would take a significant toll on Portuguese exporters, as the United Kingdom is Portugal's fourth-largest export destination. In addition, Portugal is also a popular destination for British tourists, meaning a contracted U.K. economy and weaker pound — which are both two possible outcomes of a no-deal Brexit — risk damaging Portugal's booming tourism sector.

High debt, labor market issues and rising global uncertainty risk cooling Portugal's recent economic expansion.

Over the past five years under Costa's Socialist Party, Portugal's GDP has significantly grown, as has its exports. It's thus no surprise that financial markets so far have welcomed the news of his reelection, hoping it portends a continuation of the country's remarkable comeback. But while Portugal will continue to see decent levels of growth in the coming years, Costa's second term will undoubtedly be much harder than his first — coming at a time of rising global uncertainty, and in a country where the repercussions of the 2010 financial crisis can still be felt.

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