After years of recession and high unemployment, the Portuguese economy started growing in 2014, and it is projected to continue expanding in the next two years. Unemployment is also around 12 percent, considerably lower than the 18 percent peak it reached in early 2013. Specifically, domestic reforms that were implemented at the beginning of the crisis, low oil prices, and the bond-purchasing program by the European Central Bank have supported this growth.
However, Portugal's recovery is still fragile. To finance its plans to reverse austerity measures, Lisbon will have to issue more debt. Higher bond yields, which already have risen recently, could make the process more expensive for Lisbon. According to Portugal's Technical Unit for Budget Support, the slowdown in fiscal consolidation will also require taking on another 11 billion euros ($12.2 billion) in debt by 2019. Portugal's debt is already at 130 percent of GDP, the third-highest proportion in the eurozone after Greece and Italy.
If corporate and household debt is included, Portugal has more debt in total than any other eurozone country. When an economy and government are stable, this is not a problem. But in Portugal's case, lingering friction with Brussels and domestic political instability could be detrimental. In addition, the country would need to grow by at least 3 percent for an extended period to reduce its debt burden. Yet the EU Commission expects Portugal to grow by only half that figure in the next two years. The main danger for Portugal is that foreign holders of Portuguese debt could decide to simply write it off and start selling en masse. A government that backtracks on economic reforms or starts to fracture politically could trigger that.
Portugal's banking problems are not completely finished, either. Only weeks after taking over the government, the Socialists had to rescue Banco Internacional de Funchal (Banif) with state funds, increasing Portugal's deficit. In late December, the Portuguese central bank also had to cover a 1.4 billion-euro shortfall at Novo Banco, an institution that was created after the collapse of Banco Espirito Santo in 2014.
Of course, the EU Commission has been flexible on fiscal targets in the past, and officials recently suggested they would seek a compromise with Italy. However, the Commission is also interested in preventing an avalanche of demands for budget flexibility from other eurozone countries, such as Spain. Political parties are still struggling to form a coalition in Madrid, but once there is a government in place, it will probably join Portugal and Italy in making the request to ease austerity. Brussels would like to avoid this, which explains its toughness on Lisbon. Lisbon will probably reach a compromise with Brussels, and punitive measures are unlikely, but Portuguese Prime Minister Antonio Costa will have to make some difficult decisions before a final agreement is reached. Such negotiations could hurt the Portuguese government and cause uncertainty to linger.
During the height of the eurozone crisis, countries in the Iberian Peninsula had fragile economies but relatively stable governments. In the coming months, it will be political volatility that directly threatens Portugal's financial security.
