08 April 2013

Fitch: Portugal court ruling is potential setback to adjustment

Fitch Ratings says that Portugal's Constitutional Court ruling that elements of the country's fiscal consolidation plans are unconstitutional shows the institutional limits on the Portuguese government's room for manoeuvre as it seeks to keep its EU/IMF programme on track.

In blocking a plan to suspend a monthly salary payment to state workers, the ruling could be interpreted as saying that all public spending cuts that affect civil servants are unconstitutional. This raises concerns about how the government would implement further cuts arising from its planned comprehensive spending review, which will outline how the bulk of savings from 2014 onwards, (€4 billion, equivalent to 2.5pp of GDP), will be achieved and is therefore central to Portugal's medium-term fiscal adjustment.

If that interpretation is correct, the ruling represents a setback to future fiscal adjustment efforts in Portugal. This is a greater concern than its immediate impact. The expenditure cuts affected by the ruling were worth €1.3 billion, or 0.8 per cent of Portuguese GDP. While significant, Prime Minister Coelho has already said that the government will seek to make equivalent cuts in other areas. This continued commitment to consolidation is positive.

The European Commission has welcomed this commitment and said continued and determined programme implementation "is a precondition for a decision on the lengthening of maturities of the financial assistance to Portugal." Our 5.5 per cent deficit forecast for 2013 assumes that the government will adopt offsetting measures. However, it will be challenging for the government to identify such measures at short notice. This increases the risk that the 2013 fiscal target will be missed.

Rising political, implementation and macroeconomic risks to Portugal's fiscal and economic adjustment are already reflected in the Negative Outlook on the sovereign's 'BB+' rating, which we affirmed last November. It is underpinned by continuing support from the Troika. As we noted then, the EU-IMF programme is on track but at a delicate stage as cross-party commitment to implementation, and social cohesion, are tested.

 

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