Portugal – Increased Policy Uncertainty

A general election scheduled for October looks to become a referendum on the austerity policies implemented by Prime Minister Pedro Passos Coelho’s center-right government. The main governing PSD and its smaller coalition partner, the CDS-PP, will contest the elections together, and their campaign will amount to a plea for patience and a chance to finish the job of pulling the economy out of the hole that forced Portugal to obtain an $87 billion bailout package from the IMF, the EU, and the European Central Bank.

Although Coelho’s government guided Portugal to a successful exit from the bailout program and the economy recorded positive annual growth for the first time in four years in 2014, the electorate’s tolerance of austerity is wearing thin. An anti-austerity rally organized by the Communists and Greens under the banner of the UDC brought an estimated 100,000 protesters into the streets of the capital in early June.

Recent polls show the center-left PS maintaining a comfortable lead over the governing alliance, but its support remains below the level required to have any chance of winning a majority of seats in the 230-member Parliament. PS leader Antonio Costas would undoubtedly prefer to form a center-left coalition, but he also accepts the need for austerity (with some accommodation for pro-growth spending), and he will balk at demands by the UDC for a sharp deviation from economic orthodoxy.

Both the PS and the PSD have ruled out any chance of forming a grand coalition, but if neither the Socialists nor the incumbent coalition can secure a majority on its own, such a partnership may provide the only means of forming a viable government that does not immediately trigger a panicked reaction in the markets. Even in that case, political risk would be higher than is currently the case, as the return of the PS to a   position of power would imply at least some weakening of fiscal discipline and an increased danger of policy disagreements that threaten the stability of the government.

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