The head of CDS, the Portuguese coalition Government’s junior party, resigned from the Government yesterday. Today, the remaining members of the Government belonging to CDS are expected to resign as well. Though in theory the Government might be able to remain in place – the senior Government party PSD has most seats in parliament though not the majority – it is unlikely that such it would last very long, especially because it would be unable to approve the Laws that require over 50% majority, such as the ones regulating the Ministries. PSD and CDS will be meeting tomorrow with the President to see if there is a chance of an agreement until the next elections. In absence of an agreement, the President may call early elections or try and create a grand coalition, including the main opposition party PS, in order to continue the extensive economic and financial adjustment programme agreed with Portugal’s official lenders.
Independently of the stability of a future Government, the impact of today’s news on the economy is likely to be significant. Interest rates on 10-year bond yields have risen to 8-months’ highs of 8% and the stock-market index PSI 20 has collapsed. This means that the financing costs have risen substantially. Adding to this, if this government actually collapses, the approval of the 2014 Budget will likely to be delayed well into next year, forcing the future Government to work with this year’s Budget and adding to the uncertainty. As a result, we expect financing costs to remain relatively high, which might undermine the Government’s ability to tap the markets for funding in September 2013, as was agreed with the Portugal’s official lenders. The mitigating factor is that in its last auction the Government fully funded its financing needs for 2013 and started financing for 2013, which means that the urgency to return to the markets is reduced.
Turning to the real economy, the early signs of a stabilisation that were visible in confidence and industrial production indicators are now likely to fade away as households’ and firms scale back their investment and consumption plans due to the political uncertainty. As a result, we have revised down our growth forecasts for Portugal and expect GDP to fall 3% this year and a further 0.5% in 2014.