Portugal's government lost a key parliamentary committee vote on a regional financing bill it says will undermine efforts to cut the budget deficit and Portuguese stocks and bonds suffered a rout.
The minority Socialist government said that, if approved by the full parliament on Friday, the opposition-led bill would have “serious political consequences,” but a spokesman for Prime Minister Jose Socrates denied he had threatened to resign.
“This is a wasteful law that involves an additional debt of €100 million compared with zero as the budget calls for,” said Socialist lawmaker Vitor Batista.
Markets are watching the bill on financial transfers to the autonomous regions of Madeira and the Azores as a test of the government's ability to curb public spending as it grappes with the worst recession in decades.
“This certainly does add to the uncertainty and risk aversion in the market,” said Christoph Rieger, co-head of rate strategy at Commerzbank in Frankfurt.
If the center-right and communist opposition win the full house vote, the government fears it would undermine its ability to reduce the deficit from last year's 9.3% of gross domestic product to below 3% in 2013.
Defeat could bode ill for the 2010 budget debate due to start next week and end in mid-March. The centre-right opposition Social Democrats had made a deal with the government to abstain on the budget vote, guaranteeing its passage.
However, Thursday's vote suggests the opposition may now try to change elements of the budget. In the worst case, this could make it impossible for the government to continue and trigger a snap election, analysts said.
“Clearly what is at stake is the credibility of the Portuguese state at a time when it is absolutely indispensable that the state shows rigor in its public accounts,” Parliamentary Affairs Minister Jorge Lacao told reporters.
“Approval brings problems for governability and will have to have serious political consequences,” he said.
Traders targeted Portuguese bonds, switching their focus from Greece, whose debt-reduction plans won conditional European Commission approval on Wednesday. Portuguese shares fell 5% on the day, led by bank stocks.
The cost of insuring Portuguese debt against default hit a record high and 10-year bond yield spreads over German Bunds widened as much as 30 basis points to 175 bps early on Thursday before retreating somewhat to 160 bps in the afternoon.
Finance Minister Fernando Teixeira dos Santos told Reuters the pressure came in “a context of great volatility in the markets” and reiterated the government is firmly committed to reducing the deficit below 3% of GDP by 2013.
The government is expected to present an updated EU stability program with new deficit-cutting measures in the next two weeks.
Austerity moves already announced for this year include a freeze on public servants' wages. The reaction from workers has been muted so far, but a 300,000-strong public sector union said it planned a demonstration in Lisbon on Friday. (Reuters)