Portu-Geez!

Tensions in Europe continued easing on Wednesday, when the troika recommended extending the maturity of Irish and Portuguese bailout loans by seven years. The decision seemingly came as a bit of a positive surprise to some—especially given recent developments in Portugal.

In March 2011, Portugal wasn’t doing so hot. The tiny Iberian nation owed bond holders more than €5 billion in mid-April and was hard up for cash. Parliament rejected much needed austerity measures that would help raise the funds, and Socialist Prime Minister Jose Socrates stepped down from office. The next month, Portugal requested aid from the European Union, resulting in a €78bn bailout with goals to return to bond market financing by late 2013 (fully by 2014). Though there was much political controversy (and as many fears) surrounding Socrates’s resignation and the inevitable bailout, the Portuguese political scene calmed shortly after. In June 2011, Social Democratic Party leader Pedro Passos Coelho became Prime Minister. Austerity measures were eventually implemented, and all’s been relatively quiet on the Portuguese front since—to Portugal’s benefit.

That is, until recently. On March 15, Portugal’s government “announced wider deficit targets” due to a bigger-than-expected drop in tax revenue associated with overestimating its economy’s health. That’s not an uncommon thing in bailed-out eurozone nations the last three years, so it’s not massively meaningful in and of itself. But some figured missed targets don’t help smooth talks with the troika, and the bailout loan extension is a key benefit for Portugal’s bond market re-entry.

After the deficit target miss, many felt Passos Coelho’s leadership was in jeopardy—another factor some feared wouldn’t help troika discussions. A no-confidence vote was held in Parliament last week, but Passos Coehlo’s government sailed through. The opposition’s move was a largely symbolic motion as the current coalition has a “comfortable majority,” but the vote should still demonstrate greater stability to the troika. Though Passos Coelho tried to pull a Socrates before the budget ruling, declaring he’d resign if it didn’t pass, no material moves have been made in that direction. (Likely it was political hot air.) But the confidence vote was only a prelude to another matter—Portugal’s constitutional court was slated to rule on the legality of four of nine austerity measures included in the 2013 budget.

That ruling came Friday, with the Court rejecting Portugal’s withholding of the 14^th month of pay to state workers, a 6.4% cut in retired public employees’ pensions and a tax on unemployment subsidies. With these measures deemed unconstitutional, the country will have to find cutbacks elsewhere to make up the lost €860 million. This seemingly further advanced concerns.

Yet the extension came. Perhaps the troika was heartened by Passos Coehlo’s determination to meet the deficit targets and avoid a second bailout—a precondition for the troika’s deciding whether to grant extended target dates. To make up for potential savings lost in the ruling, the Portuguese government announced intentions to cut back on public spending in areas like education and health care without raising taxes. Now how they specifically find the savings remains to be seen—after all, austerity measures are wildly unpopular, and politicians are known for politicking. But the effort seems to have convinced the troika Portugal’s willing and able to find enough cash in the couch cushions to make Ms. Merkel in Germany go along with releasing funds—and extending target dates. The troika’s made it clear exhibiting commitment to resolving debt issues betters a country’s chances for deficit target flexibility, and in our view, Portugal’s certainly demonstrated that commitment. (Besides, Portugal’s accomplished much more than Greece, yet Greece has gotten each of its installments.)

But leaving aside politicians, markets have alluded to improving health in Portugal for some time. Yields on 10-year Portuguese debt are currently at 6.45%—just 9bps higher than the day of the ruling, April 5. Since 2013 started, Portuguese bonds yields have stayed relatively steady—but a longer view back to 2012 shows a massive reduction. Yields have nearly halved in the last twelve months, from over 12.4% to the present mid-6% rates.

Besides, the ruling and hemming and hawing doesn’t appear to be a vote on austerity in Portugal. Not that it’s a formal popularity poll, but it is interesting that just last month, 100,000 Portuguese citizens signed a petition to keep former Prime Minister Socrates from giving weekly commentary on the state-run public television station. Among the loudest complaints was Socrates’s “bad management” of public funds leading to the bailout. To many, it seems the blame for the bailout and associated economic difficulties lies with Socrates, not Passos Coelho and austerity. (We’d add neither is really accurate, considering the real culprit was too much socialism built up over decades.)

After three years, we’ve seen ample evidence of euro leaders’ commitment to support the euro and its fellow nations. The recent drama in Lisbon is only the latest example.