Portugal's Costa Pins Debt Strategy on a Rosy Growth Outlook

(Bloomberg) -- Amid cheering supporters on his election night, Portugal’s Prime Minister Antonio Costa went out of his way to reassure investors he has an ambitious target to tackle the country’s big Achilles heel, its towering debt.

The problem is that his strategy assumes robust economic growth, not a given in today’s uncertain world. The external climate is deteriorating fast and there are signs that job creation is slowing. Portugal’s four main export markets are within the European Union, where expansion is falling to around 1%, and whose biggest economy looks set to enter recession.

Let’s look at the numbers. Costa said he’d bring public debt to under 100% of GDP by the end of his next four-year term in 2023, from currently 122%. In the government’s base-case scenario, that assumes average annual GDP growth of around 2%. Consensus forecasts and even the Bank of Portugal’s estimates are now closer to 1.7% growth. Rabobank even sees a slowdown to 1.2% next year, and that assumes an orderly Brexit and no U.S. import tariffs on European cars.

The debt-reduction target "is quite ambitious,” Michiel van der Veen, an economist at Rabobank, said in an interview, citing already slowing growth and trade tensions. “They need to take care of the demands that people are making for more government expenditure.’’

Indeed, there have been signs of social discontent, and voices demanding an increase in spending have become louder. Given his larger majority in parliament and reduced dependence on the far-left, the 58-year-old Costa could entertain spending cuts to offset slower growth.

But for the man who came to power reversing some of the unpopular belt-tightening measures imposed during the 2011 bailout, the chances of an about-turn are slim.

The entire strategy is to reduce debt by outgrowing it, not by squeezing the budget to pay it down more quickly, said Filipe Garcia, an economist at financial consulting company IMF-Informacao de Mercados Financeiros SA.

“To reduce the debt ratio in this way, which is a slow process, Portugal needs a favorable external environment,” said Garcia. “I am afraid that, in the context of a crisis or interest rate hikes, the debt reduction process will be interrupted.”

The government says that in a worst-case scenario in which GDP growth would slow from 1.6% in 2019 to 1.3% in 2023, it would miss its target, though debt would still fall to 103% of GDP.

For now investors aren’t terribly concerned. On the contrary, the yield on 10-year Portuguese bonds fell as low as 0.11% Monday, edging below the Spanish equivalent for the first time since December 2009.

The reason for such calm? The European Central Bank is lending a helping hand with near-zero borrowing costs, said Garcia.

To contact the reporters on this story: Henrique Almeida in Lisbon at halmeida5@bloomberg.net;Joao Lima in Lisbon at jlima1@bloomberg.net

To contact the editors responsible for this story: Ben Sills at bsills@bloomberg.net, Raymond Colitt, Chris Reiter

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