What You Need To Know About The Portuguese Crisis Reigniting Fears Of A European Meltdown

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Political tumult in Portugal is rekindling fears of a crisis in Europe that might spill over into other world economies. The country is two years into a bailout plan that imposed spending cuts, tax hikes, and structural reforms in return for funds to keep the government solvent and prevent it from departing the common currency used by 17 countries. Here’s everything you need to know about the renewed crisis.

What’s going on in Portugal? Simply put, “austerity fatigue” has the government that’s enforced steep cuts to public services on the brink of collapse. After the minister in charge of austerity plans resigned Monday, Prime Minister Pedro Passos Coelho appointed a replacement who also supports the cuts. That led Foreign Minister Paulo Portas to quit in protest of the PM’s choice to stick with austerity. Portugal is a parliamentary democracy, and Portas is the head of the second-largest political party in the current ruling coalition, so his resignation – which the PM has refused to accept – threatens to cause new elections that might boot the austerity supporters out of power. Multiple news sources in the country report two other ministers from Portas’ party will resign Wednesday, increasing the likelihood of a new election.

What led to the resignations? Finance Minister Vitor Gaspar quit over the failure to hit economic and spending targets imposed by a 2011 bailout agreement. Portugal was forced to cut its annual budget deficit to 3 percent or less of its gross domestic product by 2013. The bailout stipulated several required methods to achieve that rapid deficit cutting, including cuts to public sector wages, higher sales taxes, and reductions in the country’s social security benefits. Those cuts have caused mounting waves of public protest, including multiple strikes by transportation workers and mass demonstrations in the street. The ruling coalition has stuck to the terms of the austerity plan despite the public outcry, but Gaspar said that the country’s failure to hit debt and growth targets set by the bailout had undermined his credibility and stepped down as a result.

Why is this happening now? Portugal’s austerity has been far more painful than promised, for far longer. The bailout plan was sold partly on the promise that short-term pain would yield mid- and long-term gains – the same promise that’s failed to prove true in America over the past two years. When the International Monetary Fund and European Union agreed to give Portugal about $100 billion over three years, it expected “a recovery to begin taking hold in early 2013” after an initial economic contraction. That hasn’t happened. The economy shrank by almost 5 percent in two years – slightly worse than predicted – and the recession isn’t turning around. Instead of the 1.2 percent annual GDP growth bailout authorities projected for 2013, the economy is expected to shrink by 2.3 percent this year. Unemployment was supposed to hit 13 percent in 2013, according to the bailout announcement, but in fact it’s nearly 18 percent. More than four out of 10 young Portuguese are unable to find work.

The recession and mass joblessness create a feedback loop: a smaller economy means it’s harder to shrink deficit-to-GDP ratios as required by the bailout, and missing deficit targets leads to steeper cuts in pursuit of the targets, which prolong and worsen the recession. The longer that cycle continues – and Portugal is two years deep – the fewer options policymakers have.

What happens next? Portugal’s future sounds very different depending on who you ask. One European banker notes that in other countries where populist fury has caused a reevaluation of austerity programs, the replacement deals have been just as economically painful and politically divisive. Portugal has already gotten an extension of the repayment period for bailout funds, which is the simplest way to relax the pressure that feeds the vicious cycle of austerity’s economic harm. Further easing of bailout requirements would be difficult, but not impossible if relatively strong Eurozone countries like Germany agreed to provide the country with breathing room. This week’s events make a January speech by Portugal’s President Anibal Cavaco Silva look prophetic: He said that the economic situation was unsustainable and predicted the country might pull apart completely without a renegotiation of bailout terms. It’s increasingly likely that the EU and IMF will need to relax the conditions of its financial rescue or give up on the country, which would threaten the viability of the entire Euro economic community.