Eurozone faces new challenge as Portugal blocks cuts

The single currency bloc has already been destabilised by Cyprus and now faces fresh uncertainty if Lisbon cannot find new savings to meet the conditions of its €78bn (£66bn) bail-out.

Pedro Passos Coelho, Portugal’s prime minister, said on Sunday night that the rejection posed “serious obstacles and risks” to Portugal’s progress in meeting its bail-out commitments, but that it would “do everything to avoid a second rescue”, reports The Telegraph.

“The government is committed to all the objectives of the programme,” he said.

The prime minister said the ruling would mean other deep spending cuts, in social security, health, education and public enterprises
The European Commission warned in a statement: “Any departure from the programme’s objectives, or their re-negotiation, would in fact neutralise the efforts already made and achieved by the Portuguese citizens.”

Wolfgang Schaeuble, the German finance minister, said on Monday that Portugal will have to find new savings after the ruling.

“Portugal has made lots of progress in the last year to gain access to financial markets. But after this (constitutional court) decision it will have to find new measures,” he told a Bavarian radio station.
The court ruled that planned cuts in salaries to state workers and payments to pensioners were in breach of the constitution. The measures were expected to save as much as €1.3bn annually, a large slice of the €5bn of fiscal consolidation planned for this year. Mr Passos Coelho said that he had asked ministries to slash spending in order to avoid further tax rises.

Luis Marques Guedes, secretary of state for cabinet matters, said at the weekend: “The constitutional court’s decision places serious difficulties on the country to comply with the goals and budget targets it has to meet. The government doesn’t agree with the interpretation of the constitution.”

Raoul Ruparel, head of economic research at think-tank Open Europe, said: “With Cyprus and now Portugal, we are starting to see things worsening again in the eurozone.”

He also warned there was a danger that broad support for austerity across the country could be eroded by the court’s decision.
However, he expected the market reaction on Monday to be muted. “I can’t imagine a massive response. They will find the savings elsewhere,” he said.

Portugal’s borrowing cost rose in early trading, with the spread on government 10-year bonds rising to a four-month high of of 6.489pc.
The eurozone faces another testing week, with the formal terms of a €10bn Cyprus bail-out due to be published. Ireland is also thought to be preparing to ask for an easing of its bail-out terms at a meeting of eurozone ministers in Dublin on Friday.

Alongside Ireland, Portugal has been the eurozone’s poster child for reform and had planned to issue a 10-year bond shortly to try to regain access to the debt markets. The court ruling may have delayed those plans.

The latest escalation in the crisis came as Christine Lagarde, managing director of the International Monetary Fund, told an audience in China that “a substantial portion of the global economy looks better today than it did last year”, but the eurozone and the US still posed threats to the recovery.

The IMF in January cut its 2013 global growth forecast to 3.5pc and predicted a second year of recession in the euro area.