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Portugal Unveils Deficit-Cutting Plan as Investors Punish Debt Share Business ExchangeTwitterFacebook|

By Emma Ross-Thomas and Jim Silver

Jan. 26 (Bloomberg) -- Portuguese Prime Minister Jose Socrates delivers his 2010 spending plan today as investors seek signs he’s heeded the lessons of Greece’s budget crisis and will show his deficit-cutting plans are viable.

Portugal’s budget shortfall is more than twice the European Union limit and the debt is set to jump to 85 percent of output this year, the highest since at least 1990. That combination has pushed the risk premium on its bonds to the highest in eight months and prompted Moody’s Investors Service to warn that Portugal, like Greece, risks a “slow death” from high debt.

Portugal’s finances have come under closer scrutiny as Greece struggles to convince investors that its plan to cut the euro region’s biggest deficit is achievable and that there is no danger of default or leaving the euro. Rating companies have threatened to cut Portugal’s creditworthiness and the extra interest investors demand to hold Portuguese debt over German equivalents doubled to 109 basis points in the two months to Jan. 22.

“In the context of the crisis around Greece it was a natural development that the market would pick out the other weak links in the euro zone,” Harvinder Sian, a senior bond strategist at Royal Bank of Scotland Plc in London, said. “I expect some rating agency downgrades after the 2010 budget details.”

The Cabinet approved the budget last night, and the bill goes to parliament today.

Investor Confidence

“It’s a budget that gives confidence to investors, it’s a budget that gives confidence to the Portuguese,” Finance Minister Fernando Teixeira dos Santos said at a news conference in Lisbon last night. He reiterated a pledge to slash the shortfall to the EU’s 3 percent limit in 2013, without giving more details.

The European Commission, which set the 2013 deadline, forecasts the country’s deficit will amount to 8 percent of gross domestic product this year, the same as in 2009. The public debt will jump to 85 percent this year from 64 percent before the global financial crisis.

Portugal’s budget should put as much weight on spending cuts as on revenue-raising, said Guillaume Menuet, senior European economist at Bank of America Merrill Lynch in London.

“Hopefully they don’t do the same as Greece,” Menuet said. The market was “a bit disappointed” by Greece’s plan to cut the EU’s biggest deficit of 12.7 percent of GDP, which relied too much on boosting tax revenue and not enough on cutting spending, he said.

Spending Cuts

The risk premium to buy 10-year Greek bonds over comparable German debt rose more than 35 basis points between Jan. 15, when the plan was presented to the commission, and Jan. 22, when it reached 312 basis points, the highest in more than a decade.

Also at stake are Portugal’s credit ratings. Its debt is rated Aa2 at Moody’s with a negative outlook, while Standard & Poor’s cut the outlook on its A+ rating to negative in December. Moody’s, Standard & Poor’s and Fitch Ratings all cut Greece’s creditworthiness last month.

Socrates’ Socialists won re-election in September without a parliamentary majority. The largest opposition group, the Social Democrats, who have called for Socrates to scale back his public-works plans, said it will abstain on the budget vote, allowing the bill through but depriving the government of broad- based support.

Wasted Opportunity

Joao Duque, president of the Higher Institute of Economy and Management in Lisbon, said the “relatively weak” agreement negotiated with the opposition reduced the scope for hefty cuts.

“The government is going to waste a good opportunity,” he said.

Ireland, which has also seen its borrowing costs soar because of concern over its deficit of more than 12 percent, has slashed spending including public wages. European Central Bank President Jean-Claude Trichet on Jan. 14 called the plan “quite impressive.” Spain also plans to raise value-added tax in July.

Portugal, like Spain, has a history of rebalancing its books, particularly under the current government, said Ciaran O’Hagan, a fixed-income strategist at Societe Generale in Paris.

The year Socrates was first elected in 2005 the deficit was 6.1 percent of GDP, which he slashed to 2.6 percent in 2007. The country, benefiting from export demand as the global economy recovers, returned to growth in the second quarter of last year, before the euro region overall. Its unemployment rate, at 10.3 percent, is in line with the euro-region average and below rates of 19.4 percent in Spain and 12.9 percent in Ireland.

“Portugal is not going to be the next Greece,” said Fabrizio Fiorini, who helps oversee $12 billion of assets at Aletti Gestielle SgR SpA in Milan.

“Investors are punishing Portugal because of risk aversion caused by Greece,” he said.

Still, Moody’s linked Portugal to Greece in a Jan. 13 report when it said the two economies may face a “slow death” as they dedicate more wealth to paying off debt and higher taxes stifle growth. The International Monetary Fund this month urged Portugal cut public wages and boost tax revenue to tame the deficit.

To contact the reporter on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net; Jim Silver in Lisbon at jsilver@bloomberg.net

Last Updated: January 26, 2010 02:52 EST