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Portugal pledges to cut debt as borrowing costs rise

Portugal’s finance minister has vowed to remove his country from the “podium” of the three most indebted economies in Europe to protect families and businesses from the impact of higher interest rates.

Fernando Medina said it was vital to reduce more quickly the country’s public debt – the highest in the eurozone after Greece and Italy – to prevent higher government borrowing costs hitting the wider economy.

“Faced with rising inflation, evident signs of a slowdown in central and eastern Europe and the prospect of higher interest rates, we cannot afford to introduce an additional risk factor,” he told foreign journalists.

Medina’s pledge to make debt reduction a “strategic objective” follows a sharp rise in the spreads of eurozone government debt as the European Central Bank prepares to introduce interest rate rises as early as July.

In separate meetings with the foreign media and economists late last week, Medina stressed that alleviating the debt burden would have a positive impact on banks, companies and families at a time of global uncertainty caused by the war in Ukraine and supply chain bottlenecks in China.

His goal is supported by Mário Centeno, governor of the Bank of Portugal, who at the same economists’ conference cited IMF projections forecasting that Portugal’s public debt-to-GDP ratio would fall below those of France, Spain and Belgium by 2025. “This trajectory will determine the success of the Portuguese economy,” Centeno said.

The government has not set out specific debt targets beyond this year, but the IMF projects Portugal’s debt-to-GDP ratio could fall from 127.5 per cent in 2021 to 104.5 per cent by 2027.

Economists see reining in public spending as the biggest challenge, with Centeno warning that a big increase in public sector hiring over the past two years could not all be attributed to the pandemic. A large influx of EU recovery funds, however, will significantly reduce the cost of public investment over the medium term.

After delays caused by a snap election in January, parliament is expected to give final approval this week to the government’s 2022 budget, which targets a drop in the debt-to-GDP ratio to 120.7 per cent. Debt reduction should remain a goal for “the next five budgets”, urged Centeno.

In line with other EU countries, Portugal has seen yields on its short-term debt turn from negative to positive in about two months. “Yields have increased faster than expected,” said Filipe Silva, investment director at Banco Carregosa. “In December, most analysts expected it would take a year for them to move as much as they have already.”

Italy’s 10-year yield spread against Germany, seen as a benchmark of economic and political risks in the euro area, has climbed above 200 basis points. Among highly indebted eurozone countries, however, Portugal had succeeded in distancing itself from Italy, Silva said. Its spread against Germany is about 120bp, close to that of Spain.

The renewed determination of the Socialist party (PS) government to pursue fiscal prudence comes after years of steady progress in reducing public debt were interrupted by the pandemic.

When Covid-19 hit, “the debt mountain began to rise again”, said Medina. In 2020, the debt-to-GDP hit a record 135.2 per cent.

The austerity measures Portugal endured during the European sovereign debt crisis more than a decade ago have also cast a long shadow, making fiscal prudence a high priority for many voters, according to opinion polls, as well as politicians.

Medina’s debt-cutting ambitions have been buoyed by a robust recovery from the pandemic. The European Commission forecasts annual GDP growth of 5.8 per cent this year, the highest in the EU.

Lisbon is also in full compliance with the bloc’s deficit and debt rules and determined to remain so, the minister said, even though they have been suspended for another year.

“The aim is positive, but we’ll need to see the results,” said Silva. “The real test will be holding down public spending.”

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