Reuters Portugal looks increasingly vulnerable to contagion from the Greek crisis, with even its tough austerity program impeding the thing it needs most to tame borrowing costs — a quick return to economic growth. Portugal has gone well beyond the austerity demanded in its EU/IMF bailout, but this model behavior has failed to lower debt costs which are likely to rise further without some sign of a turning point in the country's deep recession. Uncomfortably for Lisbon, Portugal's debt yields have decoupled from those of fellow bailout recipient Ireland — a trend attributed to modest expansion in one country and recession in the other. “To become a success story, unfortunately for Portugal, growth is the only thing markets will react to,” said Harvinder Sian, a debt strategist at RBS in London. “In terms of austerity, there isn't a question mark about whether there is will to do it, but you need growth to deal with debt. Portugal doesn't have the same growth dynamics as Ireland, so there's a problem of credibility about its recovery.” Portugal's fortunes can be further destabilized by events outside its control as euro zone policy makers wrestle with the rapidly worsening plight of Greece, whose very membership of the euro zone some critics have called into question. Portugal still faces a deep recession this year and next as well as the difficult task of implementing labor market and other structural reforms to gain competitiveness. Portugal's GDP was flat in the second quarter after a 0.6 percent first-quarter drop. Meanwhile, Irish yields have managed to shrug off most of the negative impact from the Greek situation lately. Ireland's solid cost competitiveness and productivity has allowed it to eke out 1.3 percent growth in the first quarter, leaving behind last year's one-percent contraction. Ireland started on the austerity path months before Portugal. Portugal's center-right coalition government took over in June, backed by a solid parliamentary majority to pass austerity measures agreed with the troika of lenders behind the 78-billion-euro bailout. The previous minority government collapsed after failing to have its austerity bills approved. The government has since announced new taxes on year-end bonuses, high incomes and electricity that go beyond the bailout terms. It has also promised to cut spending further to avoid jeopardising this year's budget deficit goal of 5.9 percent of gross domestic product after discovering a shortfall inherited from the previous administration. Portugal in May became the third euro zone country after Ireland and Greece to get an EU/IMF bailout, pledging to hike taxes, cut spending and privatise state property. Its benchmark 10-year bond yields quickly caught up with those of Ireland, exceeded them and the spread kept growing, reaching a record 3.5 percentage points late last month. After July's EU summit gave Ireland and Portugal lower interest rates on their rescue loans, Ireland's 10-year bond yields fell much more sharply than Portugal's and have not risen much since, while Portugal's debt costs are rising again. “I wouldn't say there's any good news around the corner for Portugal. It still has a long way to go before you may see it performing well in its own right,” said Orlando Green, debt strategist at Credit Agricole in London. “If the government meets bailout targets this year it doesn't necessarily mean an improvement for Portugal,” he added. Some were even more pessimistic on Portugal's prospects. “Austerity and private sector deleveraging are depressing growth so you can't really expect positive newsflow from Portugal. In the next 12 months we'll probably see further contagion from Greece,” said Giada Giani, an economist at Citi. “A year or two from now it will probably be closer to where Greece is now due to the impact of austerity, with a greater likelihood of debt rescheduling,” she said, adding that although Portugal's new government was stable and committed to reforms, it had only just started fixing the indebted country's problems. Portugal's government expects a 2.2 percent contraction this year and a 1.8 percent decline in 2012 before the economy resumes growth in 2013 with a projected 1.3 percent rise. The first EU/IMF review of the implementation of the bailout programme last month said Portugal was on track to meeting its budget deficit target, but warned that an overall slowdown in Europe could hamper the country's plans. Although analysts acknowledge Ireland's relative success so far in terms of austerity and using a lot less money than the 35 billion euros envisaged by its bailout agreement to rescue its banks, most say it's not out of the woods yet. Credit Agricole's Green said the difference between Portuguese and Irish bonds could still tighten, but hardly thanks to any Portuguese merit. “If the spread tightens, it will be mostly an Irish story, not Portuguese,” he said, citing a possible Irish slowdown and Ireland's overdependence on the real estate sector and on foreign companies coming to do business in Ireland. Although weaker, Portugal's economy is less concentrated. Ireland's growth is expected to have slowed down to just 0.25 percent in the second quarter as export growth moderates in the face of a slowing global economy, but economists still expect an expansion of 0.5 percent for the year. RBS economist Silvio Peruzzo said that despite Ireland's decoupling, both Portugal and Ireland would likely be unable to return to the primary bond market by the time their bailout programmes end in 2013 and would require additional funding. “And if Greece has to quit the euro zone, it doesn't really matter who the next underdog is. There will be a massive contagion effect on other countries, including much bigger economies like Spain and Italy,” Peruzzo added. __
