Portugal panics as Supreme Court squashes austerity

Health and education budgets slashed to fill the black hole.

Photograph: Getty Images

Portugal's Supreme Court rejected the country's austerity measures on Friday, sparking fear that the country is next in line for Eurozone panic.

The judges ruled that portions of the plans, which cut public sector pay and state pensions, were unconstitutional because they failed to fairly spread the burden of austerity. That put the country's finances on the wrong side of the Troika in a stroke, and has led to a struggle to find alternative ways to plug the gap. If it doesn't, there's a risk that Portugal would have to request a second bailout, or even pay back its first €78bn to the EU.

In a statement, the European commission said:

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, namely the growing investor confidence in Portugal, and prolong the difficulties from the adjustment.

The Commission therefore trusts that the Portuguese Government will swiftly identify the measures necessary to adapt the 2013 budget in a way that respects the revised fiscal target as requested by the Portuguese Government and supported by the Troika in the 7th review of the programme.

As a result, last night the Prime Minister, Pedro Passos Coelho, announced that the health and education budgets would be slashed to fill the black hole. It's unlikely to be popular in the country, but wouldn't be out of the ordinary for the Eurocrisis, where austerity has been forced on countries for years now.

But the fear being voiced by market analysts is that the routine measures might interact with the thoroughly un-routine situation in Cyprus. As European officials have confirmed that, while Cyprus is not a "template", uninsured depositors really should start thinking about the safety of their money, the fear now is of deposit flight from Portugal.

The Guardian quotes Gary Jenkins of Swordfish Research making the case:

The government said that it didn’t agree with the court’s ruling and that it ‘…places serious difficulties on the country to comply with the…budget targets it has to meet.’ Portugal is supposed to hit a budget deficit target of 5.5% this year. I wonder if people / companies with savings of over €100K in Portuguese banks are feeling entirely comfortable with the situation.

As bad as things might be heading in Portugal now, they would get a lot worse if a run on the banks saw the country needing to intervene in its own financial system. There are no hints that uninsured depositors will be taking any sort of haircut at the moment, but panic is a strange thing – it can come from nowhere, and disappear almost as fast.