Fixing one financial crisis could ignite another in Portugal

Reporting from Estremoz, Portugal — — 

As one of his country’s biggest winemakers, Joao Portugal Ramos has tended his business as assiduously as he does his grapevines, which spill down the hillsides of this picturesque region of walled villages and medieval castles.

French and Italian wines may be better known around the world than those from southern Portugal, but Ramos, 57, has worked hard to court new customers abroad. His wines, mostly reds, now reach markets in Brazil and China; exports account for nearly half his company’s revenue.

That sort of export drive helped the Portuguese economy grow 1% in the first quarter of this year, the highest rate of any of the 27 countries in the European Union, where the average was just 0.2%.

Yet the recovery from recession is in danger of being stifled almost as quickly as it began.

The debt crisis that has battered the euro and leached investor confidence has placed the Portuguese government in a bind. Bowing to the demands of the financial markets, Lisbon has announced a series of austerity measures to rein in a galloping budget deficit. But the harsh spending cuts and tax increases are liable to depress demand, boost unemployment and curtail the very economic growth the country desperately needs.

It’s a potential recipe for a double-dip recession, one facing not just Portugal but other European nations that are in similar economic straits, such as Spain and Greece. There is widespread fear that the spreading debt crisis will not only kneecap a weak European recovery, but provoke worried governments around the world to take drastic austerity measures that could send the global economy back into recession.

Britain has already announced spending cuts to deal with its high public debt load, and President Obama faces strong political pressure to curb deficit spending in the United States. But the effects of tighter fiscal policies would be especially painful in smaller economies, like Portugal, where per capita income is already the lowest in Western Europe.

Difficult as it may be, analysts say, such belt-tightening measures are necessary to reassure investors worried about the prospect of a national default.

“That will not be good for growth,” Joao Assuncao, an economics professor at the Catholic University of Portugal and a former government advisor, said of Lisbon’s austerity plan. “The pill itself will cause some pain. But if you don’t take it, the pain later will be even more severe than what you’re now experiencing.”

The financial markets have pounded Portugal in recent weeks, driving up the price of government borrowing amid speculation that Lisbon stands next in line after Athens for a possible bailout.

Such assessments are a source of widespread resentment here. Officials, experts and ordinary residents have joined together in an adamantly non-Greek chorus whose constant refrain, to anyone willing to listen, is, “We’re not Greece.”

Portugal’s deficit, though worrisomely high at 9.4% of gross domestic product, is far less than Greece’s 13.6%. So is the proportion of public debt. Although Athens has played fast and loose with its figures, Lisbon has not been accused of the same level of prevarication.

Portugal can also lay claim to stronger attempts at greater fiscal responsibility; a few years ago it even succeeded in slashing the deficit to less than 3%, as expected for countries that use the euro. The government has made modest changes in pension and retirement policies, trimmed its personnel rolls and eased some labor restrictions.

And unlike its Iberian neighbor, Spain, at which the markets also look askance, Portugal hasn’t had to contend with the collapse of a massive real estate bubble. Its banks acted more conservatively in issuing property loans.

But problems remain with Portugal’s competitiveness, especially after the adoption of the euro in 1999, and high levels of private debt. Despite its region-beating rate of growth in the first three months of this year, the Portuguese economy has struggled over the last decade to keep expanding.

The government’s new austerity package aims to halve the budget deficit in less than two years through cuts in public sector salaries, in services such as education, and increases in corporate, income and sales taxes.

Critics and even supporters of the plan warn that many Portuguese will feel its effects sharply, people for whom such changes can mean meals forgone, savings depleted, schoolbooks left unpurchased. Reflecting a growing pessimism, official figures released Friday showed consumer confidence falling to its lowest level since July.

“It’s a pretty brutal package,” said Luis Campos e Cunha, a former finance minister who teaches at the New University of Lisbon. “Everyone is going to suffer quite a bit with these austerity measures.”

The fear is that such steps could cause a downward spiral in which the economy contracts, public debt rises as a percentage of GDP, tax revenue shrinks, markets get even more alarmed, additional austerity measures are required and so on.

A likely slowdown in domestic demand is bad news for Lisbon car dealer Rui Pereira.

The automotive sector posted a comeback this year, with sales of light vehicles up by a third in March compared with the same month last year. But Pereira fears that those gains are being put at risk by the austerity package.

“The right thing is to stimulate consumption, and we’re not doing this, which will cause problems,” Pereira said.

Like 97% of companies in Portugal, Pereira’s firm has fewer than 50 employees. Although some small and medium-sized enterprises are nimbler and more flexible than big companies, many lack cushions for bad falls in the economy and could be hard hit by a double-dip recession.

Here in Estremoz in the scenic Alentejo region, sometimes called the Bordeaux of Portugal, Ramos, the winemaker, sees dark clouds on the horizon, and not just from the thundershowers that drench his thirsty green vineyards.

Ramos said he expected several small winemakers to go out of business if the economy tightened yet again. His family-run company, which produced 4.8 million bottles of wine and had revenue of about $18 million last year, sought to make up for idling domestic demand by cultivating foreign clients. He also saw buying habits shift in domestic sales as pocketbooks shrank.

Sales of his “entry-level wine,” Loios, are now gaining on his higher-quality, signature label, Marques de Borba.

“The premium wines are more difficult to sell,” Ramos said. “These are the natural signs of recession.”

Despite an expected rise in July of 1 percentage point in value-added tax on wine, part of the government’s austerity plan, Ramos plans to keep his prices steady and absorb the loss.

He still predicts that his business will grow this year, with a trio of new medium-priced and premium wines coming on line, but he echoes a widely heard criticism in Portugal: the government waited too long to get its books in order, which worsened the crisis.

Campos e Cunha, the former finance minister, says that if belt-tightening measures had been introduced six months ago, before investor worries skyrocketed, the package probably would have been much less harsh.

The question now is not just whether Portugal’s austerity plan can soothe the markets but how negative its effect will be on the country’s economic growth.

“Europe was too laid back last year. Maybe now they are too stringent,” said Assuncao of Catholic University. “Given the current constraints, are the macroeconomic policies now being implemented in the Eurozone the best? It’s really unclear.”

henry.chu@latimes.com

Special correspondent Simone Cunha contributed to this report.