A potential political crisis in Portugal that would worsen the country's debt woes is looming larger as the minority Socialist government and the centre-right opposition engage in a game of chicken over the 2011 budget.
The risks of such an outcome have risen as the opposition Social Democrats (PSD) decline to say whether they will give the unpopular government the support it needs to pass the budget, due to be presented to parliament on Friday.
If the budget fails, it could plunge the country into months of uncertainty under a caretaker administration unable to take decisive action to curb the public deficit, alarming financial markets which see Portugal as a weak link in the euro zone.
Analysts have begun to doubt whether there will be a deal since the government announced last month that austerity measures will include higher taxes - something the PSD has consistenly opposed.
"We have never been as close to a political crisis in terms of having a budget rejected," said Marina Costa Lobo, a political analyst at the University of Lisbon.
Prime minister Jose Socrates has said he would resign if the budget is not passed - a step which would almost certainly trigger sharp selling of Portuguese bonds as investors doubt the country's ability to fix its deepening sovereign debt crisis.
The premium investors charge for holding Portuguese debt rather than benchmark German bonds hit euro lifetime high at the end of September on concerns over the large budget deficit. The spread eased slightly after the latest austerity promises but stood at 405 basis points today, meaning Lisbon must pay 4 percentage points more than Berlin to borrow on capital markets.
A crisis would be complicated by the fact that under Portuguese law, the earliest a parliamentary election could be held is next May, because the country will elect a new president on January 23rd - drawing out the uncertainty.
So if the budget fails, there could be a caretaker government, with limited powers, for several months.
"We wouldn't have a proper government and it wouldn't have the political ability to discuss a bailout with the EU and IMF," said Viriato Soromenho Marques, a political commentator. "This would turn the Portuguese situation worse than the Greek one, which is really frightening."
Greece received a bailout from the European Union and International Monetary Union in May but it had a majority Socialist government able to commit to and enact the austerity measures required to receive emergency loans.
Although Portugal's debt, at 83.5 per cent, is a far smaller proportion of its economic output than Greece's at 132 per cent this year, persistent budget deficits, dwindling revenues and a loss of economic competitiveness have raised doubts about the sustainability of its public finances.
At the very least, uncertainty will continue until October 29th, when parliament is due to vote on the budget. In the meantime, the legislation will go through parliamentary committees where the PSD will doubtless want to make its mark.
Even if a compromise is found this time, analysts say it offers no long-term solution as the minority government remains dependent on the opposition. The PSD also backed government austerity moves in May.
Reuters