EU wants pre-election bailout deal for Portugal

By Krisztina Than and Sakari Suoninen

GODOLLA, Hungary (Reuters) – Euro zone ministers said Portugal must make deeper budget cuts and privatize state firms in return for an 80 billion euro bailout the bloc wants to finalize by mid-May, just weeks before an election and state funding crunch.

Portugal bowed to pressure from financial markets and its European partners this week and became the third euro zone country after Greece and Ireland to request financial help from the European Union and the International Monetary Fund.

Finance ministers from the 17-nation single currency area met at a palace north of Budapest on Friday to discuss the details and timeline of a rescue, which has been complicated by political turmoil in the Iberian nation of 10.5 million.

Portuguese Prime Minister Jose Socrates resigned abruptly last month after parliament rejected a new round of budget austerity his minority Socialist government had proposed to help the country meet its deficit reduction targets.

He is continuing to serve in a caretaker capacity until new elections are held on June 5. The main opposition party has backed his request for aid, but negotiations on an economic adjustment program — a precondition for assistance — are likely to be tough as cross-party consensus will be needed.

“The preparations will start immediately to reach a cross-party agreement ensuring that an adjustment program can be adopted by mid-May and implemented swiftly after the formation of a new government,” European finance ministers said in a statement.

They said the program would be based on three pillars: an “ambitious” fiscal adjustment to restore financial sustainability; growth and competitiveness enhancing reforms including a far-reaching privatization program; and measures to maintain the liquidity and solvency of the financial sector.

Inflexible labor laws, red tape in business administration and high wages and production costs compared to Eastern Europe and East Asia have undermined Portugal’s competitiveness.

The country has posted meager growth, with an average annual expansion in gross domestic product (GDP) of less than 1 percent over the past decade, according to data from the IMF and the World Bank.

RISKS FOR SPAIN

Officials did their best to play down concerns that the contagion that has spread across the bloc’s southern periphery could now hit Portugal’s larger neighbor Spain, which has scrambled to reform its labor market, pension system and savings banks this year to avoid a similar fate.

For now markets appear to be confident Spain can avoid becoming the fourth euro zone domino to fall.

The spreads between Spanish bond yields and those of German benchmarks — a key measure of investor confidence in Spain’s finances — were hovering below 1.8 percent on Friday, their lowest levels in five months.

Spain’s benchmark stock index has climbed 6 percent in the past three weeks.

And in a sign of broader confidence in the euro zone, the single currency pushed up to a 15-month high against the dollar on Friday after the European Central Bank raised interest rates by 25 basis points — the first hike since July 2008.

ECB President Jean-Claude Trichet, who also attended the meeting in Hungary, declined to comment on the euro’s strength, which along with higher rates could undermine the economies of weak euro zone countries struggling under huge debt piles.

Because of these risks, investors are continuing to scrutinize Spain, which has a host of weaknesses — from high unemployment and weak growth to a troubled banking sector hit by the bursting of a property bubble.

“It has been clear for a long time that the current stage of the crisis is a severe combination of sovereign debt and banking sector fragilities and you cannot solve one without solving the other,” said European Economic and Monetary Affairs Commissioner Olli Rehn at the end of the meeting.

“The next round of bank stress tests is decisive,” he said, referring to tests being run on 90 European banks to gauge their ability to withstand financial shocks. The results will be published in June.

“STARTING POINT”

Ministers said the measures rejected by the Portuguese parliament last month would be a “starting point” for talks on a fiscal adjustment program.

Rehn told reporters that European officials were confident Lisbon could manage the country’s funding needs this month and next, but that June, when some 4.9 billion euros in bond redemptions are due, would be “more challenging.”

Officials said it would take 10 days to ensure financing once the bailout deal was in place, most likely by a meeting of euro zone finance ministers on May 16.

The European Commission estimates Lisbon will require about 80 billion euros in aid, roughly the same amount as Ireland but less than the 110 billion euro package offered to Greece nearly one year ago. Two thirds of the total would come from European countries and the remaining third from the IMF.

Ministers also discussed Greece, reminding Athens of the importance of sticking to its public deficit targets amid reports it could fall short for 2010.

Speculation has grown in recent weeks that Athens may have to restructure a debt load that will to peak at over 150 percent of GDP, with senior government officials in the euro zone conceding in private that such a step may be inevitable.

But the Greek government and leaders of other euro members have rejected that talk.

(Additional reporting by Jan Strupczewski, Sakari Suoninen, Gergely Szakacs, Ilona Wissenbach, Thomas Leigh, and Francesca Landini)

(Writing by Noah Barkin)

EU wants pre-election bailout deal for Portugal