Anyone who thinks that Europe's sovereign debt crisis has been resolved should take a closer look at Portugal. The country's increased signs of political dysfunctionality, coupled with its extraordinarily high debt levels, suggest that it is only a matter of time before the markets turns their attention to Portugal's shaky political and economic fundamentals.
In the wake of Portugal's recent election, the country is now almost certain to suffer from a prolonged period of political uncertainty. António Costa's Socialist Party has made it clear that it will not cooperate with the minority Portugal Froward Party government that Prime Minister Pedro Passos Coelho has been allowed to form. Under Portugal's constitution, new elections may not be held before June 2016. This almost certainly means that the country now faces at least nine months of policy paralysis. It also means that the country could very well have to operate without a budget over the next year.
Policy paralysis is clearly not a good prospect for any country. However, it is a particularly poor prospect for a country like Portugal, which has an extraordinarily high debt level at a time when its economy displays little dynamism and is now flirting with price deflation. Of particular note is the fact that five years after the start of the European sovereign debt crisis, Portugal's public debt to gross domestic product (GDP) ratio exceeds 125 percent. More disturbing yet, its cumulative public and private debt ratio stands at around 370 percent of GDP, or around the highest level in Europe, while the country's gross external debt well exceeds 200 percent of GDP.
Portugal is presently benefiting from the fact that the European Central Bank's (ECB) aggressive round of bond buying under its quantitative easing program is lulling the markets into a false sense of security about the relative safety of European debt instruments. Especially at a time that the global economy appears to be slowing, one has to hope that the ECB's bond buying is not also lulling Portuguese policymakers into a similar false sense of security.
With the Federal Reserve poised to raise interest rates next year, it would be a grave mistake for Portuguese policymakers to premise their policies on the assumption that global liquidity conditions will stay benign forever. And if Portugal does not soon adopt policies to galvanize its economy and to reduce its major debt mountain, it risks becoming Europe's second Greece when global liquidity conditions start to turn and when markets raise serious questions anew about Portugal's debt sustainability.
Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney