BARCLAYS: Portugal has 3 big problems

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Portugal isn't out of the woods yet.

Despite avoiding fines from the European Commission for failing to meet EU sanctioned deficit reduction targets in the past couple of years, the country faces several problems, according to new research from analysts at Barclays.

On Wednesday, the both Spain and Portugal were given extended deadlines for adjusting their budget deficits, and sidestepped what would have been historic fines from Brussels. The EU has never fined any nation directly for breaking the rules when it comes to budgets.

Spain will now have until 2018 to exit its excessive deficit, while Portugal which is in a worse financial state, has until the end of this year.

"Spain and Portugal have come a long way. The two countries experienced severe economic and financial crises," said EU Commission Vice-President Valdis Dombrovskis. "They have managed to restore financial stability thanks to major fiscal adjustment. And they have turned their economies around through structural reforms to regain competitiveness. These efforts should not be underestimated."

Despite those efforts, both countries are still staring down the barrel when it comes to their fiscal problems, with Portugal in particular turmoil, according to Barclays analyst Apolline Menut, who suggests that "the fiscal effort asked of Spain in manageable," despite the country's ongoing lack of a functioning government under acting prime minister Mariano Rajoy.

Portugal on the other hand, will face serious problems in exiting its excessive deficit, which could make the nation's persistent economic problems even more troublesome. Barclays highlights three key issues that are likely to hinder Portugal's attempts to get its deficit down and avoid a massive fine from the Commission at a later date (all emphasis ours):

1. "First, the European Commission calculations are based on its spring economic forecasts, which project Portuguese growth at 1.5% in 2016, vs. our expectations of 0.7% (Banco de Portugal:1.3%; IMF:1.0%). We see a significant slowdown in 2016 amid a weaker global economic environment and elevated domestic and external uncertainty, which should adversely affect fiscal performance."

2. "Second, we expect that further bank recapitalization needs for state-owned Caixa Geral de Depositos of c. EUR5bn, and for the largest privately-owned bank BCP of c.EUR 2.5bn over 2016-2017 will weigh heavily on the fiscal balance."

3. "Finally, we also believe that the political outlook remains challenging. The radical parties supporting the Socialist-led government will have to confront difficult choices on fiscal policies and bank recapitalization, and the 2017 budget to be submitted to Brussels by mid-October will likely result in lively discussions in the Portuguese parliament. The government does have a (thin) absolute majority in parliament thanks to the support of the Left Bloc and the Communist Party, but there is a non-negligible chance that some of their MPs could oppose some of the fiscal adjustment that the European Commission is demanding (0.25% of GDP of additional fiscal consolidation measures in 2016)."

Add a big fine from the Commission onto all of Portugal's pre-existing problems, and things could get ugly, fast.

Portugal's problems might not be as bad as the post-Brexit recession facing the UK, or the banking crisis in Italy, just yet, but the country is facing an uphill battle. What happens next is likely to be crucial.

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