Portugal Throws New Curve Ball in Euro Debt Crisis

Tuesday, 2 Jul 2013 | 3:37 PM ET
Portuguese Foreign Minister Paulo Portas
LEO RAMIREZ | AFP | Getty Images
Portuguese Foreign Minister Paulo Portas

Portugal faced a full-blown crisis on Tuesday after Foreign Minister Paulo Portas became the second minister to resign from the center-right government in a 24-hour period.

Portugal's Prime Minister Pedro Passos Coelho, speaking live on TV to the nation on Tuesday night said he had not accepted Portas' resignation and would speak to his coalition partner.

The leader of the opposition Socialist party speaking to the nation on TV on Tuesday night called for fresh elections and said the government had lost the confidence of the people.

Portugal's finance minister, Vitor Gaspar, who has implemented unpopular austerity measures as part of a 78 billion euro ($101 billion) EU-IMF bailout, stepped down on Monday.

The resignation of Gaspar raised hopes the government would shift away from its austerity program. But he was promptly replaced by Maria Luís Albuquerque, the country's treasury secretary.

The resignation of Portas is a major risk to the future of the government because he leads the CDS-PP, the junior partner in the two-party governing coalition. If his party pulls out from the government, Passos Coelho's Social Democrats would become a minority in the parliament.

"This is the clearest indication yet that the rapidly souring politics of economic reform in Portugal are undermining the credibility of the country's bailout program," Nicholas Spiro, managing director of Spiro Sovereign Strategy said on Tuesday. "Politically speaking, Portugal's adjustment program is collapsing."

Will Bond Yields Rise in the Periphery?
Holger Schmieding, chief economist at Berenberg Bank, explains that despite increased tension in peripheral Europe, he is not too worried about bond yields rising.

According to Spiro, Portugal is likely to face early elections. That's a prospect that will make investors particularly jittery, given the context of Greece, where anger over austerity led to a humiliating electoral defeat for both the Socialists and the center-right New Democracy Party in May last year.

That led to months of turmoil and a sharp escalation in the euro zone debt crisis.

"Make no mistake about it, this is the gravest setback to Portugal's two-year-old bailout program—and there have been quite a few of them over the past several months, including legal ones," Spiro said.

According to Alex White, an economist JPMorgan, while the risks have been heightened, fresh elections aren't a foregone conclusion.

"At this stage it is still too early to tell how things will play out. These moves may prove to be about no more than tactical positioning, designed to highlight concerns about Albuquerque, the new finance minister, and to provide more leverage in a new cabinet," White wrote in a note to investors.

Things are likely to become clearer on Wednesday when the opposition Socialists have requested a meeting with Portugal's president.

—By CNBC's Deepanshu Bagchee. @DeepBagchee

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