Portugal will raise taxes and cut wages of top public servants, it said on Thursday, following on the heels of similar austerity moves in Spain and a $1 trillion European safety net meant to reassure rattled credit markets.
Portugal now plans to cut its 2011 fiscal gap by two percentage points from its earlier target to 4.6 percent of GDP, worth about 2 billion euros according to a source.
Prime Minister Jose Socrates said Portugal would impose extraordinary income taxes of up to 1.5 percent, hike value-added tax by 1 percentage point to 21 percent and raise a 2.5 percent tax on large companies' profits.
The government will also cut the salaries of top-level public sector workers and politicians by 5 percent in an effort to cut the 2010 budget deficit to 7.3 percent of GDP, lower than the 8.3 percent target, or 14 billion euros, budgeted for 2010.
The measures will be in force until the end of 2011. (For a FACTBOX on measures, see: )
"I ask all my compatriots for us to make this effort to defend the country, to defend the euro and Europe," Socrates, a Socialist, told a news briefing following a cabinet meeting to approve the measures, which were agreed with the opposition PSD party in order to secure support for the moves in parliament.
Pedro Passos Coelho, the leader of the largest opposition party, the centre-right Social Democrats (PSD) said his party will support the strategy in parliament.
"What we are committing ourselves to is to stabilise the economic situation and to give our vote so that the measures that were approved today at the cabinet meeting are approved in parliament," he told reporters.
He added that it was important that the announced tax hikes were temporary, but spending cuts will be permanent and said his party would closely monitor the government's execution of the programme in the public sector.
The Socialists need the support of the opposition to pass bills in parliament. Together, the two parties have more than two-thirds of parliament seats. The Socialists can pass any bill even with PSD's abstention.
LESS VOLATILE
Portugal's moves topped a dramatic week for the euro zone, starting with a $1 trillion package announced by the European Union and the International Monetary Fund to prop up weaker euro zone states.
The Portuguese government has said it does not need to resort to the lending mechanism.
On Wednesday, Spain announced 15 billion euros worth of cuts, including a 5-percent wage cut for most public employees, and a 15-percent cut for higher paid workers.
Diego Iscaro, an economist at IHS Global Insight in London, said the measures "should help to restore markets' confidence in Portugal's ability to deal with its deteriorating public finances", but added that higher taxes had a sting in the tail.
"The risk I see is that these austerity measures will weigh on economic activity – which was seen as sluggish anyway – thus making fiscal consolidation more difficult."
Giada Giani, an economist at Citi, said in a research note that "the overall fiscal effort is now quite large, although still well below that of Greece or Ireland".
But she added: "Additional fiscal consolidation is likely to become necessary in the next few years and we reckon the country risk premium is likely to remain elevated."
Debt-stricken Greece has also had to implement severe additional austerity measures after resorting to a 110 billion euro bailout package from the European Union and the International Monetary Fund earlier in May.
Unlike Greece, where the measures have been met with often violent protests, analysts say Portugal is less prone to social unrest and expect the measures to stir less trouble.
"There will be some social polarisation … But the levels of social conflict in Portugal are relatively low," said political scientist Antonio Costa Pinto.
The UGT umbrella union, Portugal's second-biggest, issued a statement on Thursday saying the measures "worsen the social situation, growth and employment", but stopped short of vowing any concrete protests.
Portuguese bond spreads were calm on Thursday at around 175 basis points over German bunds, but less than half last Friday's levels, which then hit euro lifetime record on market jitters about peripheral euro zone countries' creditworthiness.
