Europe Worries Portugal Is Prone to a Debt-Crisis Relapse

LISBON – With his company’s pottery selling briskly, Joaquim Beato, president of Molde Faianças SA, said ideally he would plow some of the profit into research and new-product development. Instead the company won’t spend a single euro.


Mr. Beato said he worries the Portuguese company’s sales in Europe will slacken as economies across the continent slow and import less. He is also concerned about obstacles at home – uncertainty over the Socialist government’s policies and the difficulty of borrowing from a banking system burdened by bad loans.


“Between investing and not investing, it is just safer not to invest,” said Mr. Beato, who employs about 100 people. “My mood right now is ‘Let’s go easy.’ ”


Portugal’s souring investment climate and weak economic growth are raising concern across Europe and beyond that the country, which required an international bailout five years ago, could choke again on a debt that is now nearly 130% of its gross domestic product.


The International Monetary Fund warned in September that while the debt is manageable for now, risks to Portugal’s capacity to repay are rising, leaving the country “uniquely vulnerable to shifts in market sentiment.”


A Portuguese relapse would deal a blow to the morale of a European Union already reeling from sluggish growth, populist politics and Britain’s decision to leave the bloc. It would show just how far Europe is from overcoming the hangover from the debt crisis that early in this decade challenged the euro currency’s survival.


In Germany, the eurozone’s dominant country, officials worry that Portugal’s loosening of its fiscal policies over the past year has raised the risk of a new crisis and the need for another bailout program.


“Portugal is making a major mistake if they no longer stick to what they have committed to,” German Finance Minister Wolfgang Schäuble said in late June, “They will have to request a new program. And they will get it.”


Mr. Schäuble’s tough talk reflected his longstanding view that Southern European debtor countries such as Portugal and Greece need to take the medicine of fiscal rigor and economic overhauls if they want to leave the crisis era behind them.


His comment stirred anger in Portugal, where Prime Minister António Costa brushed aside concerns of a debt default.


Still, talk persists of a possible new debt crisis here, and its likely fallout for Europe.


“A bailout request for Portugal, while unlikely to have the spillover effects to other countries we saw in 2011, would again raise questions about the future of the eurozone and would likely make the political climate in Europe even more hostile,” said David Schnautz, a strategist at Frankfurt-based Commerzbank.


Recent indicators show Portugal’s economy struggling more than expected. On Friday, the central bank forecast a 1.8% decline this year in gross fixed capital formation, a measure of public and private investment in the country. The economy is growing at an annual rate of 0.9%, half what the government estimated for this year, as consumption and exports register only modest growth.


While other European economies are also struggling, ratings firms have singled out Portugal’s low growth and high public and private debt as a toxic combination.


Remedies applied under the country’s €78 billion ($87.6 billion) bailout program now look insufficient. Starting in 2011, a center-right government raised taxes, cut spending and overhauled the labor market in an effort to reduce the budget deficit and encourage hiring. Unlike troubled eurozone peer Greece, Portugal left the bailout program, in 2014.


But the appetite for change waned last year as elections approached. Promises to make the public sector leaner and more efficient were scrapped. The IMF and the European Commission, Portugal’s bailout lenders, said the government failed to tackle a high private-sector debt that limited investment and growth.


Mr. Costa’s Socialist government, which came to office in November with the support of three far-left parties, quickly reversed cuts in public-employee salaries. It has also raised the minimum wage and begun to eliminate a special tax on income. The retreat from austerity was meant to spur consumption and boost the economy.


That hasn’t happened. Consumption rose 1.7% on year in the second quarter compared with 2.6% in the first and a 2.4% forecast for 2016, Portugal’s statistics agency said. Families are slowing their consumption of durable and nondurable goods.


The IMF said the policy reversals “generated uncertainty that appears to be a significant factor behind the slowdown in investment.”


Paulo Vaz, president of the Textile and Clothing Association of Portugal, said the new policies are hurting productivity as well. A decision to reinstate four public holidays that the previous government had abolished, for example, is costing textile companies €150 million a year, he said.


Finance Minister Mario Centeno said the government is planning a series of business-friendly measures, including tax breaks for those who invest. He said a decline in the unemployment rate, to 11.1% in July from 12.3% a year earlier, shows the government’s policies are working and will lead to stronger growth.


Economists and investors aren’t convinced, and point to a rise in Portugal’s borrowing costs. Yields on Portuguese bonds have risen over the past year while those of eurozone peers except Greece have fallen.


Patricia Kowsmann covers the euro-zone crisis for The Wall Street Journal and Dow Jones from Portugal. Marcus Walker in Berlin contributed to this article.