Portugal Budget Crisis Flares Up

By JEFFREY T. LEWIS And BERND RADOWITZ

LISBON—After Portugal's main opposition broke off budget talks, Finance Minister Fernando Teixeira dos Santo said Portugal's credibility with its lenders will be undermined if no agreement is reached on the key austerity budget.

Markets were reacting nervously to the flaring-up of the Portuguese budget crisis. The yield spread between Portuguese 10-year benchmark bonds and similar German bunds Wednesday widened to 3.287 percentage points from 3.175 percentage points Tuesday.

"The budget has to restore confidence," Mr. Teixeira dos Santos said. He added that it would be impossible to simultaneously meet the government's budget-deficit goals and the opposition's demands. The finance minister warned that if the budget isn't passed, "the country will find itself in a serious situation with grave economic effects."

The government needs the approval, or at least abstention of the main opposition party, the Social Democrats, to get the budget approved. Portugal's parliament has until the end of November to vote on the budget.

Portugal is hoping to avoid the fate of Greece, which received a multibillion-euro bailout from the European Union and International Monetary Fund earlier this year. The PSD walked away from budget talks Wednesday after it and the government disagreed mainly over tax increases. The government's budget proposal contains a mixture of spending cuts and tax increases, among them an increase in value added tax to 23% from 21% next year. The PSD rejected most tax increases proposed by the government and instead wants to reduce the budget deficit with more drastic spending cuts.

Portuguese Prime Minister José Sócrates in late September proposed a series of harsh austerity measures for this year and next, aimed at cutting Portugal's budget deficit from 9.3% of gross domestic product in 2009 to 7.3% this year and 4.6% in 2011. The goal is to reduce the spending gap to 2.8% of GDP in 2013.

Mr. Teixeira dos Santos said the PSD had made various proposals to amend the government's budget, but failed to explain how next year's deficit target could still be reached.

"I won't accept any solution that moves us away from the 4.6% goal," he said. Any softening in Portugal's determination to cut the deficit, "would only make an already delicate situation in financial markets significantly worse," he said, accusing the PSD of having little concern about meeting the target after its party leader had suggested perhaps it would be better to give up on the 2011 goal and accept a higher deficit.

Portugal's President Aníbal Cavaco Silva has called a meeting of Portugal's Conselho de Estado, or State Council, for Friday to discuss the budget situation. The Conselho de Estado is an advisory board to the president that includes the prime minister, former presidents and prime ministers and other prominent people from the different branches of government.

Write to Bernd Radowitz at bernd.radowitz@dowjones.com