Germany Urges Portugal to Stay on Austerity Path after Court Rules Against Coelho

Germany's finance minister has urged Portugal to re-examine its austerity programme and find savings elsewhere after the country's highest struck said nearly half of the governments intended cuts were unconstitutional.

Wolfgang Schaeuble told a German radio programme Monday that the Constitutional Court's decision late last week to reject government plans to cut civil service salaries, limit unemployment benefits and reduce holiday bonuses for pensioners should not sway Prime Minister Pedro Passos Coelho from his austerity programme and put the country's €78bn bailout in jeopardy.

"Portugal has made lots of progress in the last year to gain access to financial markets. But after this (court decision) it will have to find new measures," he said.

The Court's decision, announced late Friday, will likely delay the release of around €2bn in aid from the so-called Troika of lenders which includes the European Union, the International Monetary Fund and the European Central Bank. The funds had been due for release following the seventh review of Portugal's bailout.

Coelho said Sunday that he had instructed his ministers to find other savings through spending cuts that would compensate for the estimated €1.3bn in savings that were ruled out by the Court, but insisted that "the government does not accept more tax increases, which seems to be the solution that the Constitutional Court favours in its interpretation."

Portugal's benchmark government bond yield rose 11 basis points to trade at 6.52 percent, the highest since early January. On 28 March, Moody's Investors Service affirmed its Ba3 rating - which is two notches below investment grade - and kept its negative outlook, citing "very high debt levels and subdued growth prospects."

"The primary driver underpinning Moody's decision to affirm Portugal's Ba3 rating is the Portuguese government's comprehensive response to the economy's structural weaknesses, most notably institutional reform in the public sector, the tax system and the labour and product markets, within the context of its EU/IMF economic adjustment programme," Moody's wrote.

"The Constitutional Court decision also comes at a particularly delicate time as Portugal was expecting this week a favourable decision by its European peers (at the Eurogroup/Ecofin meetings) on lengthening the maturity of the programme loans, thereby easing the return of Portugal to the markets, which the government and troika had hoped for by the end of this year," said Barclays analyst Antoni Garcia Pascual. "In our view it will be difficult for the government to fully compensate in 2013 for the measures lost by the Court decisions ."