As Europe left struggles, Portugal's alliance wins over voters and Brussels

LISBON (Reuters) - While the European left is largely struggling where it holds power, Portugal's government alliance stands out as a remarkable exception; it is raising wages and gaining popularity and yet delivering the lowest budget deficit in living memory.

The unlikely alliance of center-left Socialists and two far-left parties has overcome deep scepticism since it was formed in 2015, achieving stability and maintaining economic recovery at a time of political uncertainty across Europe.

Even President Marcelo Rebelo de Sousa, a conservative, acknowledges its running of a country that left an international bailout program only in 2014. "I have been surprised," he said in February. "Frankly, I didn't think it would be as resilient as it has shown itself to be in the past year."

The government is a minority Socialist administration rather than a coalition, with the party filling all ministerial posts. However, it relies on support from the Communists and Left Bloc for its parliamentary majority, breaking a taboo that had kept the far left out of power since the 1974 return of democracy.

Portuguese are warming to the government as it unwinds some austerity polices imposed under the bailout, although this comes at the cost of heavy cuts to longer-term public works spending.

Prime Minister Antonio Costa has acknowledged the balancing act. "Budgets can't be managed with miracles, they are managed with rigor, hard work and careful management," he said.

Voters' trust in the alliance has more than doubled - albeit from a low level - and the Socialists, who were in power when Portugal had to seek the 2011 bailout, are benefiting most.

Polls put support for Costa's Socialists at 42 percent, up 10 points from their share of the vote in the 2015 election and close to a level that would give them a majority in parliament were the country to vote again.

Most European governments of the left can only dream of such ratings. In France, polls have put the candidate of the ruling Socialists, Benoit Hamon, in fifth place for the first round of presidential elections in May with support around 10 percent.

In Italy, Prime Minister Paolo Gentiloni's party is around five points adrift of the anti-establishment 5-Star movement, while Greece's ruling Syriza party lags conservatives by twice that.

Portugal's experience may be of interest in Germany, where the Social Democrats are exploring options for a coalition after elections in September. Along with the Greens, they have sounded out the leftist Linke party, shunned so far at a national level due to its origins in the defunct East German communist party. 

THE CONTRAPTION

Today, some Portuguese fondly refer to the alliance as 'geringonca', or 'the contraption'. But in 2015 the far-left's inclusion raised fears on financial markets that fiscal policy would go off the rails, reversing tough reforms and budget cuts during the 2011-2014 bailout by the European Union and IMF.

To win support from the Communists and Left Bloc, Costa agreed to increase workers' pay in western Europe's poorest country. Last year, the government already raised the minimum monthly wage to 530 euros ($570) from 505 euros a year earlier. It will continue rising till it reaches 600 euros in 2019, the last year of the government's current term.

State sector salaries and pensions are also being increased in stages, while the alliance is slowing a privatization drive pursued by the previous center-right government.

Despite this generosity, the alliance succeeded in lowering the deficit. It fell last year to 2.1 percent of gross domestic product - lower even than a target agreed with Brussels - from 4.4 percent in 2015. The National Statistics Institute forecasts it will drop again to 1.6 percent this year.

The European Commission has expressed optimism that Portugal can soon exit an EU excessive deficit procedure imposed after it breached the bloc's budget rules.

Three years of economic growth have boosted revenue. While the rate remains modest - the Bank of Portugal forecasts it will reach 1.8 percent this year, thanks to rising investment and exports - it compares with a four percent contraction in 2012.

Unemployment has also dropped from a peak of 17.5 percent in 2013 to 10.5 percent in the last quarter of 2016, while a crackdown on tax evasion has likewise increased state income.

Nevertheless, the popular public pay increases have not been funded entirely by higher revenue, with the budget savings also demanding spending cuts. Much of the burden has fallen where voters may not notice the effect immediately: public investment. The government slashed this by 16.5 percent last year, to just 1.8 percent of GDP, the lowest proportion since 1960.

AECOPS, the main construction industry association, warns against the danger of false savings. "Through drastic cuts in public investment to reduce the deficit, the government has contributed decisively to the degradation to construction activity and prevented the recovery of the sector," AECOPS chief Ricardo Pedrosa Gomes told Reuters.

Economists have also expressed concern about any further cuts to state spending on the likes of hospitals and schools.

In Greece - which unlike Portugal is still in a bailout program after seven years - the IMF has warned that decaying infrastructure is hampering growth while basic public services such as transport and health care are being compromised.

Costa has promised to raise public works spending this year by 20 percent. "It's necessary to invest more, but with prudence in order not to upset the balance of our public accounts," he said in a recent speech.

TENDING TO TRUST

Portugal has another problem, a debt burden that at 130 percent of GDP is proportionately the third biggest in Europe after Greece and Italy. The EU is pressing for this to be cut.

Still, voters are willing to credit the alliance. In the EU's latest Eurobarometer survey, the number of Portuguese who "tend to trust" their government jumped to 39 percent in late 2016 from just 15 percent at the time of the 2015 election.

Support for the Communists and Left Bloc has slipped since the election when they won 8.25 and 10.2 percent respectively. But the Socialists are now just about the most popular mainstream center-left party in western Europe. Their gains have come at the expense of the center-right Social Democrats who ruled from 2011 to 2015 and emerged the biggest party in the last elections, only to be outflanked by the alliance.

Centrist voters - who doubted in 2015 the alliance could tame the excessive spending that many blame for Portugal's debt crisis - appear to be regaining confidence in the Socialists.

All broad policy elements, including budgets and the pace of social policies like raising the minimum wage, were agreed by the alliance before the election. 

Costa's job in achieving internal harmony may also have been made by easier by the fact that the far left is represented by two parties competing for votes. "The Socialists prefer to negotiate with both of them, in other words creating a dynamic of rivalry between the two smaller parties that helps to moderate them," said political analyst Marina Costa Lobo.

Likewise, the lack of a formal coalition also helps by allowing all three parties to maintain their own identities. That means the Left Bloc and Communists can continue to push for a renegotiation of Portugal's debts, even though this is not included in the agreement with the Socialists, thereby posing no threat to the government's efforts to control the budget.

There are risks, not least if the euro zone debt crisis were to reignite, but it's a case of so far, so good. "In principle, the longer this continues, especially for the electorate on the left, showing positive results in economic terms, the better," said political analyst Antonio Costa Pinto.

(editing by David Stamp)