Portugal follows Greece down austerity path

Portugal became the latest eurozone country to announce austerity measures to rein in a ballooning budget deficit yesterday as debt-stricken Greece urged global action to curb speculation in credit default swaps.

The European Commission said it was prepared to propose the creation of an IMF-style European Monetary Fund to cope with future debt crises in the euro single currency zone.

German Chancellor Angela Merkel said she favoured the idea, which she said would require a change in the EU treaty, but the European Central Bank's chief economist branded it illegal.

EU sources said finance ministers of the 27-nation bloc would discuss ways to dampen speculation in the sovereign CDS market at their next meeting on March 16.

Hedge funds have been accused of aggravating the Greek debt crisis by so-called "naked short selling" - betting on a default without owning the underlying Greek bonds, hence forcing up Athens's borrowing costs.

Greek Prime Minister George Papandreou, who took draconian austerity measures last week to stem attacks on his country's debt, called credit default swaps a "scourge" that threatened the Greek and global economy and asked the US to join Europe in action on the issue.

Portugal announced plans to cut its deficit to 2.8 per cent of gross domestic product in 2013 from 8.3 per cent this year by trimming spending on civil servants and public investment, and raising taxes on high incomes and stock market gains.

The programme is seen as the key to convincing markets that Portugal will tackle its high deficit and debt after coming under scrutiny by investors fearing it may be next in line to have Greek-style fiscal problems.

Under the plan, Portugal's public debt would peak at 90.1 per cent of GDP in 2012 and fall thereafter. Greece's debt is set to reach 125 per cent of GDP this year.

"This is a bet on reducing the weight of the state in the economy and the weight of public spending," Portuguese Finance Minister Fernandio Teixeira dos Santos said.

Borrowing costs of the peripheral eurozone countries and the price of insuring their debt against default both fell after French President Nicolas Sarkozy gave the clearest indication so far that firm plans to help Greece were ready if needed.

The premium investors charge to hold Greek debt rather than German benchmark bonds has risen as high as 400 basis points this year, prompting Athens to announce its third and most draconian package of public sector pay cuts, a pensions freeze and sales tax rises last week.

Analysts said the Portuguese stability programme was more cautious than Greece's in its growth and revenue assumptions, but extra measures might still be required if growth fell short.

Portugal's spread over benchmark 10-year German bonds stood at 109 basis points yesterday, down from a peak of 175 bps on February 4 at the height of the market panic over Greece. Spain's spread was down to 67 bps, the lowest since mid-January.