The political price of austerity

European and US sharemarkets slumped overnight as investors fretted that the European Union/IMF bailout of Ireland had ignited a major political backlash. Irish Prime Minister Brian Cowen said overnight he would call for the dissolution of parliament in the new year, after a crucial budget vote in early December.

There are fears that the Fianna Fil-led government of Brian Cowen may not be able to muster sufficient support for its austerity budget – due on December 7– after two independent MPs signalled they may vote against it.

The budget is a crucial first plank in the Irish government's stringent four-year plan for curing the gaping Irish budget deficit through a combination of €10 billion in government spending cuts and €5 billion in tax rises.

At the same time, the Green Party, which is the junior partner in the Irish coalition government, called for a general election to be held in the second half of January, indicating that it will quit the coalition unless an election date was set.

With an early election looming, there is a fear that some Fianna Fil backbenchers may lose their appetite for additional tough budgetary measures.

There are also worries that a newly elected Irish government may seek to renegotiate the terms of the austerity program. The Irish government is currently negotiating terms with the EU/IMF in exchange for receiving the emergency rescue.

According to Finance Minister Brian Lenihan, officials from the European Union and the IMF are "broadly satisfied” with the government's four-year plan for repairing Ireland's finances, which is expected to be unveiled on Wednesday. He indicated that under the terms of the bailout, Ireland's banks will shrink in size, and will focus on domestic business and consumer lending.

But even more worrying is the fact that Ireland's rescue has failed to quell eurozone sovereign debt fears. Instead, financial markets are now targeting Porgugal, with investors speculating that it will be the next eurozone country in line for a bailout.

As a result, yields on 10-year Portuguese bonds edged up to 6.53 per cent overnight. Many analysts argue that Portugal will ultimately decide that it makes little sense to pay 6 or 7 per cent to borrow money in financial markets, when it is able to access EU/IMF funding at much lower interest rates.

Portugal's minority Socialist government tried to calm markets overnight, releasing a statement saying the country had a "clear strategy” to cut its huge budget deficit and to boost economic growth.

But markets are worried that Portugal may face difficulties in raising funding at acceptable prices. Portugal has completed its borrowings for 2010, but markets are worried that problems could emerge in 2011, when Portugal has to refinance €25.6 billion ($US35 billion) in maturing debt, €19.7 billion of which matures in the first half.

Portuguese prime minister, Jose Socrates, was emphatic the country did not need a bail-out. "The country does not need any help,” he said in a radio interview. He stressed that Portugal did not have any problems with its financial system and never had experienced a bubble in house prices. He also expressed the hope that the Irish financial rescue would normalise markets, "because Portugal is experiencing a clear contagion effect”.

The Portuguese parliament will vote on Friday on a budget of unprecedented severity aimed at reducing the budget deficit from 7.3 per cent of GDP this year to 4.6 per cent of GDP in 2011. The budget includes a 5 per cent cut in public sector pay, a freeze on state pensions, and tax increases.

In response, Portugal's two main trade union confederations are preparing to stage a 24-hour general strike on Wednesday, which they claim is the most important social movement since the advent of democracy to the country in 1974.