By Samuel Indyk
LONDON (Reuters) - Portugal holds a snap election on Sunday, its second in two years, with polls pointing to a hung parliament and strong showing for the far-right Chega.
Markets have taken political uncertainty, sparked by the November resignation of centre-left Socialist Prime Minister Antonio Costa, in their stride.
"Given that you have centrist parties who are likely to be in government, you'll have a certain degree of continuity," said Antonio Barroso, managing director at political consultant Teneo.
Costa's Socialist Party, now led by Pedro Nuno Santos, looks set to lose its majority and trails the centre-right Democratic Alliance, led by Luis Montenegro, in the polls.
The populist Chega is expected to more than double its vote share, potentially becoming kingmaker.
Here are five key questions for markets.
1/ HOW SERIOUS IS THE POLITICAL INSTABILITY?
It is a concern, this will be Portugal's third election since 2019.
Neither the centre-left nor the centre-right is expected to clinch an outright majority, so a post-election stalemate is likely, potentially leading to another election.
"More than specific policies, the strength of the mandate will be key," said Banco de Investimento Global (BiG) portfolio manager Ricardo Seabra.
"If this renders greater future fiscal stability and a reduction in red tape, Portugal will remain attractive for foreign investors."
2/ WHAT DOES THE ELECTION MEAN FOR THE ECONOMIC OUTLOOK?
Not much damage, investors hope.
Portugal's recovery from its 2011 bailout has been a euro area success story. Economic growth recovered and the public debt ratio fell to 98.7% of gross domesticu product in 2023, its first time below 100% since 2009.
Finance Minister Fernando Medina says balancing the budget and reducing debt must continue, whichever government emerges post-election.
"The fall in Portugal's government debt is quite incredible," said Capital Economics assistant economist Bradley Saunders.
"Both major parties are quite fiscally conservative and so, I'd expect to see a pretty similar path of debt reduction regardless of which major party wins."
3/ IS THE RALLY IN PORTUGUESE BONDS JUSTIFIED?
Yes. Portugal's debt load, while high, is coming down and ECB rate cuts are coming.
Ratings agency S&P Global just raised Portugal's rating to "A-" from "BBB+", citing an improved debt outlook and saying a change in government should not alter that trajectory.
At around 3%, Portugal's long-term borrowing costs, are lower than in Spain, Italy and Greece. The gap over top-rated Germany, at 65 basis points is near its tightest in two years.
"Parliament has already approved the 2024 budget, and we think risks to policy continuity are limited due to a consensus on fiscal prudence," S&P said in its report.
4/ WHAT ABOUT PORTUGAL'S COMMITMENT TO THE EURO?
That has not been an issue in this election, leaving the euro undisturbed.
The euro-scepticism evident in many European elections in the 2010s and early 2020s has subsided in Portugal, partly thanks to Portugal being one of the main beneficiaries of the EU's 800 billion euro post-COVID recovery fund.
"Portugal has already received some disbursements because it's met its targets very quickly," said Capital Economics's Saunders.
"I'd be very surprised if any leader would bite the hand that feeds it at this moment in time."
5/ SHOULD EQUITY INVESTORS WORRY ABOUT A WINDFALL TAX?
A little perhaps.
Post-COVID, Portugal has introduced some of the broadest windfall taxes in Europe, targeting energy and food companies. Markets are on edge for similar policies.
A levy on bank profits has been mooted by Chega but analysts reckon the chance of this happening is slim, with Chega unlikely to be a part of the new government.
"Simply put, it's just one of the many populist pre-election soundbites they have generated," said BiG's Seabra.
Any signs of a tax on banks could however hurt Portugal's stock market, which has performed relatively poorly in 2024. That is partly due to an 18% decline in the index's largest component, utility company EDP.
($1 = 0.9177 euros)