Portugal's coalition fights to keep its head above water

UPDATE (17:15) - First reports of an agreement to keep the coalition alive. Stay tuned for more details.

UPDATE (16:40) - Portuguese Prime Minister Pedro Passos Coelho and Foreign Minister Paulo Portas have just come out of another (swift) round of talks.

The outcomes of their third meeting in less than 24 hours are still unclear. Passos Coelho is now heading to the Belém Palace - where Portuguese President Aníbal Cavaco Silva is waiting for him.

UPDATE (14:45) - The second meeting between Portuguese Prime Minister Pedro Passos Coelho and Foreign Minister Paulo Portas is over. It was "very positive" - according to the Prime Minister's office - but inconclusive. Negotiations over a new coalition agreement will therefore continue.

According to the Portuguese media, Portas may backtrack on his resignation. If he did so, he would reportedly be appointed Deputy Prime Minister (the post is now vacant after former Finance Minister Vítor Gaspar quit) and Economy Minister (which in Portugal is a separate portfolio from Finance Minister).

More interestingly, a source quoted by Diário Económico suggests that a revamped coalition agreement would involve discussing "a new compromise with the [EU/IMF/ECB] Troika" - so potentially a relaxation of Portugal's deficit and reform targets.

ORIGINAL BLOG POST (11:25) 

As we noted in yesterday’s flash analysis, tensions in the Portuguese coalition reached critical levels over the past few days. They have eased off somewhat overnight, but there is still plenty of uncertainty around.

Key developments:

• Despite tendering his resignation from his post as Foreign Minister, the leader of junior coalition member CDS-PP, Paulo Portas, now seems to be backtracking somewhat. This is down to both internal pressure from his party, which is clearly not keen to be seen as bringing down the government, and external pressure from markets and eurozone partners over fears of snap elections which would delay the implementation of key reforms in Portugal.

• Portas already met Prime Minister Pedro Passos Coelho, with another meeting due later this morning. The two will also meet Portuguese President Aníbal Cavaco Silva this afternoon.

What are the potential outcomes?

• Portas is reportedly seeking a renegotiation of the coalition agreement. At the moment, it's not entirely clear whether his desire is more power for his party or less focus on austerity - or both. The former seems possible, although his party is significantly smaller (Passos Coelho's Social Democratic party controls 108 seats compared to 24 for CDS-PP). The latter seems less likely. The government has very little scope to adjust its economic policy due to the bailout requirements, while, as we noted yesterday, austerity and structural reforms need to continue with the country already falling behind in terms of implementing its programme.

• It is, of course, still possible that no agreement is reached and the CDS-PP confirms its withdrawal from government. However, the Portuguese media seem to agree that, even in that case, CDS-PP would keep granting parliamentary support to the government (an arrangement the Portuguese call incidência parlamentar).

• No matter the outcome, the divisions within the coalition are clear and present. There are likely to be some tough votes to come, particularly on labour market reform and further budget cuts. Whenever these take place, the spotlight will be on the coalition to see if it holds up under pressure.

We will continue to update this blog throughout the day with developments and news as we get them.