OREANDA-NEWS. The defeat of Portugal's minority government highlights the political instability created by October's elections and the resulting risks to fiscal consolidation and reform implementation, Fitch Ratings says. The extent of these risks will depend on any new government's cohesiveness, its policy programme, and whether political uncertainty damages economic and financial market confidence.

Prime Minister Pedro Passos Coelho's centre-right coalition failed to win parliamentary backing for its programme in a vote on Tuesday, less than six weeks after it lost its majority in October's general election and 18 days after President Anibal Cavaco Silva had appointed Mr Passos Coelho to form a government.

The President may now ask Antonio Costa, leader of the opposition Socialists, to form a government after they said they would co-operate with smaller left-wing parties, although this is not certain. New elections cannot be held for six months.

A government led by the centre-left Socialist party and supported by the more radical Left Bloc and Communist party would command a parliamentary majority, but this would not eliminate political uncertainty. The three parties' agreement falls well short of a comprehensive policy platform, and any kind of co-operation had seemed unlikely until recently, given their disparate outlooks and policy priorities, increasing the risk that any government they form will not serve a full term.

Statements so far indicate that the potential new government has little intention of adopting some of the smaller parties' more extreme proposals (such as sovereign debt restructuring), and would maintain the Socialists' commitment to abiding by EU fiscal rules, implying a slowdown rather than reversal of existing deficit-reduction plans.

But there are significant uncertainties on likely fiscal policy. The combination of continuing political uncertainty and the advent of a government relying on parties that have hitherto taken an outspoken anti-austerity stance, would increase fiscal downside risk. Portugal's public finances remain a key weakness of its 'BB+'/Positive sovereign rating, with the general government debt and deficit forecast at 127.9% and 2.9% of GDP respectively this year.

Similarly we think the prospect of reforms to boost investment and growth is fading due to political uncertainty. This would be negative in combination with fiscal policy changes that made debt and deficit reduction more dependent on a strong GDP performance. The growth outlook is fragile (we forecast 1.6% real GDP growth next year and 1.5% in 2017) and may come under pressure if political instability and policy uncertainty damage confidence.

Further near-term political uncertainty around the appointment of the next government cannot be ruled out. The President has been hostile towards the idea of a left-wing alliance taking government, citing its possible "anti-European" stance. We think the most probable outcome is that the President appoints Mr Costa as Prime Minster in the coming days.

Fiscal relaxation resulting in a less favourable trajectory in government debt/GDP levels could lead to negative rating action, as could weaker growth that had a negative effect on public finances.