Portugal: Democratic Alliance Won the Election Bringing Continuity to Debt Reduction

The ruling Democratic Alliance (AD) party won yesterday's election, improving its results compared to the previous elections in March 2024, but again fell short of an absolute parliamentary majority. The traditional centrist parties no longer hold a 2/3 majority in Parliament as anti-immigration Chega party made further electoral inroads. More broadly, Portugal, rated A (high), Stable trend, veered further to the right with the combination of AD, Chega and Liberal Initiative (IL) on track to win 2/3 of the seats in Parliament following the weak results of the Socialist Party (PS) and other smaller parties on the left. The most likely scenario is that of another minority government led by Prime Minister Luís Montenegro from the AD, potentially supported by the Liberal Initiative in the form of a broader coalition or parliamentary support.

The snap election, which was Portugal's third parliamentary election in less than four years, was triggered by conflict-of-interest allegations against Prime Minister Luís Montenegro. While the results give a stronger hand to AD for the new legislative period, the next government will still need to have the support or abstention of third parties to govern and legislate. Therefore, the stability of the government could face challenges and lead to early elections at some point. Still, the earliest Portugal can hold parliamentary elections is in May 2026.

The next government will face challenges like those of previous years, namely the implementation of reforms and investments linked to the recovery and resilience plan, the shortage of affordable housing, and managing and integrating inward migration flows. On top of this, Portugal faces a more complex external context, both due to growing protectionism and greater geopolitical tensions. Fiscal pressures are increasing, not least due to the need to step up defence spending. However, we expect the next administration to maintain its commitment to reducing Portugal's public debt ratio, in line with previous governments of the last decade, and to implement its policy agenda and increase defence spending gradually without compromising Portugal's commitment to fiscal responsibility.

Key Highlights
-- The Democratic Alliance won the election again but failed to obtain an absolute majority.
-- Another minority government led by Prime Minister Luís Montenegro from the AD, needing the support or abstention of other parties in Parliament, is the most likely scenario.
-- We expect the next government to continue to pursue sound fiscal policies and to reduce the public debt ratio during the new legislature.

"The next government will face greater challenges, especially on the external front, and may not last due to a still-fragmented parliament. However, we expect the next government to maintain its commitment to prudent fiscal policies and a further reduction in Portugal's debt burden. In our view, the implementation of its policy priorities and the increase in defence spending are likely to follow a gradual approach that takes into account the fiscal space available each year," said Javier Rouillet, Senior Vice President, Morningstar DBRS, Global Sovereign Ratings.