LISBON (Reuters) - The passengers on a night train chugging along Portugal’s northern coast last month got the fright of their lives when the 40-year-old locomotive’s diesel engine literally fell off.

FILE PHOTO: Workers unload containers using a forklift at a port in Lisbon September 6, 2013. REUTERS/Rafael Marchante

Luckily, the train didn’t derail and Portugal Railways ordered taxis to take the 15 passengers home. But the incident was a shocking reminder of Portugal’s chronic underinvestment in public services and the hidden frailty of its economic rebound.

The Portuguese economy, bailed out by the European Union eight years ago, is booming.

It is enjoying its highest economic growth in nearly two decades, fueled by record tourism, an upswing in the housing market, a growing tech sector and strong exports. Private investment has returned to 2009 levels, helped by foreign investors including Chinese companies.

But for every glitzy new hotel and fancy restaurant in Lisbon there is a creaking bit of infrastructure or aging locomotive, including the one that fell apart in late February. It had been rented from neighboring Spain as a stopgap measure.

Some economists fear a lack of public investment is starting to undermine the economy, or worse, could be storing up trouble should another recession come.

And with total debt close to 120 percent of gross domestic product, one of Europe’s highest, the ruling Socialists have limited room to finance a big investment drive without putting almost a decade of budget repair at risk.

The budget deficit, once 11 percent of GDP during Portugal’s 2010-14 debt crisis, has been almost eliminated under the Socialists. But that has come largely at the expense of public investment, according to Ricardo Arroja, visiting economics professor at the University of Minho.

Arroja said the government was not taking a long-term view.

“Since the start of the legislature, this has been navigation by sight,” he added.

In 2018 public investment reached 4.14 billion euros ($4.7 billion), but in a sign of how this item of spending has been used to balance the books in recent years, it was cut from an initial budgeted amount of 4.53 billion euros.

Public investment represented 2.1 percent of GDP in 2018, up from 1.5 percent in 2016 but still less than half of the 5.4 percent registered in 1960, according to Pedro Brinca, professor of economics at Nova School of Business & Economics.

However the government says it has had little choice but to prioritize cutting the deficit, to gain credibility among investors and help the economy recover.

‘BURDEN FOR FUTURE’

A recent report by the International Monetary Fund found Portugal actually had net public investment of about negative 1.2 percent of GDP in 2016, putting it at the bottom of a list of 26 rich countries, including Greece, Italy and Spain. That means it is not spending enough to offset the depreciation of state assets.

“We are consuming capital, that is we don’t have sufficient investment to replace capital (stock),” Luis Moraes Sarmento, deputy director of the statistics department at the central bank, said at a recent conference.

“These two things mean that we are leaving behind a burden to future generations that is extremely high. We are confusing the good times with having no problems on the horizon.”

Brinca said Portugal’s declining capital stock “could have especially serious effects for economic growth”.

Since coming to power in 2015, Prime Minister Antonio Costa’s Socialists have focused single-mindedly on restoring fiscal credibility, something that helped win the prestigious post of Eurogroup leader for their finance minister. As Eurogroup chief, he chairs meetings of the euro zone’s finance ministers.

Costa has opened the purse strings in two areas: rolling back austerity with lower taxes, especially for those on lower wages, and raising public pensions. As promised in his electoral campaign, this has boosted families’ disposable incomes.

But as he faces re-election this year, the lack of public investment is coming back to haunt him.

HOW TO SPEND IT

“This is an inheritance of the previous (center-right) government as it wasn’t three years ago that no locomotives were bought, but 20,” Costa told parliament this month when asked about the train incident.

Strikes and protests have been staged by public workers, from prison guards to teachers and nurses, demanding better pay. Repeated strikes by surgical nurses got so bad this month that the government had to enact special emergency legislation to force them to keep working.

In the hotel sector, which has expanded massively in the past few years, there are growing complaints that failure to expand capacity at Lisbon’s overstretched airport is undermining the tourism boom.

To address the complaints, Costa has announced a series of public works projects since the start of 2019, including new hospitals, a new airport for Lisbon and extensions of the subway systems in the capital and Porto.

Costa also launched a tender in January to buy 22 new locomotives for 168 million euros.

While big public works may be beneficial for the Socialists in an election year, some investors question whether they are the best way to spend public money.

“It’s non-existent (public investment), but where it does exist - because it doesn’t use a balance sheet framework - it uses debt, it’s not allocated financially where it will have the biggest impact,” Paul Kazarian, a billionaire investor who has started a public financial management initiative in Portugal, told Reuters.

At the same time economic growth in Europe is slowing and global trade rifts rising, raising risks to the outlook. If they materialize, budget consolidation could quickly suffer, hitting investment from its already very low levels.

“A significant slowdown would doubtless put great pressure on controlling the (budget) deficit,” said Brinca.

($1 = 0.8870 euros)