Country Report Portugal
Portugal has made considerable progress regarding the implementation of structural reforms and safeguarding financial stability. However, the high short-term socioeconomic costs have increased political instability, which might weigh on support for further reforms.
Strenghts (+) and weaknesses (-)
(+) Reform appetite
Despite high short-term costs, the current government has implemented an unpopular austerity and reform agenda since 2011 and the budget 2014 shows they are willing to continue this policy.
(+) Access to European rescue funds
European leaders have declared they stand ready to support Portugal until full market access is regained, albeit on the condition of strict program implementation.
(-) Structurally low economic growth
Portugal is characterized by a structural lack of robust economic growth which has negative implications for welfare, unemployment and debt sustainability.
(-) Worrying state of public finances
Amid the very high public debt level a robust budgetary effort will be necessary for many years to come, while a scenario of debt becoming unsustainable cannot be excluded.
1. Slowly moving towards recovery
There are several signs that the Portuguese economy is slowly recovering from the harsh contraction faced in recent years. In 13Q2, GDP grew by a whopping 1.1% q-o-q, but one should keep in mind that Portuguese quarterly figures have been very volatile in the past. New quarterly GDP contractions in the coming quarters should not be ruled out, although we expect the country to return to modest GDP growth in 2014. This picture seems confirmed by the rise of several sentiment indicators in recent months, e.g. the Economic Sentiment Indicators from the European Commission rose in September to its highest level since April 2011. Despite the improved outlook, we believe the IMF’s and the Portuguese government’s GDP growth forecast for 2014 (0.8%) is too optimistic. Both private deleveraging and public retrenchment will remain a substantial drag on growth in the coming years. The budget 2014 shows a continuation of the large consolidation effort in previous years, which is partly due to the fact that the Troika did not relax Portugal’s budget target for 2014 (4%-GDP). Despite the large budgetary effort (2.3%-GDP), it is positive that a large part of the measures consists of lower government expenditures instead of higher taxes. Based on this outlook we do not expect that the unemployment rate –which slightly waned in recent months to 16.5% - will drop significantly further going forward. While the Portuguese economy is clearly far away from internal balance, the external balance has improved quickly. The current account of the balance of payments almost turned positive in recent quarters.
2. Coalition stability under pressure
The ambitious budget 2014 signals that the current coalition is trying everything to avoid a second bailout program (see below). However, since the large public protests in September 2012, there has been rising disagreement between the coalition partners –the Social Democratic Party (PSD) of Coelho and the People's Party (CDS-PP) of Portas- especially on how to improve the budget balance. This disagreement led to the resignation of Finance Minister Vitor Gaspar, after which only a cabinet reshuffle was able to prevent early elections. CDS-PP leader Portas has been promoted to vice-president, which has reduced the acute risk of a political crisis. Political agreement on the ambitious 2014 budget is clearly positive, as it was widely seen as a potential stumbling-block. Together with the relative positive recent statement by the IMF on the eight and ninth program review, which stated that the program remains broadly on track, one might conclude that political risk has reduced somewhat. However, we stress that there remain large challenges. Firstly, coalition stability might be tested further by future decisions by the Constitutional Court to reject measures from the budget 2014. Up till now, there have been already four decisions of this kinds, which mostly ruled out budgetary measures but also rejected elements of the 2011 labour market reform. Secondly, public support for the current coalition has dampened quickly last year, which obviously deteriorates the political willingness to push through with unpopular reforms. Recent polls show that especially the Social Democrats have lost much support to the main Socialist opposition party, the latter is leading the polls by around 10%-points. In the unfortunate case of new elections, it is expected that the Socialists will become part of a new coalition. Although they might try to renegotiate with the Troika, which could deteriorate investor confidence, a full rejection of the current Troika program is implausible, as also the Socialists have signed the current Memorandum of Understanding.
3. Full market access by mid-2014 unrealistic
The current bailout programs runs until May 2014 and it is still unclear what kind of financial assistance will be needed to assure sufficient funding for the Portuguese government. Although interest rates on 10-year government bonds have dropped significantly compared to the levels in 2011 and 2012, the recent rise of the yields due to abovementioned political unrest makes that full market access by mid-2014 has become an unrealistic scenario. Depending on the development of investor’s appetite in the coming months, two options remain on the cards. A realistic policy option is that Portugal receives an enhanced credit line from the European Stability Mechanism (ESM). Such a credit line should help Portugal to regain access to the capital markets, while it does not entail a full Economic Adjustment Programme. As this option implies only light policy conditions and no further financial package, it is both appealing to the Portuguese government and to European creditors. However, if investor’s confidence deteriorates in the coming months, a full second bail-out might turn out inevitable. Under the very conservative assumption that Portugal will not be able to issue any government bonds from 2014-2017 (except T-bills), it will have a financing gap of €53bn in these years. Therefore it is very likely that a second package will be significantly smaller than the current package of €78bn.
In general, we take comfort from the fact that, if Portugal perseveres with strict program implementation, euro area member states have declared they stand ready to support until full market access is regained. If there will be further IMF involvement, we note that the IMF’s debt sustainability analysis will be important for the discussion on a possible debt restructuring. In their latest review, the IMF stated the Portuguese debt is still sustainable. Combined with the fact that European leaders have stressed the uniqueness of the Greek private sector involvement (PSI), our base case remains that such a PSI will not be applied to Portugal.
Partly due to the period of structural low economic growth since the 1990’s, Portugal has the lowest GDP per capita of the larger eurozone countries. This period of low growth can be explained by several structural weaknesses in comparison to its European peers: a low level of domestic competition, an inflexible labor market, an inefficient government and a poor business climate. After the financial crisis Portugal entered several years of severe economic contraction, driven by a large austerity effort, private deleveraging and weak external demand. While the relatively closed Portuguese economy is far away from internal balance, the external balance has improved quickly since the crisis. It should be noted that this rebalancing is driven largely by an import contraction and only to a smaller extent by export growth. Structural low growth has increased worries about public debt sustainability: in November 2011, the Portuguese government received a rescue package from Europe and the IMF, worth €78bn. Considerable progress has been made under this bailout program, especially regarding the implementation of structural reforms and safeguarding financial stability. However, the self-defeating character of recession and austerity led to a rapid rise of Portugal’s unemployment rate (16%) and to increasing public dissatisfaction with the policies demanded by Portugal’s creditors. Since the large public protests in September 2012, there have been several disputes between the current coalition partners, fuelled by stiff pressure from the opposition and by the decision by the Constitutional Court to reject several austerity measures. Although the fragmentation of Portugal’s political landscape is limited –since the democratic reforms after the dictatorship ended in 1974 the landscape is dominated by two parties- the harsh economic situation makes it difficult to continue with necessary structural reforms.