Transcript of a Portugal Conference Call on the Fourth Review of the IMF-Supported Program Under an EFF

July 17, 2012

IMF Mission Chief Abebe Aemro Selassie and IMF Senior Economist Ivanna Vladkova
Moderated by Simonetta Nardin, IMF External Relations Department
July 17, 2012

MS. NARDIN: Welcome to the conference on the staff report for the fourth review of the IMF-supported program with Portugal. Mr. Selassie will offer us introductory remarks, and then we will open it up for questions. Thank you.

MR. SELASSIE: Good afternoon to you all. I will just to highlight a few things regarding the fourth review, and more broadly the discussions we had some weeks ago and our assessment. I think the first point to make is that program implementation in Portugal remains strong. We are very impressed by how the authorities have been advancing a reform agenda. And more importantly, this reform agenda has been delivering notable results. The government has been fairly successful at reducing economic imbalances despite the fairly difficult environment in the Euro area. The contraction in output, so far at least, has been contained. Actually, you will have noticed we revised our growth numbers a little bit. So instead of output contracting by 3.25 percent we’re now projecting output to contract by about 3 percent in 2012.

This also shows that their economic performance are beginning to bear fruit. The fourth discussed three issues. The first one was whether the fiscal targets for 2012 remained appropriate. On the basis of the data through May, what we see basically is some revenue shortfall, but with that shortfall offset by a number of other measures, implying that the deficit target of 4.5 percent.

We had some discussion on that, and the conclusion we reached with the government was that on the basis of the numbers in May the deficit targets looked within reach.

Another important area of discussion was unemployment. In particular, employment had gone up about one, one-and-a-half percentage points higher than we had projected. We had some discussion about how the government was trying to respond to this and you would have seen the government’s policy response in this area. And then another area of focus for the mission was strengthening the capital buffers of the largest banks.

These were the areas of focus. What I would stress again is that, program implementation has been very tough, considering the headwinds that the government has been facing from the external side.

I’ll end my remarks here and we will open for questions.

QUESTION: I would like to ask a question regarding the targets for the deficit, because you say that they remain achievable, but in the staff report you also opened the door to adjust the targets if the targets become difficult to achieve in the result of weaker revenue performance.

There could be room to discuss this possibility in the next review?

MR. SELASSIE: The numbers that we have through May -- and that’s all the numbers that have been published -- show that the target remains on track. Now, the question is what happens if revenue performance weakens -- has been weak in June and continues to weaken going forward.

It is important to note that, first of all, we’ve always said that we keep an open mind when setting these targets. They are not cast in stone and they are reviewed to make sure that they are consistent with economic developments. I think that’s an important thing to note, that we have this general principle that we look at the outcomes and decide on the targets, what will be the target, that’s the purpose of the reviews that we have. That’s the first broad principle that I want to highlight.

Now on the specific case of what to do at this juncture. As I said earlier, what we are seeing on the one hand is that output is being a bit better than we had previously projected. Strictly on the grounds of what’s been happening to outputs, there isn’t a big reason to revise the target. What has been happening, however, is that the composition of output has changed, so you have domestic demand weaker and export sector stronger. Domestic demand tends to be more tax intensive; the domestic sector is taxed more relative to the export sector. So, maybe this has something to do with it? Why despite growth being a bit better than targeted, revenues have been weaker. These are all issues that we will raise and look at in the context of the next review mission, and we’ll see what the appropriate policy response will be then. QUESTION: I was wondering if you could help us with three things that I believe are quire simple. One is you are aware of the decision of the Constitutional Court on the salaries of the pensioners and civil servants. My question here is basically for 2013. In the staff report you say that you praise the fact that the government aims at reducing the deficit by two-thirds, with a contribution of two-thirds based on expenditures.

I would like to know how important is it that the targets are met with this composition. Two-thirds on expenditure, one-third on revenue. Another question is would you accept one-off measures this year or next year to achieve the targets, or is that completely -- in the beginning of the year it was completely out of question. I’m wondering if at this point that might make sense.

And finally if you assume that the deficit might be higher at some point in the future, what I would like to understand is where is the limit given that on the sustainability analysis we are already reaching that limit of 120 percent of GDP, which is kind of a threshold that has been hanging over the countries.

So whether this balance between -- eventually allowing for a flexibility in deficit clashes with the sustainability of the debt. Thank you.

MR. SELASSIE: On the first question, on the Constitutional Court ruling. You know this was a surprise of course. The government was quick to highlight that they would remained committed to the target and would be looking to identify measures to compensate for this. We’ve got to wait and see what measures the government is going to be able to identify.

Now, in terms of the composition -- spending vs. revenue. We keep an open mind but I would stress economically it’s very important to try and maintain this composition as much as possible. We see spending being a bit higher than probably what Portugal needs over the medium term, so there may be savings on the spending side that the government should look at. I think economically it’s important, also in terms of restraining demand.

Of course the focus on public wages had been because studies show that public wages for similar professions are a bit on the high side relative to the private sector. It was those reasons that had motivated the government to look at public wages and at least temporarily look for savings there. The bottom line is that maintaining the composition of spending -- two-thirds, one-third -- is a very important objective and one that the government should try to achieve.

Can this be paid with the one-off measures? Again, what we are after in the program is durable fiscal adjustment. I don’t think you can mask the fiscal adjustment need by doing one-off measures. What we will be looking for is durable, permanent fiscal measures. That’s what Portugal needs to reassure investors, domestic and external, that the fiscal situation is under control. The debt situation is under control. I think one-off measures basically meet you the target and they mask weak underlying performance, and I don’t think those kinds of operations are helpful at all.

Lastly on the debt sustainability limit, what is striking is that the debt trajectory has been broadly where we had envisaged this at the start of the program. It has varied within a margin of three, four percentage points. Our original program document had 116 percent. I think the second review it was up to 118 percent. Went down to a degree to a 115, and is now, I think, 118, 119.

Yd. The key really, in terms of what we look at, for a certain debt trajectory, is when the debt stock is expected to peak, which it remains probably next year. Not only that but also that there is a break there, and from then on it declines. So the trend is really what we focus on when we look at the debt sustainability analysis. That remains the case, and would remain the case within a range of fiscal deficit outcomes. That’s the key which we focus on rather than the precise point at which the debt stock is at.

QUESTION: About the Constitutional Court’s decision. One of the measures that has been mentioned is tax increases, and especially taxes for private sector workers. I would like to know how do you think this would impact the program, whether it would be positive or negative for the program going forward? And also, in the report there are several mentions of increasing downside risks. So, it would be interesting to have your sentiments on how these risks are affecting going back to the market as planned. Do you think it’s becoming harder to go back to the markets at the envisaged date? Thank you.

MR. SELASSIE: On special taxes, I really don’t have any detail on that and I think it’s very premature for me to comment. All of this will be discussed in the context of the fifth review comprehensively, so we’re going to wait to see what the government has in mind and take it from there.

On the downside risks, what we really have in mind is what’s been happening in the rest of the Euro area, where there’s been some weakening in economic activity indications, but also heightened markets threat. This environment hasn’t been helpful to Portugal at all, of course.

If you actually look at the deterioration outside, it’s all the more credible what the Portuguese have been able to do and the excellent performance that we’ve seen coming out of Portugal. The broader environment really hasn’t been as helpful as it could be for Portugal to advance with their reforms.

What does this mean for the return to market? I think we’re going to have to see how things evolve over the next several months, but on the basis of what we’ve seen so far, I think the government’s proposal to return to market is a credible one. We don’t see this return to market as a binary thing. It’s not that you don’t have access today and then you have access tomorrow, is something that you build gradually, and the government has been doing a fair amount of work in this direction, as you guys know. They’ve been lengthening the maturity of T-bills and we have seen the yield on the T-bill issuances coming down over time. This is a gradual process where you build investor confidence. Yield coming down, lengthening of maturities, are all associated with some buy-in by investors that the program is working and Portugal is moving in the right direction in terms of reducing its imbalances. This is a gradual process and one the government will need to continue building on over the next coming months. If the external environment improves, this will make the return to markets that much easier.

QUESTION: Thank you, good morning. I just wanted to go back to this idea of returning to markets. Basically what you’re saying is that unlike what happened with Greece, we shouldn’t expect a decision from the IMF on whether the financing is in place 12 months ahead as it did with Greece. We shouldn’t expect that in the fifth evaluation that’s starting the end of August, beginning of September?

MR. SELASSIE: You’re talking about the 12 month -- the financial assurances review?

QUESTION: Yeah, the IMF always requires the 12 months, at least, that guaranteed financing is in place.

MR. SELASSIE: Well, it’s a bit more nuanced than that. For us the key things we look at are whether credible and meaningful steps have been taken to facilitate the financing of the program. And I think the government has shown the work the government is doing to increase T-bill issuance, to build up cash coffers, are all going in the direction of ensuring that the program can be financed. That is what we are focusing on at the moment.

QUESTION: The Portuguese Prime Minister said in Brussels that there would be a discussion, an obvious discussion and a focus on this idea of returning to markets next year. Is that correct?

MR. SALASSIE: The financing of the program is discussed at every review. On a forward-looking basis, we look to see how the government’s going to be financing itself. That’s something we do at every review, and we’ll be doing that in the fifth review. But the point I’m making is the last several months the government has been rolling out this program where they’ve been extending the T-bill maturities that I noted a little earlier. The next step they have in mind is the issuance of medium-term notes, which are privately placed. There are a number of things that the government is planning to do and we will see how much progress is being made on those dimensions, and that’s the thing we focus on.

”QUESTION: I have three points that I would like to make. One is about also the adjustment of the deficit target. And if really the deficit grows bigger because of external factors, would the IMF accept a deficit bigger than the 4.5 percent of GDP?

My second question would be about the reduction of the social contribution. You say it should be neutral in budget terms. So what type of measures should the government apply to guarantee that it is going to be neutral? My third question is about the public enterprises. You also say that no other public enterprise should be created until the new government is approved. But the Portuguese government recently created a new public enterprise, the IGCP, which runs the public debt. Is the IMF analyzing these situations? That seems to go against the rules of the memorandum.

MR. SELASSIE: On the first point on fiscal adjustment, I think this is a point I made earlier. Again, as I said, on the basis of the numbers through May, it looks like the 4.5 is within reach. But if revenue continues to weaken, the target may be at risk. So we’re going to see when the revenue data points have come out, current activity indicators that come out, and our projections, and make a decision. We’ve been consulting with the government on what the appropriate targets would be for 2012 I think. We keep an open mind. As I noted earlier, we have the principles of allowing -- the noted principles of allowing stabilizers to operate. We’re going to see what needs to be done.

On social contribution, I’m surprised I haven’t been asked more questions about unemployment. The government has a three-pronged strategy to help address the rise in unemployment. One part of it is addressing or looking at the supply side response, with active market policies trying to particularly focus on youth unemployment and. I think that’s one important element of it. But another important element is labor market reforms to make sure that you don’t have any policy-induced reasons that cause excess job losses. And then another element is trying to help boost demand for labor, which is where the social security contribution comes in. Here, as to how to pay for this, I think we keep an open mind, and we leave it to the government to decide how to finance this. But we do think this will be a nice measure if it can be achieved, but we have no preconceived ideas as to whether this should be financed from the tax side or from the spending side.

And then lastly on the public enterprise, the redesignation of IGCP as a formal enterprise. We don’t see this as being inconsistent with the program targets. It was already in existence and its designation has been changed and we don’t see this as flying in the face of the understandings that we have. QUESTION: Hi, good morning. My first question would be about the cuts on the social security contributions. Can you be a little bit more precise about what we are talking about when you say lower-income workers and young workers? Are we talking about 25 years old? This would be my first question.

My second question would be about the reduction of severance payments to 8 to 12 days and if it will affect all the workers or just the new employees?

My third question would be about if you can estimate the financial risk of renegotiating the PPP contract in 2012 and 2013?

My final question is you say in the report that wages have fallen more than you expected, at least in historical perspective. Do you think it’s enough? And if not, how much more should it fall? Thank you.

MR. SALASSIE: On the first question about targeting social security contribution cuts, again, we keep an open mind as to whether the government will try to target this at young workers versus workers closer to the minimum wage. We’re leaving it to the government to see where the problem is most acute and where such a cut would have the desired effect. I can see a case for both targeting it for young workers, but also for lower-income workers. The Youth unemployment is particularly high, so I think there’s a case for targeting young workers. But also there’s a case to be made where you want to have it a bit more broad based and look at workers up to a certain level of income Again, we will have to leave an open mind

On the PPP renegotiation and fiscal risk that that imposes, we’re waiting for the study that the government is undertaking at the moment. I don’t think I’ve seen an English version of that myself yet. We are going to wait and look into this issue during the fifth review to form a view on what kind of risk the PPP contract may pose. Your question is a little early for that.

And then lastly on wages having fallen, the discussion in the staff report basically is referring to is relative to the historical relationship that we’ve had in Portugal between wages and the evolution of unemployment. The outcomes we’ve seen in the last few quarters do show overall compensation being lower than has historically been the case, and this is to be expected. There’s a big recession right now in Portugal, of course, but also perhaps some scaling back of payment. If you look at both public but also private sector, the same trend is evident. Now, in terms of how much wages have to fall further, I was asked this question many times before. This program cannot succeed if it’s all about wage cuts. It has to be also about improving productivity. It also has to be about having better growth outcomes. So in terms of the competitiveness gap, we’ve identified at the start of the program for it to be around 15 percent. But as to how this gap is addressed, we expect for it to be met as much with productivity as with wages growing less than in the past. I’ve got a very important point: We don’t expect the whole competitiveness gap in Portugal to be closed through wage cuts. It’s difficult for me to give a precise number, but a lot of the emphasis in the program on structural reforms, on labor market and product market reforms, is exactly to facilitate productivity increase and avoid wage compression.

Ms Vladkova: : On your question about severance payments, in fact, it generally states that the goals of the labor market reforms in Portugal are to reduce distortions that exist. And the natural benchmark for where certain compensations would lie would be the EU average in this particular case. And as you know, there’s been successive changes to the severance pay system. First there was a reduction for current employees, for new hires, followed by an alignment of the severance payments of current employees with that. And the next step is essentially lowering the severance pay to the EU average for all contracts, of course, without reducing accrued to-date entitlements.

The answer to your question is yes, it is for all contracts. And the goal, again, is to reduce distortions to some sort of a natural benchmark, which in this case is the EU level.

QUESTION I want to ask if you can clarify about the easing of the adjustment that they have been reviewing over the last few weeks. Our Finance Minister has said it repeatedly and also Brussels said something like that and if that relates with your open mind regarding our fiscal targets.

Also, I want to know if you can clarify about what is really the plan regarding unemployment, and if you can tell us something about the report that the government has presented to Troika and the measures that will follow.

The finance minister said that the troika, which will ease the adjustment of Portugal, and something like that will be discussed at the next review. I wanted to know what that meant.

Also I have a specific question on the wage moderation because it’s a goal of the memorandum to ensure wage moderation and discretion by not extending collective contracts until clear criteria is defined. And I wanted to know what is troika doing about that?

MR. SELASSIE: On the remarks that the minister made, I don’t have the context in which these points may have been made, it’s very difficult for me to comment, also, on things that might have come out from Brussels.

As I mentioned, the purpose of these review missions is exactly to put everything on the table and have very candid discussions about all of the issues. I think the next review will be no different and we’ll reassess the perimeters that are relevant at that time.

On unemployment, it was very clear that that was probably the number one issue that everybody brought up in our meetings -- business community, the trade unions, of course, and also other civil society members, parliament, et cetera. The government also identified this as the number one agenda item, so we spent quite a bit of time, first of all, trying to understand the reasons behind the sharp increase in the six months or so, the last six months or so. And then trying to come up with policy measures that the government had put on the table and working on those.

This three-pronged strategy is what the government came up. Rather than a wholesale relaxation of the deficit, the idea was to have a very focused response to get at the nub of that employment problem. So a three-pronged approach, as I mentioned earlier, supply side-type measures with a particular focus on active labor market policies, the demand element with Social Security capped to try and boost demand for labor, and then also to look at anything in terms of policy-induced barriers to weight flexibility.

One of the issues that came up was, the near automatic extension of wage contracts to whole sectors that prevails in Portugal. The idea there is to try and make sure that you don’t have contracts agreed by a small group of firms and a small group of employees being extended and basically being accepted across a whole sector and affecting firms that are not in a position to be able to pay those kind of wages. So A balance has to be struck in terms of, you know, the very important principle of collective bargaining, which we recognize and very much support, but also to make sure that this principle of collective bargaining doesn’t completely overwhelm the need to allow some flexibility for firms to determine wages, you know, in terms of looking at how profitable they are.

So I think the key thing that we’re after is balance and we’re leaving it to the government to strike the right balance in consultation with the trade unions, employers, and other stakeholders. The key principle here is striking the right balance between wage bargaining and a system which allows better alignment between productivity and wages.

QUSTION: Thank you. Let me just ask you something just to be clear. Regarding the social contribution of enterprises, the cut that will be analyzed is regarding the youth end at the lower wages or it’s something that you are hoping the government to do? Because it’s not really clear if you are open-minded regarding those two options or it these two are the only options?

MR. SELASSIE: The envelope for this is fairly small, about half a percentage point of GDP. If you had a bigger envelope, then you could consider other forms of more across-the-board cuts. But given the small size of the envelope the question was how much bang could you get for this small envelope and how productive can you make this relatively limited envelope? And the idea that was explored at the time was whether it would pay to target at younger workers or workers closer to the minimum wage.

We keep an open mind as to what kind of targeting will yield the most benefit from this limited envelope of cuts.


One question, on the SOE’s reform, at some point you said that things are going as planned, but there is a problem concerning the debt that was accumulated by these companies in the past, which is a huge amount. And you said that some kind of strategy to deal with it will be needed. What do you have in mind? Could you be a bit more specific on this point?

Then at some point, regarding the TSU (the cut in social contribution of employers), in the beginning of the program when the IMF was putting forward the idea of the fiscal devaluation, there was this argument saying that to be effective any cuts in the stocks would have to be quite big in order to have some impact. Do you still keep that, so that’s targeted to some small group or smaller groups, but still keep the idea that it has to be several percentage points? And I don’t know if you have any idea of how many percentage points that can be. Thank you.

MS. VLADKOVA: As you note, this discussion of the TSU of the Social Security contributions has been around from pretty much the beginning of the program. What you’re referring to there is that at that point we were fairly ambitious about recommending a very large cut in the Social Security contributions, mainly because we were looking at or we thought we were looking at fiscal space of about 4 percent of GDP in terms of the revenue switch.

Now, as you know, the consolidation effort has been quite significant and some of the margins to be able to affect that revenue switch from Social Security contributions to VAT is not there merely because of the consolidation effort. We have scaled back what we think is a feasible revenue switch for this purpose. And let me add that also at that time we were looking at an across-the-board reduction in Social Security contributions.

If you’re able to target better this reduction we will be able to effect a fairly large reduction in the Social Security contribution rate with a smaller reallocation of taxes. The idea here is to think carefully about how best to target those to get the biggest effect basically on labor demand, on employers’ demand for workers.

MR. SELASSIE: The key issue is that unemployment has become a big problem now. It has increased sharply. And so the question is, in addition to the supply side measures that we talked about, can we find a way to boost demand for labor and, you know, at that point which is particularly problematic: youth employment, lower-paid wage unemployment? So it’s in the context of those kinds of discussion that the Social Security contribution cut, which is much more targeted, came up. On your questions on SOEs, I think you’re referring to the state-owned enterprises which do not consolidate within the general government, the ones that are outside the perimeter. The issue has been there all along. They have, as you know, a large stock of debt. And, again, when the program was started we were very much focused on trying to address all of the issues within the general government perimeter, but we also had work going on to try and identify continuous liabilities from outside the general government perimeter. And the two big blocks of this are the PPPs and then the SOEs that are outside. With the PPPs, there’s been this study going on to try and identify any continuous liabilities from there and what hits, if any, that might imply for the budget. And then the SOE sector, also, there’s been a lot of work going on. And the work that’s going on now is to try and identify how able the SOEs are going to be to service the debt that they have.

That’s the big picture context. This work is going on and a solution is going to have to be found if it is indeed the case that these enterprises are not going to be able to service their debt. A solution will have to be found as to how enterprises can be placed on better financial footing.

QUESTION: Sorry, just one quick one. What does the IMF foresee as a normal employment rate and GDP rate for Portugal in the long term? I don’t know if that’s something you guys have worked out. What would be normal after all those reforms and changes?

MR. SELASSIE: Our expectation under the program is that we gradually go back to a 2 percent growth rate over the long term. And I think this is a bit of a conservative projection if you consider all of the reforms that have been done. Historically, the economy has been able to grow at 1.8 percent and, you know, our debt sustainability analysis, et cetera, we’re over the long term projecting 2 percent. Now, there’s some variation around this but overall I think a 2 percent growth rate is reasonable. But I have to say that we think -- if I’m pushed I would say this is a relatively conservative growth rate because given all of the reforms that the government has been undertaking in the last several months to liberalize labor markets, product markets, and this should all help raise productivity. But 2 percent I think is a reasonable number for growth.

On unemployment, we see unemployment coming down relatively gradually after it peaks later this year or in the first quarter of next year. And we have it coming down relatively slowly, which is a source of concern. You see it peaking at around 16 percent, I think -- to be precise 15.9 -- and then it comes down more gradually than we would like to see.Which is why we attach importance to the labor market measures that we’ve identified.

QUESTION: Is it clear for you that the unemployment rate is always going to be higher than it was in the past?

MR. SELASSIE: You mean unemployment could be higher?


MR. SELASSIE: I think as you have this transitioning it’s going to be declining gradually, but if you’re talking about in the steady state I hope not. Of course, once the full effects of this crisis have worn out, I very much hope that we can return to prehistoric rates of employment.


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