Café in Lisbon’s Chiado district. Creating new jobs, especially for the young, is one of the main objectives of a support package agreed with the IMF and the European Union (photo: Newscom)
INTERVIEW ON PORTUGAL
The EU has pledged a total of €52 billion. The IMF’s contribution will amount to €26 billion, to be provided over three years under the Extended Fund Facility.
Portugal is the third member of the 17-country euro area to seek assistance from the IMF, after Greece and Ireland. Its growth rate has averaged only 1 percent during the past ten years, making it the slowest growing economy in the euro area. This lack of growth, combined with the impact of the global financial crisis, has resulted in a large fiscal deficit, high levels of debt, and persistent unemployment.
The financing package provided by the IMF and Portugal’s partners in the EU is intended to give the country the breathing space it needs to address its longstanding problems.
In an interview, the IMF’s mission chief for Portugal, Poul Thomsen, discusses the challenges facing the economy, and outlines the details of the policy package announced by the caretaker government in Lisbon.
IMF Survey online: What are the main objectives of the policy package agreed with Portugal?
Thomsen: The government’s program is bold but realistic. It comprises basically a three-pronged strategy.
The first priority is to tackle the longstanding and deep-rooted structural problems that have caused Portugal to have the lowest rate of growth in the euro area over the past decade and the highest level of unemployment in over a decade.
The second priority is to strengthen fiscal policy. A carefully balanced mix of measures—amounting to about 10 percent of GDP, including those in the 2011 budget—will reduce the budget deficit to 3 percent of GDP by 2013, and stabilize public debt.
The third priority is to ensure the stability of the financial sector. We have included measures that will increase banks’ capital positions, strengthen regulation and supervision, and have introduced a new solvency support mechanism, which is fully financed under the program.
IMF Survey online: How did you balance these different goals?
Thomsen: When designing a program like this, it is important to avoid excessively fast fiscal consolidation and financial sector deleveraging. Going too fast would cause a large contraction in demand before the structural reforms that are aimed at boosting the economy’s growth potential begin to yield results. I believe the program strikes an appropriate balance between these two priorities.
The financing package will give the government the breathing space needed to establish a strong record of policy implementation before having to return to the market, while undertaking the needed adjustment in a socially responsible way. This is going to be a tough program. But without the support of the international community, market realities would have forced a much faster and much more painful adjustment on Portugal and its people.
"We think a recovery will get under way in the first half of 2013, provided the reforms are implemented as planned."
In addition, and importantly, the policy package is rich on measures to boost output and employment in a lasting manner. As these measures begin to take effect, Portugal should begin to see results. We think a recovery will get under way in the first half of 2013, provided the reforms are implemented as planned.
IMF Survey online: What are the main elements of the fiscal strategy?
Thomsen: The fiscal adjustment is strong and frontloaded. The deficit is coming down from 9.1 percent of GDP in 2010 to 3 percent of GDP already by 2013. This sharp reduction, at a time when the economy will be facing strong headwinds, requires measures of more than 10 percent of GDP. Undertaking such an adjustment in only three years is extremely ambitious by any standard.
Half of the necessary adjustment has already been incorporated into the approved 2011 budget. The government has also identified all the measures needed to reduce the fiscal deficit to 3 percent by 2013. An ambitious program of fiscal policy reforms will help restore control over public sector spending.
IMF Survey online: How will competitiveness be restored?
Thomsen: Portugal’s problems are above all structural, as evidenced by the very low growth during the good years before the global crisis hit in 2008 and by record-high unemployment. In a nutshell, Portugal needs to become much more open to competition. This is the only way to create jobs and generate higher incomes.
In this regard, I would highlight that the government is now considering what could be a dramatic “game changer” in the form of a sharp reduction in social security contributions in the order of 3–4 percent of GDP (offset by other appropriate tax and expenditure adjustments). This would reduce labor costs significantly and make goods produced in Portugal more competitive abroad.
More generally, Portugal’s economic problems have been caused in large measure by a lack of competition in the nontradable sectors of the economy, such as electricity, transportation, and telecommunications. The program includes measures to increase competition and reduce excessive profits in these sectors. These changes will happen through regulatory reform and accelerated privatization.
IMF Survey online: Would it be right to say that this program is more balanced and less stringent than some others?
Thomsen: Every country is different and there is no one-size-fits-all for the programs we support. In the case of Portugal’s program, as I said, there is no question that it is going to be tough. The country has deep-rooted problems that need to be tackled head on.
So the program includes some difficult measures: following a 5 percent cut in public sector wages this year, wages and pensions will be frozen until 2013; civil service staff numbers will be reduced in both 2012 and 2013; all new public-private partnerships and large infrastructure projects are being suspended; and spending on state-owned enterprises, local and regional government, and defense are all being streamlined.
"In a nutshell, Portugal needs to become much more open to competition. This is the only way to create jobs and generate higher incomes."
In the discussions we had with a wide range of people in Portugal, there was a strong sense that the country could no longer shy away from doing the difficult things that are needed to build a better, more sustainable economic future. And there is a feeling that now is the time. So let me be clear: there is no question that this is an ambitious, tough program. But equally important, it is also a realistic program and a fair one as well.
IMF Survey online: So who will bear the main burden of adjustment?
Thomsen: A major goal of the program is to ensure that that the burden is shared fairly. The measures attack rent-seeking behavior in the nontradable sector and privileges that are enjoyed by the relatively few and well-off in the Portuguese economy. Part of this effort will be designing a fairer and more equitable tax system, for example.
At the same time, the program makes considerable efforts to protect the most vulnerable groups, including those earning the lowest wages and pensions. This is essential to the program’s credibility and sustainability. The agreed policy package will enhance means testing for all social transfers. This will help ensure that benefits go to those who need them most. Low-income earners will be exempt from public sector wage cuts, and low-income pensioners from a planned pension freeze. The package also protects the poor from a co-payment increase in healthcare and reduces the period needed to access unemployment insurance.
IMF Survey online: How worried should we be about the banking sector?
Thomsen: Our work in Lisbon confirmed our initial judgment that the financial sector is fundamentally sound. Banks have been hurt by the problems facing the government, and have seen their access to wholesale markets dry up as the government bond market was hit by the downgrade in ratings.
The increase in capital adequacy ratios to 10 percent, already under way, will be critical to restoring confidence in banks and returning them to wholesale markets ahead of the normalization of the government’s access to capital markets.
While we believe that the Portuguese banking system will be able to restructure itself through market-based solutions, the program also includes fully funded backstop mechanisms for capital and liquidity support, should some banks need help.
IMF Survey online: Will the IMF-supported program help create jobs?
Thomsen: Unemployment, especially youth unemployment, is an enormous economic and social problem in Portugal today. For this reason, creating new jobs—especially for the young—has been one of our main goals.
The reforms to improve competition should boost employment. But Portugal also needs better-functioning labor markets. The current employment protection system holds back job creation and is unfair because it protects those with well-paying jobs at the expense of those who are trying to enter the labor market—not least the young.
The policies we have agreed will address the “dual contract” problem and align measures to protect open-ended and fixed-term hires, thereby reduce the disproportionate burden on temporary workers. The program will also increase training opportunities for low skilled workers.
IMF Survey online: Will the upcoming planned elections in Portugal affect the program?
Thomsen: Portugal is at a critical juncture, where broad political support for reform is essential for success. This is particularly important in this case where the problems are of a structural nature. In this regard, we have been encouraged by our discussions with the main opposition parties, which suggest that such a broad consensus does indeed exist.
IMF Survey online: How does Portugal compare to Ireland and Greece?
Thomsen: Every country and every program is unique, so these kinds of comparisons are not very meaningful. On the surface, the problems might seem similar, but they are not. The programs buy breathing space, but the different countries need this breathing space for different reasons. In Portugal, the main problem is persistently low growth and a stagnant economy. For this reason, the program puts the most emphasis on reforms to restore competitiveness, reignite growth, and create employment. It doesn’t make sense to try and force comparisons across countries.
IMF Survey online: Why should we believe that this program in Portugal will succeed?
Thomsen: This is a comprehensive, multi-year program designed to help Portugal at a critical point in its history. It will succeed because it has the right mix of policy measures that are credible and frontloaded. It will succeed because it is well balanced economically and socially. It will succeed because the international community—including the IMF—is extending exceptional support, with a large financing package.
Finally, and above all, the program will succeed because there is a broad political consensus in Portugal—and a strong sense of ownership—that this is the right program at the right time that is needed to get the country back on the right track.
