IMF Survey: Portugal to Stay Challenging Reform Course
October 25, 2012
- Good progress in reducing macroeconomic imbalances under IMF-supported program
- Country will have more time to implement fiscal adjustment
- Maintaining support for reforms will be crucial as program enters more challenging phase
Portugal continues its difficult adjustment process, with economic recession set to extend into 2013.
INTERVIEW ON PORTUGAL
The government has made excellent progress in implementing the reforms agreed under the program supported by Portugal’s European partners and the IMF. It will now have more time to implement fiscal adjustment and continue reforming its economy, as the global economic slowdown and continued uncertainty in the eurozone makes it more difficult to rely on exports and the private sector to generate jobs and growth.
In an interview, the IMF’s mission chief for Portugal, Abebe Aemro Selassie, discusses the prospects for economic recovery.
IMF Survey: You have just wrapped up the fifth review under the IMF-supported program. How do you assess the discussions during this review? What is the outlook for Portugal?
Selassie: The discussions during the fifth review revolved around how to strike the right balance between advancing the required fiscal adjustment and avoiding undue strains on the economy. Fiscal adjustment in Portugal is required to contain the high levels of debt and financing is limited. And, to the extent possible, this adjustment needs to pay heed to the evolution of output and employment. This is why we focused on trying to strike the right balance. And it was in this context and at the request of the government that the fiscal deficit targets for 2013 were revised from 3 percent to 4.5 percent of GDP, to be careful about the impact on growth of further adjustment. This decision was also partly informed by the work that IMF colleagues have been doing.
A range of revenue and spending measures were accordingly discussed with the government meet the 4.5 percent deficit target for 2013. Subsequently of course one of those measures—a partial shift in the burden of social security contributions from employers to employees—faced a lot of resistance, and the government replaced it with an increase in personal income taxes instead. The new measures have now been factored in our assessment of the current review.
The Portuguese government and people have made great strides in reducing economic imbalances. It has entailed a lot of sacrifice and more is still to come in the context of the 2013 budget. Good progress has been made so far, with two-thirds of the fiscal consolidation envisioned under the program to be reached by the end of this year.
The key now is how to advance the reform agenda and continue with fiscal consolidation. It is important for the country to complete the adjustment program, so that Portugal can return to growth.
IMF Survey: The 2013 budget includes more austerity measures, including tax increases. Why is that necessary?
Selassie: Even in good times, fiscal adjustment is difficult. In a country like Portugal, where unemployment is high and the economy is in recession, it becomes even more challenging. But there are few alternatives, unfortunately. Portugal has a very high level of debt and available financing is limited.
Ultimately, the aim is to return the economy to a sustainable growth path―one that leads to a vibrant economy that creates jobs, and where the country is able to meet its own financing needs. The only way to make this happen is to address the current imbalances, and this is why further fiscal adjustment is inevitable.
And yes, adjustment has entailed a lot of tax increases and spending cuts. In an ideal scenario, you would probably want to see somewhat more reliance on spending cuts, but the decision on the composition of the package lies ultimately with the government, and it is understandable that in a recession the government does not want to cut things like social benefits. Instead, it wants to rely more on tax increases and do it in a progressive way, so that people with higher incomes will be contributing more than people with lower incomes.
The government is conducting a comprehensive public expenditure review, exactly to find and identify areas where savings could be made in a productive manner. There is always hope to identify and possibly reduce unproductive spending, but a lot of the low-hanging fruits were already identified and started to be addressed in the 2011 and 2012 budgets. We look forward to the expenditure review to put on the table areas where savings can be made.
IMF Survey: Your outlook for Portugal now implies a stronger negative effect of the austerity measures on growth— what economists call “fiscal multiplier,” and you mentioned new IMF research published in the October World Economic Outlook. Can you elaborate?
Selassie: The main insight from the October World Economic Outlook study is that fiscal multipliers prevailing at this moment are higher than have generally been assumed. Recent economic outcomes in Portugal also point to a higher multiplier being at work. This evidence is partly what informed our support to the revision of the deficit targets in 2013.
But it is very important to stress that one cannot infer from the analysis in the WEO the appropriate size of the multiplier for an individual country. It varies across time even within countries. And of course, it is not just fiscal policy but other factors also have a bearing on growth. But the overall message from the study—that fiscal multipliers in the current environment are higher than the 0.5 assumed—is one that we share, and as I said informed our thinking and influenced the revised fiscal deficit path in Portugal. The downward revision to growth in 2013 is also related to this. Effectively, a higher multiplier is now being utilized.
One other point I should make is that the quarterly reviews under the program are there exactly to ensure that the program continues to strike the right balance between advancing the required adjustment and avoiding undue strains on output and employment. We have always said that if growth outturns prove to be weaker than projected, automatic stabilizers should be allowed to operate. This is all related to ensuring that the fiscal adjustment effort is one that pays attention to growth considerations as much as possible, within the constraints related to debt and financing that are there.
IMF Survey: Portugal needs deep structural reform to restore competiveness and jumpstart the economy. What reforms are being implemented, and how are they making a difference?
Selassie: Reforms are indeed key to improving the business environment in Portugal, and a lot has already been done under the program to restore competitiveness.
In particular, huge efforts have been made to improve the judicial system and the insolvency framework, increase the efficiency in sectors like telecommunication, gas, electricity, and transportation. A landmark port work reform is near completion, with substantial positive effects on labor costs and efficiency.
Also, on the fiscal front, it is not all about adjustment―fiscal reforms to modernize tax administration and upgrade public financial management will help put public finances on a sound footing.
The IMF has provided technical assistance to support the judicial reform process as well as in both of these fiscal reform areas. These are all things that will in the long run provide much-needed support to growth in Portugal. In the near term, their payoff is going to be limited, but over the medium term, I have no doubt that these will help boost potential growth.
IMF Survey: Are the policies implemented at the European level to solve the crisis having a positive impact on Portugal?
Selassie: To some extent they are. External conditions have not been as favorable as we had envisioned at the time the program was put in place. Portugal faces internal difficulties―lack of competiveness that predates the crisis and a slowdown coming from fiscal adjustment and the deleveraging process. But it has also been hit by headwinds from Europe and the stresses in the euro area.
In recent weeks, as European-wide crisis resolution measures have been put on the table, especially by the European Central Bank, we have seen some positive impact on Portugal’s borrowing costs. The government recently was able to extend the maturities of bonds that were set to mature next year—its first foray into the bond market for a while, albeit on a limited scale.
These are all steps in the right direction.