Difficult Outlook for Portugal but Program on Track
IMF Survey online
April 5, 2012
- Good progress has been made on implementing agreed reforms
- Outlook still difficult, with economy expected to shrink further this year
- Restoring growth through improved competitiveness will be critical
Portugal’s newly elected government continues to make good progress on the reform program it agreed to as part of the €78 billion (about $116 billion) international rescue package with the European Commission, the European Central bank, and the IMF.
It has initiated reforms to improve the functioning and fairness of the labor market—measures that will in due course help bring down the high unemployment rate and make it easier for young people in particular to find jobs—and it has started liberalizing important parts of the economy, including the telecommunications sector.
Because the government has met all of the main objectives of the program so far, the IMF’s Executive Board approved April 4 the release of about €5.17 billion under Portugal’s 3-year Extended Fund Arrangement.
Yet the outlook for the Portuguese economy remains difficult, in part because of the mild recession that has been projected for the eurozone this year. The recession is set to deepen in 2012, and unemployment will likely rise further, affecting about 14½ percent of the work force. The debt-to-GDP ratio is expected to peak at 115 percent of GDP in 2013, before starting to decline.
In an interview, the IMF’s new mission chief for Portugal, Abebe Aemro Selassie, discusses recent developments and looks at what it will take for Portugal to overcome the steep challenges ahead and restore growth and competitiveness.
IMF Survey online: Your team has just finished reviewing Portugal’s economy. Despite the difficulties, is the reform program on the right track?
Selassie: Yes, the program is on track. The reforms being pursued are an ambitious and unavoidable response to the serious economic adjustment challenges that Portugal faces. The country not only has high public and private debts but also needs to restore its external competitiveness. As a member of a monetary union, its policy choices are very constrained.
With this in mind, one has to give the government credit for implementing a difficult program pretty much as agreed.
IMF Survey online: Despite the important progress that has been made both in terms of restoring fiscal discipline and reforming the economy more broadly, financial markets still seem weary, with spreads on Portuguese debt on the high side. Why do you think that is?
Selassie: Spreads have eased a bit recently, but overall, yes, markets have been a bit sticky in their views on Portugal. Building credibility from a low base takes time and, perhaps not surprisingly, markets are not yet fully convinced that the big adjustment challenges will be met.
We think the challenges can be met as long as the government stays on course. In fact, one of the things we point to in our report is the significant adjustment (3½ percentage points of GDP) in the external current account deficit last year—sign that the required adjustment is in train.
IMF Survey online: Will Portugal meet its fiscal deficit target for this year? What are the risks that could derail the government’s efforts?
Selassie: The deficit target of 4½ percent of GDP for 2012 remains within reach. The main risk is that the recession turns out deeper than projected. In that case, we think that chasing after fixed nominal deficit targets may not be the best policy. At the same time, missing the target because of manifest policy slippages must be avoided, and government is very well aware of the damage slippages could do to the program’s credibility.
Portugal: An Economy in Need of Reform
• Stagnating economy. The Portuguese economy is one of the smallest of the 17 eurozone countries, accounting for just 2.0 percent of the bloc’s economic output. Economic growth has been weak in recent years. GDP fell 1.5 percent in 2011 and is expected to decline by 3.3 percent in 2012.
• Chronic high unemployment. Unemployment has increased during the past decade and stood at 13 percent in 2011. It is expected to reach 14½ percent in 2012. Youth unemployment (those aged 15–34) exceeds 35 percent.
• High public deficit. The government deficit was 9.8 percent in 2010 but is forecast to fall to 5.9 percent in 2011 and to 4.5 percent in 2012.
• High public debt. Government debt stood at 107 percent in 2011. It is projected to peak at around 115 percent in 2013, before starting to decline.
IMF Survey online: How much progress has been achieved with respect to the key challenge of restoring competitiveness, and what remains to be done?
Selassie: Much has already been done on structural reforms, which run the gamut from changes to the collective bargaining framework to getting the commercial courts to work better. But the nub of Portugal’s competitiveness problem, excessively high nontradable sector prices, still remains to be tackled fully. This may well mean curbing excessive profit margins in some nontradable sectors. Absent this, it will be difficult for the tradable sector to turn into a strong and durable growth engine while its production costs remain magnified by excessive nontradable sector prices.
IMF Survey online: How will the planned reform of the energy sector benefit consumers?
Selassie: Without reforms to open up the energy sector to more competition, energy consumers will face steep increases in electricity prices over the coming years. This would aggravate the competitiveness problem even more, as energy costs feed into all other aspects of the economy.
IMF Survey online: The Portuguese government has reached agreement with its social partners on an important package to reform labor markets. When should we expect unemployment to start coming down?
Selassie: Unemployment is a lagging indicator, and it’s unfortunately realistic to assume that it will remain high for some time. That doesn’t mean one has to be fatalistic. Younger and older workers have particular difficulties in finding jobs, and some of the active labor market policies that are in place or being considered should be helpful.
In the longer term, the reforms sought by the government should make it easier and less risky for companies to take on new employees. This will help create new jobs, especially for young people, who are excluded in large numbers from the job market today. Youth unemployment in Portugal is among the highest in Europe, at about 35 percent.
IMF Survey online: Many commentators have argued that Portugal will need a second program. What is the IMF’s view?
Selassie: We still think the program is of the right size. Certainly, regaining market access next year will not be easy. But building on recent success in lengthening t-bill maturities and the broader euro area-wide measures that have been taken, market access should still be possible in 2013. In short, there seems sufficient time to build a convincing track record of strong performance that regaining market confidence requires.
I would also note that European leaders are on record that they will continue to provide adequate support to Portugal as long as the program is on track, so there is something of a safety net in place if risks to market access materialize.