Waiting for a train in Portugal: strong policies are needed to fight high unemployment, according to the IMF (photo: Newscom)
PORTUGAL'S ECONOMY
On the heels of the IMF’s latest review of its loan to help Portugal weather the global crisis, Abebe Aemro Selassie, IMF mission chief for Portugal, sits down for an interview with IMF Survey online, to discuss the challenges of reforming the country’s economy and explain the global lender’s policy recommendations.
IMF Survey online: Financial markets continue to hold a skeptical view of Portugal that belies the progress the IMF says the country has made—why is this?
Selassie: One of the better gauges of the perception of the Portuguese program out there are bond spreads. And while they have been volatile, the overall trend has been for them to decline since they peaked in January 2012. The current level of spreads does show that financial markets are beginning to buy in to the success of the program.
That said, the spreads are still quite high and I think this reflects two factors. First, the required economic adjustment is quite formidable, and there clearly are risks associated with the implementation of the program. Second, spreads are also influenced by what’s been going on in the broader euro area, where conditions in recent months have been difficult.
IMF Survey online: What are the risks? You’ve mentioned the crisis in the euro zone, what else?
Selassie: I think the first thing to note is that the Portuguese government has been implementing the required reforms in a very rigorous manner, and these have moved the economy in the right direction. In particular, the imbalances that gave rise to the crisis in Portugal are being addressed.
But there are also attendant risks.
The recession could prove more protracted than currently envisaged. So far, this has not been the case, with real output broadly evolving broadly as expected. But the composition of growth has been different. Export growth has been a bright spot, offsetting weaker domestic demand conditions and supporting output. But if conditions in the euro area weaken further, this would affect the growth outlook.
Another source of risk is fiscal performance. Exports generate less tax than domestic economic activities and so revenue performance has been weak in recent months. If this persists, it could imply lesser adjustment this year and unemployment has been higher than envisaged under the program, so this is another risk factor.
IMF Survey online: Why is unemployment so high in Portugal, especially among young people, and what will the reforms achieve?
Selassie: The recession clearly plays a major role in the increase in overall unemployment.
As to why the young have been affected more, there is some segmentation in the labor market between those with established jobs and those trying to break into the job market. The former group have stronger employment protection and tend to be sheltered from job losses, whereas young workers who are employed on more flexible contracts tend to be impacted more by job-shedding when companies face difficult economic times. This partly explains why you’re seeing the young affected to a larger degree by the recession.
In the face of this rise in unemployment, the government has come up with both supply and demand measures to alleviate the pain. They are going to provide worker retraining schemes and provide incentives to employers, with a particular focus on the young, to help get the workers back into jobs.
The ongoing labor market reforms should also help. The main thrust of the reforms is to facilitate greater wage flexibility, which should reduce the extent of employment losses in the face of economic shocks.
IMF Survey online: There is an ongoing debate in Europe and elsewhere about the right balance between austerity and growth—how does Portugal’s program fare on this front?
Selassie: When Portugal turned to the IMF in early 2011, it was beset by very large economic imbalances. Public debt and the fiscal deficit were excessively large, and market financing had dried up. Large fiscal adjustment was unavoidable, and it was inevitable that this was going to hurt economic growth. But the program was designed to limit this impact.
In particular, an effort was made to avoid both public and private sector deleveraging—cutting back—at the same time. An effort was made to sequence the deleveraging, with fiscal adjustment coming first and credit and liquidity conditions being sustained as much as possible to allow more gradual private sector deleveraging.
The expectation was that in the course of 2011 and 2012 output would decline by around 4 percentage points of GDP. And developments so far have been broadly in line with this. Where developments have been different, of course, is unemployment which, as I mentioned, has been higher than we expected.
But I should also note that the program is not just about cuts and retrenchment. A very important element is about improving the efficiency and competitiveness of the Portuguese economy. So there are a number of reforms being pursued—in the labor market, product market, to improve the efficiency and effectiveness of public administration—with an eye to helping economic growth.
IMF Survey online: How will reforms help boost economic growth?
Selassie: Historically, Portugal has had very weak growth rates so the program focuses on the policy-induced distortions that have been hindering higher economic growth. I think it is fair to say that many of the obstacles to growth were well known. They had been identified by previous administrations, the current government, and academics.
A good example is the rental housing market, which was until recently virtually nonexistent because of rent controls and other policies. And the effects from this extended beyond the rental market, because labor mobility is hindered by the lack of availability of rental accommodations.
Another example is the inefficient judiciary system, which basically hindered all types of contract enforcement—a critical facet in a market economy.
The program tackles these and other issues, such as product market competition. Essentially, wherever factors that erode competition and result in increased domestic production costs are identified, the program tries to address them. A very good example of this are the efforts in recent months to scale back excessive profits in the electricity sector.
IMF Survey online: How does the IMF expect banks to support credit growth while cleaning up their balance sheets and selling off assets?
Selassie: Portuguese banks didn’t engage in exuberant real estate lending, but they relied a lot on foreign borrowing and then loaned to the private sector. The banking system remains robust and a number of steps have been taken to strengthen its capital position.
Also, you can’t have both the public and the private sector selling off assets and cutting back or deleveraging at the same time without causing a massive economic contraction. We’ve always been of the view that given the strong deleveraging in the public sector, you have to have more gradual private sector deleveraging, including by the banks.
As I noted earlier, for policy reasons we have decided that the public sector needs to deleverage faster because they are shut out of the financial markets. Banks are shut out of the market also but they are being sustained by European Central Bank borrowing and can be more gradual in how they deleverage.
So while it is true that credit growth has decelerated sharply, it has likely been as much due to demand for credit weakening as due to credit supply falling.
The next joint review by the European Commission, European Central Bank, and the IMF of Portugal’s progress is scheduled for the end of August.
