Transcript of a Conference Call on the Release of the Staff Reports on the Sixth Review under the EFF Arrangement with Portugal and on the 2012 Article IV Consultation

January 18, 2013

Friday, January 18, 2013
IMF Portugal Mission Chief Abebe Aemro Selassie
IMF Senior Economist Stéphane Roudet
IMF Senior External Relations Officer Simonetta Nardin

MR. SELASSIE: Good morning, or afternoon, to you all. On Wednesday, January 16, the IMF Executive Board approved the sixth program review, commending the Portuguese authorities for their very impressive effort in trying to advance the adjustment program.

At the same meeting, they also considered the 2012 Article IV Consultation. The Article IV Consultations are conducted every couple of years in a program context, but every year with all members of the IMF outside of a program context. In addition, what this allowed us do at this juncture in Portugal was to step back and see how the various elements of the program were working. We have also published a number of economic studies to support some work we were doing through the fall.

I know you guys will have a lot of questions on the program review aspects, but I really would like to touch on a few of the things that have come out from the Article IV studies.

The problems that Portugal is addressing, the root causes of economic crisis that the country is going through now, really come out of a failure to adapt to the needs of the monetary union. In the context of the monetary union, the only way to improve living standards and strengthen the economy is by pursuing structural reforms, and Portugal failed to do that. On the contrary we saw a big increase in spending both by the government and public sector, so a big increase in debt. This resulted in the economic crisis of 2011.But in response to this crisis, the authorities have mounted a very impressive policy effort to gradually reverse the imbalances that have accumulated and avoid future crises, avoid a deeper still economic crisis.

Fiscal adjustment has been proceeding well. Imbalances in the financial sector have also been addressed. But all of this adjustment has come at a price. Unfortunately, it has entailed higher unemployment and a squeeze on household incomes. This is not something that we ignore or do not take into account. But the adjustment – for instance, the problems that we are seeing in the labor market -- has not been in vain and there has been some progress in reducing imbalances.

But challenges remain. This is no time at all for complacency. Some more fiscal adjustment remains to be done. The broader Euro area environment, while improving, remains an uncertain one, there are headwinds coming to Portugal from slower growth there, lower demand for Portuguese exports.

Navigating all of this is going to be a challenge in the coming months. There are still risks out there, albeit attenuating, and advancing the program and completing the work that has been started is going to be important.

I will stop there and take your questions.

QUESTION: I have two or three questions. The Constitutional Court will probably block part of the budget for this year, mainly the one related to pensions. In your documents you say that should that happen, the government has to immediately put in place alternative measures. Have those measures been discussed and what kind of measures are we talking about?

The second question is about spending cuts of about 4 billion [euros]. From a strictly technical point of view, what is the best option? To cut salaries? The amount of public employees? Pensions? What is the best option?

And finally, the main opposition party is completely against the 4 billion cuts on expenditure. They even refuse to discuss that option. Doesn’t this undermine what the IMF says should be a broad and public debate on this measure? Thank you.

MR. SELASSIE: Thank you. First, on the Constitutional Court, it is very important that everything be done according to the Constitution. I don’t want to anticipate and try and answer a hypothetical question. Just suffice it to say that we think it is important that we abide by the Constitution, the measures that are taken, and it is good that the constitutionality of these measures is being reviewed by the Court.

We faced such a challenge in the program last year also, and we were flexible in moving forward with alternatives that were suggested by the government. In the event something like this happens, we will look at what the government has in mind as alternative measures and go according to those. We remain open on that count.

On the 4 billion spending cut and where best it should fall: We have provided a comprehensive technical assistance report to the government laying out the various options where spending could be cut going forward. First of all let me say that these are just suggestions and something that lays out the options. It is an exercise where we look at various spending areas in Portugal. We compare them with comparative countries, looking at how these countries spend in those areas, what kind of efficiency levels we get out of those areas. We are basically benchmarking Portugal in those areas, and identifying where efficiencies and savings could be made.

An important element of how the program was cast was to try and make sure that changes would be implemented in an equitable manner, to ensure that the distribution of income is more equal. So those are all very important considerations in the technical assistance report. We leave it to the government and broader society to have a dialog and decide which, if any, of those spending cuts are appropriate or desirable for the specific context of Portugal. We will listen to the conclusions that the government comes up with.

Lastly, on the opposition objecting to any of these cuts. I have nothing to add to that except to say we welcome any inputs that come from broad society and will respond to those accordingly.

QUESTION First one question regarding the spending measures that you already wrote about in the report. I just want some further clarification on this.

First of all, you say that most of these measures will be a frontloading of the expenditure review. But if the budgetary execution risks turn out not to materialize, will the government need to implement the contingency plan? I mean will developments be to frontload part of the measures identified under the expenditure review? You guys make it pretty clear that some of the measures that you are talking about are reducing the wage bill. Could this be a contingency measure for 2013?

And I also want to ask regarding the social consensus that is a valuable asset under the Portuguese program, if this expenditure review threatens the political consensus, does the IMF think that we still need to push forward with this at any cost or can we track a more smooth way to do this?

And finally, about the excessive rents on the sectors because Article IV says that we are not being that much successful on the transition to the tradable sectors. And one of the main causes for this is the excessive rents and that we are not being successful in reducing them. What can the government then do to address this issue? Thanks.

MR. SELASSIE: On fiscal risks and contingency measures, at each review we always talk in very broad terms about the risks of attainment of the targets under the program. And in general there are two sources of risks to the fiscal targets. One can come from the economic development basically, for example, economic outcomes being weaker than we had projected.

As we have always said in the past, if these risks come from the economic situation then we would say let the “automatic stabilizers being allowed to operate,” -- we continue to believe this is an important consideration. But if there are policy slippages, we would want to see offsetting measures. So that principle continues to apply, and this is a discussion that we have at each review, and we always rely on the government to come up with particular measures to try and offset risks to the attainment of the program target. It is really up to the government to come up with these measures.

You mentioned also a question about how much the IMF values social consensus. We value this, of course, very much, like everybody. This is a necessity for all societies. But taxes have increased significantly over the past many months in Portugal. And there were many complaints that there is too much of a focus on the tax side and something needs to be done on the spending side. Well, this technical assistance report lays out some of the areas where spending savings could be made. There are only two ways of trying to reduce the fiscal imbalances that remain: one is on the tax side and the other is on the spending side.

We leave it to Portuguese society to decide where the adjustment should come, but my sense was after the heated debate about the taxes increases that we should switch to the spending side. If that is not the case; if the society decides that more taxes may be the way to go forward, then, this is something which we will try to internalize into the program. However, I would only note that on the tax side Portugal is already at the limit on the higher end very clearly, so I think there’s a limit as to how much you are going to be able to push by increasing taxes.

Lastly, on rents in the non-tradable sector or how better to improve competitiveness, this is something which, you know, is really a key element of the program and the program stands to succeed or fail on the extent to which competitiveness has improved. Many of these rent have been caused by policy. So to the extent possible, there has been an effort to try and reverse the policies that are causing them. So the policy-induced rents have been tackled reasonably well under the program. But more needs to be done and what needs to be done really is to open up the economy to a lot more competition, particularly in the non-tradable side of the economy. You know, there needs to be more of an attempt to enhance more entry of competitor firms into all areas of the economy. I think this is going to be a very important objective in the coming months and years. This is not something which needs to be done just under the program period, but also well beyond that.

Regulatory policy has an important role to play, basically making sure that you have very strong regulatory agencies that are monitoring hawkishly those sectors which are naturally of a monopolistic nature. And just continuing to do reforms is going to be a very important element of making sure that Portugal realizes its tremendous growth potential.

QUESTION: I’ve read the report and I know that IMF economists have started correcting their own estimates about the effect of austerity and the multipliers that should be applied, basically the amount of growth that is taken out or negative growth that is caused by or can be caused by austerity. And I am wondering whether you have anything to say about this looking at Portugal, which many people hold up as an example of a country that has had to make its adjustment perhaps too fast. Do you think (inaudible) the IMF’s change of view on the multipliers that it is now time for slow adjustment? That’s one question.

And the second one is your talk about the risk of sluggish growth in the rest of the European Union. We seem to have that sluggish growth already and we have certainly seen it in Germany. Do you think that Portugal needs stimulus in other parts in Europe?

MR. SELASSIE: On your first question on the multipliers, this was a debate that we had last summer -- a debate which also benefited, from the IMF’s side, from the internal work that had been done showing the possibility of higher multipliers at work. The targets for 2013 were eased by 1-1/2 percentage points. Original targets under the program were 3 percent and they were revised to 4-1/2 for 2013, reflecting exactly those kinds of considerations. So I would argue that Portugal is one of the places where we have tried to make sure that whenever the opportunity arises the right balance is being struck between, on the one hand, the need to advance the fiscal adjustment and then, on the other hand, the adverse effect that this can have on output and employment.

A very important consideration in all of this is the reason for which fiscal adjustment has to take place. It is because you have a situation where the size of debt is very large and, as importantly, the financing envelope is constrained. Now, admittedly, in recent months, you have seen some easing of the financial constraints and it is this easing that we were able to exploit by adjusting the fiscal deficit targets by relaxing the fiscal deficit targets in the context of the 2013 budget discussions Going forward we do not monitor things carefully. As I mentioned earlier, also, we look at the reasons why fiscal adjustment should not proceed. And if this is due to headwinds coming from economy weakening and to the extent that there is fiscal financing room, we try and exploit this as much as possible. But the room for maneuver is constrained, as I said, by the size of debt plus the financing envelope.

Turning to the other question, I am not sure of the extent to which fiscal stimulus in Germany, per se, would be beneficial to the specific case of Portugal. But what is needed clearly is for, you know, broader euro area policies to be more supportive of growth. I think we have provided a lot of advice at the euro area level in this respect. But I think for the specific case of Portugal what will help is continuing support by the euro system. Provision of liquidity that is made by the euro system is important.

Another area which will help more immediately and help offset the slower activity would be, you know, some monetary policy easing in Portugal. The credit transmission mechanism is impaired, so continued euro system support I think is one of the way in which the conditions in Portugal can be facilitated.

QUESTION: One first question is about the budget deficit in 2012. You say in the report that you saw a deficit a quarter percentage point higher than the objective of 5 percent, but the government says that it will stick with it. Now that the year is over are you sure or are you more sure that the 5 percent target is achievable?

And the other question, you say in the report that exceptional access to funding remains justified. What do you think about the recent announcement of the government that it will soon return to the market for three or five years in the market? Do you think that Portugal is ready to do that already? Thank you.

MR. SELASSIE: On your first question, 5-1/4 versus 5, I think as we make clear in the report that - the target could be missed by around a quarter of a percentage point. The government said was they were going to be able to take steps to basically offset potential revenue weakness and the 5 percent would remain within reach. As you well know, there are no data published yet, so I cannot say what the deficit outcome was as of the end of 2012.

On return to markets, firstly, I would argue that the government never lost market access, at least for the T- bill markets, over the last year and a half or so. We have basically seen this market deepening and the government continuing to issue T-bills at longer maturities, at lower yields. There’s been a lot of work in the gradual process of returning fully to markets, to bond issuance. It started a while back.

What has happened of late is basically yields have come down across all maturities, and markedly so, so that longer maturity issuances are being considered. I think it is a very encouraging position for Portugal to be in and we look forward to seeing what the government is going to do at this juncture. The ultimate objective of this program has always been to facilitate return to markets, so, you know, the more we move rapidly in that direction, the more pleased we are.

The key point I would like to stress, however, is that what’s important is not a single bond issuance, but a process of returning to markets just as happened in the T bill market of gradually rebuilding the yield curve. And I think the government is also thinking along those lines and so we look forward to developments in coming months.

QUESTION I would like to know what kind of measures you would like to see in case the Constitutional Court [decides that some measures cannot go forward]. Do you insist that they should be replaced by measures on the spending side or on the revenue side? And still we haven’t talked yet about unemployment which is a key concern for the IMF. I would like your comments on that given that your provision for the recession is a 1 percent decline in GDP but this week the Portuguese Central Bank made an estimate that the fall in GDP will be around 1.9. Are you worried that unemployment could worsen further than your forecast?

MR. SELASSIE: On the first point there really is not much more that I can add. It is appropriate that the Constitutional Court reviews provisions if they are seen to be testing the boundaries of the constitution and, really, we will be guided by the government on how to proceed with alternative measures.

On unemployment, you raise a topic which, like everybody else in Portugal, we are of course concerned about--how high it is. And it’s also closely related to how the economies are going to be expected to evolve. We have also seen of course the Bank of Portugal’s recent numbers where the revision was largely motivated by the slowdown in the rest of the euro area and a slow demand for Portuguese exports, something I mentioned earlier on. So as soon as more data is available we look forward to having a discussion at the next mission in particular, or the government to try and see what information -- or by that time hopefully we will have more information to make a considered judgment on what the output path is going to be.

But the encouraging thing I note also from the Banco de Portugal’s projections is that they too broadly expect output to bottom out sometime in the course of this year with a very gradual recovery from the second half of this year onward; this my understanding. I think that the signs that we have seen of interest rates coming down, not just for the sovereign but also Portuguese banks’ ability in recent weeks to be able to issue papers on capital markets, large companies being able to issue capital markets. These are early signs of some confidence that seems to be returning, at least to some segments of the corporate sector. They are all encouraging signs and perhaps also pointing to more positive developments in the months to come. The picture is uncertain but one where it is not all darkness and gloom.

QUESTION I have a question here that is related to a previous topic you have mentioned. I was wondering if you could elaborate a bit on how come the 4 billion euros came up in these discussions. How flexible are you on those cuts? And I would like if possible to relate this to what you said previously in this conference saying that if the society decides that there could be more taxes we will try to incorporate that into the program. So in the end are the 4 billion flexible or not? That’s one point.

Another point is in the Letter of Intent written to you the 5th paragraph it says “We are exploring a new proposal to rationalize and redirect the most productive segments of the economy existing government initiative including the setting up of a revolving mechanism to leverage EU’s structural funds.” I was wondering if you could elaborate a little bit on this also first to understand the problems we are facing.

MR. SELASSIE: Let me answer your first question. On the spending review, the size of cuts, et cetera, the program essentially identified the need to do structural primary adjustment of around 10 percentage points of GDP, 9 and 1/2, 10. Of that about 2/3rds have been completed as of the end of 2012, and the key for us is really how the remaining adjustment is done in a timely period. And, again, I repeat that why fiscal adjustment is needed is exactly because there is a need to stabilize debt and be consistent with the financing picture also. So for us, the key objective is to make sure that the remaining adjustment can be pushed forward in a timely way and this is where the spending review comes in, and, again, the recommendations that are there. We look forward to the 7th review discussions by which time the government I think will hopefully have a finalized an informed view of what direction this should take.

On your second question I think this is a reference to a desire going forward to use these structural funds better -- leverage them a lot more to be able to use them in many areas rather than just simply falling on public infrastructure, tied to activities as they have in the past. I think the government is doing some thinking in this area. I don’t think we have seen a fleshed out proposal yet. This is something down the road.

QUESTION: Let me just make one final question. There has been a discussion here on the proposals and specifically on the proposals you have presented in the report and specifically on the idea that you put forward that the spending expenditure in Portugal might even be regressive. In those analyses you seem to include pension and non-pension expenditure which is something that kind of mixes the results in the sense that pension expenditure represents around 70 percent of our expenditure.

So the Bank of Portugal published just this week an article that looked at the remaining 30 percent. So I’m just talking about (inaudible) benefits, unemployment insurance, other social expenditures and actually say that the system is efficient, aimed at reducing poverty, and in fact Portugal spends less than other countries in the EU. So I was wondering how all this can fit together?

MR. SELASSIE: I think this is an excellent question and if you had read the IMF report closely you would also find that we very much -- I think it’s important first of all to distinguish between pension and non-pension spending as you have, and in terms of social assistance, as you said, about 3 quarters of social spending falls on pensions which are less targeted. And this is exactly the point -- if you look at how effective the targeting of your pension system is in terms of alleviating old age poverty and the like, what we show is it’s less effective than in other countries in terms of alleviating poverty at old age. And that’s exactly the point. The report’s main point is that better targeting of pension spending would that spending to be more effective at alleviating old-age poverty. We very much recognize the effectiveness of non-pension social assistance and also its effectiveness at reducing inequality and that’s certainly something that is recognized and acknowledged in the report.

But the issue is exactly the fact that 3 quarters of social assistance spending is on pensions and the effectiveness of this pension spending at reducing poverty is less than in other European countries. So this is one of the points that the study makes. There are a lot of nuances which is why it’s important to read the report carefully because we certainly try to bring out these nuances. Maybe we could have done a better job. But our reference about pension spending not being adequately targeted is really all about pension spending and it doesn’t affect non-pension spending.

QUESTION: Hi good morning to you all in Washington. My first question is related to the reform of the corporate rate. The IMF staff in the selected issues report argues that for a more competitive CIT rate, I would like to know what is in the staff opinion a more competitive CIT rate and how can that be articulated with any reform in the VAT stemming and improving of its efficiency. And I would like to know if you can give me more details for this reform or this improving of VAT to offset the more competitive CIT rate.

My other question is related to the fiscal compact rules and I would just like to clarify if the IMF argues the fiscal compact rules should be in the constitution or not. I read the report and I read it this way: are you arguing that it should be in the constitution?

And my final question relates to the macro economic projections, to a thing that Mr. Selassie said. There is a weak demand projected for the euro area and (inaudible) included that in her -- it’s projections for 2013 but the IMF it seems is not integrating this weakening of the demand from the euro area in its projections because the projections is still a recession of 1 percent. Will you integrate later on this weakening demand, as estimated by the ECB last month? Thank you very much.

MR. ROUDET: Let me say a few words about the CIT. I think what we discussed with the authorities during the review was their intention to make the overall CIT system more competitive in attracting investment. And there are many ways to do that. From a general point of view we think that it is already better to have a broader tax base and lower rates to the extent possible. There are many aspects that can be reviewed and compared to experience in other countries to make the system more competitive and efficient in attracting investments. The rates can be reviewed, the existing deductions, exemptions, depreciation rules, the loss-carry forward rules, et cetera. All of that can be reviewed and compared to best practices, and I think this is what the government intends to do.

MR. SELASSIE: Okay. On the European compact, whether it should be included in the Constitution, we don’t have a strong view on that, quite frankly. And, you know, I don’t think we say anywhere in the report that it should be included in the Constitution. Far from it. I think countries have latitude to introduce this either in the Constitution or by other strong budget laws, and we’re comfortable with whatever Portugal decides to do. I think they have gone for the latter and that is fine with us.

On weak demand from the rest of the euro area: The numbers in the reports published today are based on discussions with the government back in late November. So all of the information that we had available through then was included, including euro area conditions, the demand as was projected back then. Of course, when we come in February, as we do at each quarter, we will review all of the available information and it is on the basis of all of that information that we will make our projections. So we will take into account how well exports have been faring, demand from abroad, all of the data points that we have available through February we will internalize in our projections.

QUESTION: Hello. When you talk about contingency measures that the government pledged to come up with, are these in addition to the 4 billion euros in spending cuts?

And the other question, I mean, I understand, I get your point that it’s important to respect the Constitution, but are you at all concerned that the whole program can be thrown off course by the constitutional court decision? Thank you.

QUESTION: Wondering what kind of criteria the IMF would like to see from the ECB on [OMT eligibility]. Thank you.

QUESTION: I just want to ask you if you are more worried about the debt sustainability because you have some -- you point on the report, especially on the Article IV, and the sustainability analysis that you have plausible risks that could happen. It’s not the more common ones, but you raise this possibility, also. If you could elaborate a bit more on the question of the possible contagion from Portugal to the euro area and what is this exceptional are you talking about.

MR. SELASSIE: On the contingency, (inaudible) addition, et cetera as I said, the program’s fiscal targets really are the ones that we set in terms of the annual targets, and so it’s difficult for me to answer by saying this (inaudible) goes into this pot, this contingency goes into this pot. That’s not at all how it operates. So what we have are the annual targets that we have for the year, and so it’s difficult for me to give you nominal numbers that are consistent with that because the numbers are typically as a ratio to GDP and are revised as and when conditions warrant. So all I can say is that the fiscal deficit target for this year is what it is, 4-1/2 percentage points of GDP. And the measures that are going to be taken will be consistent with that. And for next year, again, consistent with bringing the deficit below 3. So that’s what will guide the discussions.

On the constitutional court and whether it will bring the adjustment, the whole program, off course. No, I certainly don’t think so. It’s a relatively small part of the budgetary provisions that have been asked for review by the Court. And, you know, I can’t say any more than that. I don’t want to prejudge what the Court is going to say. And depending on what they say, though, I think we’re going to be flexible to work with the government to make sure we come up with measures that are lawful.

On euro system support our view really is that -- first of all, I think the ECB has shown tremendous pragmatism through this whole crisis in terms of coming up with facilities to help address the challenges that banks have been facing. Part of this, of course, has been the provision of liquidity support by the euro system to the banking sector. I think this is very important going forward, also, to try and alleviate the credit constraint that small- and medium-scale enterprises in particular face. And it’s really in this context that we also see the Outright Monetary Transactions (OMT) coming in and being able to support the better working of the transmission mechanism in Portugal. And so this is the broader context in which we see this.

On the eligibility criteria, it’s up to the ECB to determine these. I don’t have a strong view on what these should be. I think we will rely on the ECB if and when it deems that OMTs should be deployed in countries.

Lastly, on debt sustainability, you know, I think our assessment of debt sustainability has not changed at all. If you look a where debt is peaking, 122 percent of GDP in our latest projection, this is even lower than the projections we had at the time of the fifth review. Our forward-looking assessment hasn’t changed much at all. If anything, as we’ve seen, the interest rates on Portuguese government bonds come down dramatically, well below what we assume in the debt sustainability analysis. If anything, this actually improves the debt sustainability picture going forward. This, of course, assuming that interest rates would remain at this low level and endure at this low level and going forward. So, if anything, on debt sustainability our overall assessment is that the same or better than the previous review.

The exceptional access criteria discussion that we have reflects internal Fund policies. Portugal is being provided exceptional access for very high levels of access and there are certain criteria which need to be fulfilled for a country to be eligible for those criteria. So exceptional access criteria is more a discussion than is reflecting whether Portugal meets this eligibility. And one of those criteria is basically the extent to which problems in Portugal might have spillovers into other countries. And, again, the assessment in terms of these four criteria is broadly the same as in the previous three or four reviews, so there is no change there at all either.

QUESTION: I understand that you don’t want to talk about nominal amounts, but from what I understand, and please correct if my logic is not right, but if the contingent measures are part of the measures that are being prepared in the expanded review and if the budgetary execution goes as planned does this mean that the expanded review measures are only going to be implemented in 2014 or are they still going to be implemented this year? Because if budgetary execution goes as planned and we start to implement contingent measures on the expanded (inaudible) side, we could have a deficit lower than the 4-1/2 percent of GDP.

MR. SELASSIE: Okay. Sorry, I actually don’t think I get the premise for the question. The target for this year is 4-1/2, so if that target is going to be met… I don’t see why the government would take additional measures if that is going to be met.

QUESTION: Yeah, but that would mean that the measures from the expenditure review that are supposed to start this year would only start in 2014 because the (inaudible) measures are the same -- are part of the measures that are being prepared in the expanded review, right? So that would mean that the expenditure review would only start to be implemented next year and not in 2013.

MR. SELASSIE: If that’s what the government is going to decide, sure.

QUESTION: Hi, good morning. I would like to ask you to clarify in concrete what you mean by further advanced fiscal consolidation to Portugal. Thank you.

MR. SELASSIE: As I mentioned earlier in order to realize the program objectives as we have them now, of being able to stabilize debt at the 120 percent mark and bring them down gradually for the remainder of the decade basically, we assess that there is a need to do additional adjustment of around 3-1/2 percentage points. This adjustment is expected to be done over the next two years, so that’s what we mean by further fiscal adjustment.

Of course, this is a number that could change, to some degree, depending on economic circumstances, on the interest rates that are going to prevail. The lower interest rates are, maybe the less adjustment there is going to be. If there is higher economic growth, also a possibility that less adjustment is going to be needed.

But at this point, the assessment is that there is still around 3, 3-1/2 percentage points of adjustment that is needed.

MS. NARDIN: Thank you very much, Abebe. Thank you, Stephane. And thank you to all the journalists who were on the line.


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