Transcript of a Conference Call on the 2008 Article IV Consultation with Portugal

October 3, 2008

Washington, D.C.
October 3, 2008

MS. GAVIRIA: Good day. This is the conference call on the 2008 Article IV Consultation with Portugal. We posted under embargo this morning the Public Information Notice (PIN) and the staff report. I hope you had a chance to look at them. We will start with brief opening remarks by James Daniel, who is Division Chief in the European Department and the Mission Chief for Portugal. After that he will be happy to take your questions.

MR. DANIEL: Good morning, everyone, or good afternoon over there. Thank you for calling in. I'm here to talk about the report that you have in front of you and the PIN, which is an IMF term, but it's basically a summary of the facts and what the international financial community thought of our report.

A couple of housekeeping matters first. In the PIN, there's a change to the 2005 deficit, a small one, just a correction. A bigger piece of news for you is that, if you look at 2009, in the PIN and in the staff statement, you'll see a number of 0.6 percent for growth for 2009. That is what we were thinking a week or two ago.

Let me tell you that things have changed since then. This number is being revised down; it is not the number you will see in the published World Economic Outlook (WEO) next week. The number you'll see in the WEO for 2009 will not be 0.6, it will be substantially lower, and I'm not talking about 0.1, 0.2 lower. I can't give you the final number yet, not least because it's still in some degree transitioning, but I want to alert you to that.

I'd like to make now a few points about what the report, and IMF staff, are saying about Portugal, and then we'll take some questions.

The big picture here is that over the last 10 to 15 years, Portugal has accumulated very large macro imbalances. Basically, Portugal is spending far more than it consumes, and it's lost competitiveness because it's had very low productivity and reasonably strong wage increases. That's the fundamental problem that Portugal is facing.

The challenge to policy-makers is how to address these imbalances. And the trick here is to try and get incomes to grow more and not rely so much on having to compress consumption. But that's the over arching agenda here. The agenda for the policy-makers is to continue structural reforms to boost productivity, and fiscal consolidation to get macroeconomic imbalances sorted out.

Now, that's a bigger picture. In the last couple of years there's been substantial progress made on this agenda. A clear example is getting the deficit down from six to under three percent, the largest reduction in Europe, and it's been mainly spending-based, which is just how it should be. I would also point to things like the SIMPLEX reform for the business environment and the recent labor agreement. And as you can see, the international community has supported and welcomed these measures.

I would also add that were it not for these recent measures, Portugal would be in a much worse situation to confront the current financial crisis than it would otherwise have been. And look at the spreads on Portuguese debt, that's 60 - 70 basis points. Think what it would be like with a deficit of six, seven, eight percent, with debt on an upward spiral.

This crisis, though, will affect Portugal like the rest of Europe, and it will do so through two main channels. The first one is the typical trade channel. Pretty much all the Portuguese trading partners will have much lower growth. This will mean fewer exports by Portugal.

But there's another channel, and that's the financial channel. Banks will be much less willing to lend going forward. And added to this, Portuguese households are comparatively heavily indebted, and they're facing a rising debt burden. All this will translate into much lower growth, as I said, lower than the numbers that you've got in front of you. The financial system is also, as elsewhere in Europe, coming under pressure. Now, we're not bank auditors, we don't go into all the books. We look at the system as a whole. And overall, we remain of the view that it's sound, it's profitable, it's competitive, and it's well supervised.

But let's be frank, vulnerabilities have risen, especially on wholesale financing, where Portugal relies relatively heavily. And this is a reflection of what I was saying before. Because Portugal has this very large external debt, it means that it has to borrow a lot from other people, and that's the vulnerability.

On the other hand, I'd also point to some strengths. Banks start from a relatively strong position; there's certainly no housing boom, banks aren't holding significant amounts of these subprime toxic assets, and I know from my conversation with the Governor and from the FSAP, which is the financial assessment that we did a couple of years ago, and from our ongoing work, that the quality of supervision is very high, the bank of Portugal is well on top of the situation, and they stand ready to take measures promptly, as warranted.

Now, let me just summarize one more point, and this is for the policy-makers. There could be a temptation, certainly we've seen it in some countries, to say this crisis means we should give up on our policies for structural reform and fiscal consolidation; I would say quite the opposite. This is now not the time to start undoing the benefits of fiscal credibility, of making your economy more flexible and competitive. We should try and keep the policies in Portugal such that you can resume the income convergence with the rest of Europe, and that means building on the recent achievements, building on the growing record of fiscal credibility, making domestic labor and product markets more flexible, keeping wages moderate while enhancing productivity, and as necessary, taking some further steps to enhance financial system regulation. I'll leave it there and take your questions.

QUESTIONER: Do you think that the 2008 growth forecast will be revised?

MR. DANIEL: The value of the 2008 will be revised down very marginally.

QUESTIONER: Will it will be around 0.5 or 0.6 percent?

MR. DANIEL: I can't confirm a particular number, but that sounds like a reasonable guess to me.

QUESTIONER: Do you think that this is provisional? How confident are you that it won't be revised down again? So what are the risks here?

MR. DANIEL: You have a good point there, because we, as other commentators have been revising down very continuously, I would point out that the IMF has been leading the world and certainly Portugal, in realistic forecasts for this current difficult situation.

We have tried our best in the WEO that's coming out next week to give a forecast which we think reflects this down-side scenario. So, before we were talking about down side risks being there, now we think the down side risks are pretty much coming to fruition. It could be worse, but we have a pretty negative outlook now, and we don't expect significant revisions going forward. But the world is changing quickly. We certainly have taken a pretty negative view on the impact of the financial crisis through the various channels. So we are fairly confident with this, and as you'll see, we're probably leading the world in the amount that we're taking account of it. I can't guarantee it won't change, but we hope not.

QUESTIONER: Concerning the fiscal consolidation, I don't understand quite well, you have here for general government balance two percent in 2007 and then two percent in 2008. I guess there must be something that's not right with these numbers in the PIN.

MR. DANIEL: We have 2.2 percent for 2009, 2.4 for 2008, 2.7 for 2007. Is that a different series than what you have?

MR. GEORGE: Okay. There must be some problem.

MS. GAVIRIA: I think it's the version that you have. We will correct the table in the PIN posted in the Media briefing Center.

QUESTIONER: The government is saying 2.2 for this year in the excessive deficit procedure report. Basically the government says that it will be able to meet the 2.2 percent objective, mainly due to social security revenue. Is there something that you can have on the consolidation part?

MR. DANIEL: Yes, you're right to point it out. The number we have in the PIN is 2.4. But if you look at the report, on table three, we explain it. There are two numbers. The overall balance, that's the one that people look at, is 2.2.

However, the number that we reported, excluding one-off of measures, because there were a couple of minor measures, that's why we have minus 2.4. But, yes, we think the government will hit its target this year.

QUESTIONER: Okay, this year. Is there any chance the fiscal and tax receipts are growing for the first time since 2003, growing below the growth of the economy? I guess the next budget, which will be presented in a couple of weeks, will be very hard on that part. Are you confident that the government will keep to this consolidation or what can be said on that?

MR. DANIEL: For 2009, we advise and we expect, and the government had certainly indicated the same when we were there, that they will still go for a structural consolidation of 0.5 percent in structural terms. Now, that doesn't translate into a deficit reduction of 0.5 percent because the economy is worsening. But we will look at the budget and we will expect to see a structural consolidation that's of the underlying balance of half a percentage point of GDP, and that's certainly the message that we got from the government. And that's also the message that the international financial community was sending to Portugal in our meeting last Wednesday: that they expect to see that amount of structural adjustment next year.

QUESTIONER: Just one final question on the financial part, on the financial system. Portugal has been, well, not directly affected by this turmoil; however, there are, even in the stability reports from the central bank, there is this point that is mentioned regarding the pension funds, and the effect that might have on capital requirements. Is it likely that banks might have to raise capital in the near future to meet the solvency ratios, the requirements, or are you comfortable with the overall picture here?

MR. DANIEL: I think overall we're very comfortable. I mean, we notice that Portuguese banks have been proactively raising capital early in the year, which is a very sensible and forward looking step, and that gives a lot of confidence. We do know that Portuguese banks are particularly exposed to equity prices through their pensions, and we do know that, of course, these have come under pressure. We don't have the very latest information, but I do know that Portuguese banks entered into the situation with relatively good capital buffers, so I think you'll probably see capital raising done elsewhere before Portugal, but that's more of a tactical matter and I wouldn't want to comment on that.

QUESTIONER: Would that be a strong restriction on growth, the fact that banks will find it harder to refinance this 10 percent of external deficit in Portugal?

MR. DANIEL: I think this is going to be a major channel through which the international financial crisis will affect Portugal. Banks are finding funding much more difficult. They're now fighting for retail deposits, they're refinancing with the ECB, they're slowing credit growth. Households will be feeling the pressure of their debt burdens much more, they'll be paying much more in interest and principal repayments, conditions for lending is going to be tightened, costs are going to be much higher. The household sector in Portugal is relatively high in debt; this will be a major channel, yes. That's one of the reasons why growth will struggle to be in positive territory.

MS. GAVIRIA: If there are no more questions, We end the conference call here. Thank you everyone for participating.

MR. DANIEL: Thank you.


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