Transcript of a Conference Call on the Second Review of the IMF-Supported Program with Portugal

December 21, 2011

Washington, D.C.
December 21, 2011

Ms. Nardin: Good morning and thank you for joining this conference call on the second review of the IMF-supported program with Portugal. My name is Simonetta Nardin with the External Relations Department of the IMF, and here to conduct this conference call are Hossein Samiei, an Adviser in the European Department, and Ivanna Vladkova, Senior Economist in the same department.

MR. THOMSEN: Thank you, Simonetta. Welcome to this conference call. I shall be very brief in my introductory remarks. As you know, the IMF Executive Board reviewed the second review of the Portuguese program on December 19. Directors agreed that the program is off to a good start. It's broadly on track. In particular, the 2012 budget is in line with the program's ambitious targets for fiscal consolidation, financial sector policies are being implemented as agreed, and the structural reform program is also off to a good start.

Directors noted two areas of concern. One, as you know, there is a considerable fiscal shortfall in 2011. This is being offset by transfers from the pension fund, but this is obviously a one-off arrangement and the fact is that the underlying fiscal adjustment has fallen short of targets in 2011. The good news is that the government is catching up and the 2012 budget gets Portugal back to the original fiscal targets, and that it does so through high-quality measures.

The second area of concern is related to fiscal devaluation. Fiscal devaluation was a key measure of the program and the decision to forego it clearly leaves a gap in the structural reform agenda. Again, the good news is that the government is fully aware of that, and has decided to redouble its effort in this regard starting with a dialogue with social partners, other parties, academic institutions, on what can be done to strengthen the structural reform. This is of course is important. As we know, Portugal's problem is above all of a structural nature and reforms to boost potential growth and improve competitiveness are key to ensure the success of the program. Without it, the competitiveness gap will be closed through recessionary channels and nobody wants that. We wanted it as a measure to boost productivity and growth and employment.

Let me conclude by saying again we're off to a good start. Most of the program is on track, and in the areas where there has been some shortfalls, measures are being taken to catch up and overcome it.

QUESTION Mr. Thomsen, I was wondering about the fiscal devaluation. When does the IMF estimate that the government will once again study the proposal, and if the IMF maintains its recommendation of significant cuts in social contributions.

MR. THOMSEN: Perhaps I was not clear enough on this. My understanding is that the government has taken that off its agenda, at least for now. So what I was saying is that that means that we have a gap in the structural reform agenda, that one needs to come up with alternative measures for how to boost productivity, for how to improve competitiveness, for how to make sure that this adjustment does not take place through recession but to increased productivity. That's the challenge facing the government. And then given that Portugal's problem is above all to open up what is in many ways a closed economy, I think this is where one should be looking. What can one do to have more competition and to shift resources to the tradable sector? My understanding is that the government will be intending to come back already at the time of the next review with a strengthened reform agenda in this regard.

QUESTION: One follow-up. What do you think could be a few alternative measures to the fiscal devaluation then?

MR. THOMSEN: As I said, I think where one has to look is on measures that accelerate the opening up of the non-tradable sector to more competition so we get some downward pressure on prices in those sectors. This is where I would look first, but we will see. We will be a part of this discussion in January or February, ahead of the next review. QUESTION: Mr. Thomsen, I have three questions for you. First on government employees. In this review, you said that the annual reduction of the number of government employees must be of 2 percent between 2012 and 2014. I want to ask you this. How can the government achieve this goal? What are the IMF's suggestions to achieve this goal? The second question is about public transportation and the rise of prices of public transportation is also a measure here in the second review. Our government is set to raise public transportation prices 4 percent in line with inflation. I would like for you to comment if this rise is sufficient or is not enough. The third question is about health benefits, especially the scheme of health benefits for government employees. You said in the second review that we must reduce the cost of health benefits. I would like to know if this means to end the special schemes and integrate them in an overall scheme of Social Security. Thank you.

MR. THOMSEN: Thank you. Several of these questions go beyond what I can specifically give you at this stage. This is being discussed and this is really for the government to decide. On the first issue of the targets for employment reduction, my understanding is that this can be largely be achieved through attrition, so that's that. On public transportation, we have no means for their determining what should be the increase. This is decided by the government. But obviously there needs to be a restructuring plan for the public transportation enterprises and that's what we want, and one parameter in that is of course tariffs. But we are looking at the bigger picture. We need a restructuring plan that makes these companies viable and the government will determine the parameters for that. The same is with health benefits. Clearly regaining control over health expenditures is very important, but we certainly at the Fund do not have the expertise to go in and say how precisely that should be done. The government will bring in experts that will do that.

Let me add. Of course, one thing that we are concerned about is the health system. We need to regain control over that, and this is one of the overall objectives of these reforms.

QUESTION: I have three questions. The first is what are in your opinion the main obstacles for achieving the deficit goals for next year? Do you think public companies' costs, mainly transports, and sovereign debt and the Euro crisis are the main difficulties? And I would ask also in the scenario of a deepening of the Euro crisis, do you foresee the need to establish additional measures?

MR. THOMSEN: These are very good questions, actually. On the risks next year, I think it's clear that if we look at this year, we all know that there are problems with expenditure controls at all levels of government, but not least in state enterprises. And clearly, the feasibility of the target assumes that the government delivers on this process, that is, on the way of gradually strengthening expenditure controls in the public sector. So I think this is the key domestic challenge. And it is indeed possible that Portugal will face stronger headwinds from a more difficult situation in Europe, so I do think this is indeed the second main risk. And you go on to rightly ask what should one do? One would have to obviously look at how serious the situation is and quantify carefully. If the fiscal program is implemented as agreed, if there is no shortfall on measures and expenditure control holds up but there are much stronger headwinds from Europe, then I think one needs to keep an open mind about whether one at that stage would need to relax the fiscal targets. One would have to look at the strength of the economy and on domestic factors, domestic demand. But if there is a major deterioration in the external environment that really hits growth badly in Portugal, I don't think one can just blindly say we need more fiscal adjustment to keep to the original fiscal targets. One would have to be willing to review that, but I'm not saying that to you that the result would be one of the other but I certainly would need to keep an open mind about reviewing it.

QUESTION: Mr. Thomsen, I have two or three questions. Do you have any advice on how the government should spend the extra money from the bank pension funds that are being transferred to Social Security? Then about fiscal devaluation, do you think it's enough to boost competitiveness to increase by 30 minutes the daily working schedule? Finally, do you think it will be necessary in the near future to fire public servants?

MR. THOMSEN: Again, good questions. Given the risks that we just talked about, I think any extra money should be saved to give more margins for maneuver in the case of downside risks. Two, on fiscal devaluation, no, I don't think 30 minutes itself is enough to offset the lack of fiscal devaluation and I think the government is recognizing this by saying that we'll need to do more on structural reform and we need to have a dialogue on what this should be so that I think definitely more needs to be done. On public servants, civil servants, as I said before, my understanding is that the targets can mainly be achieved through attrition, but there is also a process underway of evaluating the boundaries of the public sector including the usefulness and viability of public entities and if it's decided to close a public entity, I think that one would then have to consider options regarding layoffs. But, no, this is for the government to decide. I think the overall objectives should be to have a thorough review of all public sector functions and be willing to close public sector enterprises if they are not needed.

QUESTION: Good morning. I have two questions, one on the pension fund transfer from the banks. Obviously it will have an impact this year in terms of the deficit. I was wondering if you had any comments in terms of the impact it would have on the other side in terms of liabilities of the government over the course of pension liabilities. I suspect that it will be very diluted over the years so it won't necessarily have an impact on debt to GDP figures in any one year, but I was wondering if you had any comments it would have on the liability side for the government or for the state. My second question if possible, a more historical question, on whether you see any similarities between the adjustment that Portugal is undergoing and will have to undergo without currency devaluation with any similar adjustment processes that you've seen say in the last two or three decades. Are there any similarities with Eastern European countries or elsewhere?

MR. SAMIEI: On the pension fund, as you know, under ESA 95, this counts as capital revenue above the line which means that the amount of deficit this year will fall by the full amount of the transfer. So this year we do not differentiate the program target from the standard definition. For next year, however, any transfer that may take place will not still affect the standard definition of the deficit but not the program definition so that in effect it cannot be used to lower the deficit. As far as liabilities are concerned, this as you know, is a pay as you go system so the way that assets and liabilities are assessed is different from the way it was under the banks, but I can give you some estimates for next year. The transfer that is going to take place this year is going to have additional expenditure costs for the government of about 500 to 500 million euros for the year as a whole.

MR. THOMSEN: On the lessons on structural reforms, I think it's clear if you are in a currency union and you suddenly one day gradually develop a severe competitiveness problem relative to your partners in the union and suddenly one day you cannot finance it anymore, fundamentally there are two options. You can either try to make your existing wages affordable by becoming more productive, or the other extreme, you reduce your wages meaning you become poorer, and we all want it to happen through the first channel and not to the recessionary channel. This is why I say that the structural reform in Portugal, where you do not have the benefit of exchange rate, changes are so important to be able to do this in a socially acceptable manner.

MR. SAMIEI: Could I add that the experience of the program in Portugal in the 1970s and 1980s one thing you had in mind illustrated that devaluation could work well and that is why we were keen on fiscal devaluation as the nearest alternative to a regular devaluation. This would have had to be supported by structural reform anyway as Mr. Thomsen noted and now it would be harder but it still a reform that is needed because the domestic non-tradable sector needs to be opened up.

QUESTION Good morning. Mr. Thomsen, you said that one of the biggest risks that Portugal faces is the deepening of the European debt crisis. What I would like to know is if in fact in the next year this crisis gets worse, the IMF still expects Portugal to return to the market in the next year as was expected or do you think that Portugal will need another bailout? My second question is about the extra money that the government is going to save with the transfer of the pension funds. The government is saying that it wants to use it to clean some arrears in the public system, mainly of the public enterprises but you were saying it would be better to save that money in case of slippages in the budget. So what do you think about this option of the government?

MR. THOMSEN: On our first question, let me just be clear. I don't think that the debt crisis will get worse. I do think that Europe is putting in place the mechanisms to get control over this. But what I said is that I think that as for European GDP, there's the risk that GDP will slow significantly compared to what we assumed before. We are still looking at that to give you some numbers, but I think it is likely that we're going to have lower demand for Portuguese exports from Europe than we thought before, possibly notably lower. So this is the main risk.

That being said, of course the uncertainty about debt in Europe and the periphery is not going to go away overnight. I am still confident that with the implementation of this program, Portugal can return to the market as expected and will not need what you called a second bailout. But I would also again refer you to the decision of the European leaders back in the summer where they say they stand ready to support Portugal and other countries for as long as it takes for them to get back to market provided that the program is being implemented as planned. So I think that's all that needs to be said on this issue.

On pensions, I think using money to clear arrears is a good idea, but we need to have an overall picture on what are the risks and the priorities before one does so, and one needs to have safeguards that one can control expenditures and that there is no new accumulation of arrears before one starts pouring in a lot of money to clear arrears. Clearly, settling arrears should be a priority.

QUESTION: Good afternoon, Mr. Thomsen you were very concerned for the rent seeking behavior of some companies, namely in the energy sector. I have two questions on that if you'll allow me. One is what do you mean by eventually establishing new conditionality in this area? What can this actually mean? I know what conditionality means, but could you be a little bit more concrete on this and elaborate on this? Then the other one is we are having the major energy company being privatized and tomorrow I think we'll know the results. I was wondering if you can comment on that. How will the privatization help in this problem of higher rents that are not good for the economy? Then also on the public sector, it is said that there is going to be a review of all wage scales in the general government in order to also eliminate eventual -- the fact that they might earn more than in the private sector. I was wondering how deep is this commitment and how important is this commitment of trying to introduce some kind of logic in salaries when comparing the public sector and the private sector. Thank you.

MS. VLADKOVA: Thank you. I will answer the question that you had on the energy sector more generally what we mean by further conditionality and how this relates to the privatization of EDP. Basically the idea here is to follow-up on what Mr. Thomsen had mentioned earlier: that in the absence of fiscal devaluation, we need to look for measures to put further downward pressure on relative prices in the Portuguese economy. In that respect, the energy sector has been widely recognized as a sector where excess rents exist and there's a lot of scope for putting downward pressure on prices. The reason why we don't have a specific measure this time around is particularly because of the privatization process, we wanted to look for an effective but market-friendly measure in this particular sector. There is a commitment that we will revisit this particular conditionality at the time of the next review in the broader scope of looking to expand the agenda of structural reform. I'm sorry, could you repeat your question on public sector wages?

QUESTION: There is going to be a review of all wage scales in the public sector. I was wondering why is this and how important is this in the strategy to reform the public administration?

MR. SAMIEI: This is something that obviously is not built quite in the program. It is important for the improvements of the efficiency and rationalization of the public sector to do such a study, but at this point I don't really have any more comments to make.

MS. NARDIN: Thank you very much. This concludes our conference call.


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