Portugal has learned the hard way that there are two sides to the euro. In the late 1990s, qualifying to join the single currency prompted an enthusiastic surge of government, corporate and consumer spending, fuelled by historically low interest rates, EU funds and a buoyant international economy.
The euphoria quickly turned sour. Levels of state, company and family debt soared to unsustainable levels. Wage increases unrelated to productivity gains damaged competitiveness. The external deficit spiralled. And when the global economy began to falter, Portugal fell headlong into recession.
GDP growth plummeted 1.3% last year, hitting Portugal with Europe’s worst recession just as tough austerity measures were being enforced to comply with the eurozone’s growth and stability pact. From confidence and exhilaration, the mood swung rapidly to gloom and pessimism.
Recession, however, has had a salutary effect. Government, companies and consumers have retrenched, bringing soaring debt levels under control, cutting back the current account deficit and holding down inflation.
“Sometimes you need a shock for people to wake up and see that increased spending cannot be indefinitely sustained by higher debt,” says Miguel Namorado Rosa, chief economist at Millennium BCP, the country’s biggest listed bank.
Resilient banks
Portuguese banks have weathered the downturn with surprising resilience. Net income and net assets for the sector both rose more than 8% last year despite the bleak economic outlook. Non-performing loans ratios are historically low.
“The fact that banks have emerged from this difficult period on such a sound footing reflects the huge effort they have been making to modernise, streamline and cut costs,” says Ricardo Espírito Santo Salgado, chairman of Banco Espírito Santo, one of the country’s big five banks.
Low interest rates have made the debt burden easier to bear for companies, families and the state. Amid encouraging signs from the global economy, Portugal is now confident of moving out of recession in 2004. The central bank, which is the most conservative forecaster, projects GDP growth of 0.8% this year and 1.8% in 2005.
The Euro 2004 football championship, which Portugal is due to host in June, will help to kick-start the economy and rebuild confidence. Whatever happens on the pitch, Portugal is banking on big rewards from the tournament. Officials expect up to half a million extra tourists because of the competition and an additional e260m in tourism revenue this year. Up to e360m a year in additional revenue is also forecast for the following six years as a result of the international attention the championship will bring to Portugal. This will boost government plans to strengthen tourism as one of the main pillars of the Portuguese economy.
Building seven new football stadiums and renovating three others for Euro 2004, involving a total investment of e5bn, has provided an important stimulus for construction, retail development and related sectors. Investment in a new high-speed rail network planned for the next decade is forecast to be more than e15bn and is expected to boost GDP growth by 1.7%.
The government expects the economy to be growing at about 3% by 2007, enough to resume closing the gap with the rest of Europe. GDP per capita grew from about 55% of the EU average in 1974, when democracy was restored in Portugal after 48 years of dictatorship, to 72% in 1997. But it has since fallen back to below 69%.
This has deepened a sense that the country has fallen behind. “Much progress has been made. But we’ve failed to make the structural reforms or change our culture so that we can achieve our full potential for growth,” says António Carrapatoso, chairman of Vodafone Portugal, the country’s second largest mobile phone operator. “When Europe suffers a downturn, all our weaknesses come to the surface.”
The new generation
Mr Carrapatoso is one of the promoters of an initiative called Compromisso (commitment) Portugal, which has mobilised more than 300 of a new generation of top businessmen, bankers, economists and academics in the belief that “Portugal can be transformed in 10 years ... and achieve a permanent place among the most developed countries in Europe”.
This generation, which came of age after Portugal returned to democracy, is now coming to the fore in politics, business and banking. They see it as their duty to push Portugal rapidly forward. “I have grown tired of seeing Portugal at the bottom of every statistical chart,” says Prime Minister José Manuel Durão Barroso, 48. “I believe it’s my generation’s responsibility to change that.”
Mr Durão Barroso, whose centre-right government took office two years ago, has adopted a rigorous approach to controlling public finances. This has set the tone for a national return to prudence and financial discipline after the spending spree of the late 1990s.
He inherited a soaring budget deficit from the previous Socialist government, with Portugal under the threat of sanctions from the European Commission for breaching the stability pact. Determined to comply with the pact and regain Portugal’s international credibility, he imposed tough austerity measures: raising VAT, holding down public sector pay, freezing civil service recruitment, abolishing dozens of state institutes, raising university fees and postponing a promised cut in corporate tax. He urged stoicism while the country suffered the sharpest recession in Europe, with unemployment reaching a six-year high of 6.6% last year.
Rapid deficit cut
In 2002, against all expectations at home and abroad, Mr Durão Barroso succeeded in cutting the deficit from 4.4% of GDP to 2.7%, within the 3% stability pact limit, in just eight months. Last year, he again overturned the pessimistic forecasts of the big international institutions by keeping the deficit down to 2.8% of GDP.
“This was a great victory not only for my government but for the whole of Portugal” he says. “It’s a testament to the adaptability of the Portuguese economy and I doubt that any other country in Europe could have achieved it.” At the same time, the current and capital account deficit has fallen from 8.8% of GDP in 2000 to about 3.5% last year.
The deficit battle could not have been won without the help of extraordinary, one-off revenue-generating measures, such as the sale of state-owned real estate and other assets. This effort to hold down the deficit is also providing business opportunities for banks.
A consortium led by Citigroup has won a contract to securitise outstanding tax and social security payments worth e1.8bn The state also plans to securitise e700m in debts owed to the pharmaceutical industry by the national health service.
Avoiding recession
Manuela Ferreira Leite, the finance minister who has been dubbed Portugal’s “iron lady” for her uncompromising approach to public finances, defends these extraordinary measures as the best way to avert tax increases and drastic cuts in public spending that would aggravate the recession. Non-recurring measures also provide revenue in the intervening period before long-term structural reforms produce results.
“We have tried to establish a balance and not increase revenue or cut expenditure so intensely that it would have a recessionary impact,” she says.
She insists that Portugal has to maintain strict control over its deficit, not just to comply with the EU pact or to uphold its international credibility, but mainly because it is right for the economy. “It would be a dramatic mistake if we persisted with the idea of public expenditure as an impulse for economic recovery,” she says. “We need to keep the deficit below 3% of GDP regardless of the stability pact.”
Wage restraint has been important in consolidating public finances, with public administrative sector pay, which accounts for the lion’s share of state spending – 15% of GDP compared with an EU average of 10% – being virtually frozen in real terms over the past two years. As unemployment rises, public sector workers, who are protected from redundancies by the constitution, have come to value their job stability above pay increases, says Ms Ferreira Leite.
The government has welcomed proposals for public sector wage agreements to take place every few years and for a pact with the Socialists, the main opposition party, on budget consolidation. The aim is to manage state spending on a stable, long-term basis, regardless of any change in government, to avert future deficit overruns. Party politics are still standing in the way of such a deal but economists have been encouraged by the positive response to the idea.
The fight for fiscal rectitude, however, is not yet over. The central bank, the IMF and the European Commission all warn that a difficult struggle still lies ahead. But Mr Durão Barroso believes that he has at least been successful in instilling a new mood of prudence. “Not since Portugal was founded in the 12th century has the deficit and the need to control state spending been such a focus of attention,” he says. “We are at last discarding the idea that the state is more important than individual initiative.”
Global downturn
Not all of Portugal’s economic difficulties, however, can be blamed on the deficit crisis and the readjustment of the domestic indebtedness. Vitor Constâncio, governor of the Bank of Portugal, the central bank, highlights the sharp impact that the global downturn had on the small, open Portuguese economy. More than 80% of Portuguese exports go to the other 14 EU countries and more than two-thirds to the eurozone. This has helped to protect Portuguese exporters from the impact of the strong euro but it also means that Portuguese growth is greatly determined by what happens in the big European economies.
“Between 1995 and 2000, external demand increased at an average of 9% a year and reached 10.8% in 2001,” says Mr Constâncio. “In 2001, the growth rate fell to 1.4% and in 2002 to only 0.8%. This had a very significant impact on the economy.”
The fall in domestic demand during the past two years has encouraged companies that had been relying on buoyant local markets to redirect their energies into exports, he says. This has produced positive results, with Portuguese companies increasing their share of export markets even though export growth has slowed.
Mr Constâncio is also encouraged by a favourable change in the structure of Portuguese exports. Over the past 10 years, he says, Portugal’s traditional low-cost, low-wage export sectors – mainly textiles and footwear – have fallen by 15 points as a percentage of total exports, while more technologically demanding sectors such as electronics, car components and chemicals have gained 14 percentage points.
Fernando Ulrich, the newly-appointed chief executive of Banco BPI, one of Portugal’s five biggest banks, identifies a more enterprising, competitive approach by the corporate sector. “Companies are focusing their strategies, cutting costs, streamlining their operations and reducing their debt,” he says. “They’ve done their homework and are now in a much better position to invest than they were two years ago.”
New economic model
Mr Durão Barroso wants exports and private sector investment, rather than public spending, to lead the economy out of recession and become the foundation for a new model of economic development based on increased productivity and competitiveness. The government’s job, he says, is to create the right conditions for companies to thrive.
Increasing productivity, which is currently the lowest in the EU, is the big challenge. According to the European Commission, productivity per employee was only 44% of the EU average in 2002. The barriers to higher productivity include an under-performing education system, a low level of spending on research and development, a slow-moving, bureaucratic public administration and a low level of competition in industries such as telecommunications, energy, water and motorways.
The government coalition has earned respect from the banking sector as pro-business and reform orientated. Its reform programme is aimed at increasing productivity, with a focus on improving the business environment, enhancing competition and upgrading skills.
Confidence is growing that the new generation now taking the reins in Portugal will move the country forward at a faster pace. António Horta Osório, chief executive of Banco Totta, one of Portugal’s top five banks, and part of Spain’s Santander group, points to the example of Ireland. Its GDP per capita grew from 90% of the EU average to 125% in only 10 years, he says. Portugal still has a long way to go, but a belief is taking hold that the country is accelerating in the right direction. Government reform The government’s reform programme includes:
- new labour legislation to make the job market more flexible
- new social security laws aimed at increasing choice and making the system more sustainable
- creating an independent competition authority with a mandate to combat anticompetitive practices and promote market transparency
- new bankruptcy and intellectual property laws
- streamlining industrial licensing measures, significantly speeding up the incorporation of companies, privatising notaries and cutting the tax costs of mergers and acquisitions
- tax credits for companies that reinvest earnings and a pledge to reduce corporate tax from 30% in 2003 to 20% in 2006
