Portugal exited a punishing three-year bail-out almost a year ago, and the chief question facing voters in a general election in October is: has it worked? The ruling centre-right coalition led by prime minister Pedro Passos Coelho embraced a painful economic adjustment programme devised by the EU and the International Monetary Fund (IMF) in return for €78bn in rescue funds, promising not only to implement the raft of tough measures, but to “go beyond the bail-out”.
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Four years on, the two coalition parties are trailing in opinion polls behind the opposition Socialists, whose leader, António Costa, condemns the rescue programme as “an abject failure that has produced nothing but poverty”. However, the gap in the polls separating the combined vote of the right-of-centre coalition parties from the centre-left Socialists is narrow, at about three percentage points.
Hit hard
Portugal has escaped the populist left-wing backlash against mainstream parties that has radically altered politics in other crisis-hit countries such as Greece, Spain and Ireland. Given that the Portuguese have been hit comparably hard by record unemployment, swingeing public spending cuts, tax increases and a wave of emigration, the political signs suggest that a substantial proportion of the country’s hard-pressed voters share at least a grudging belief that the bail-out has proved relatively effective.
“In Portugal there is the additional uncertainty that always accompanies an election year, but it is a stable political environment, and that is remarkable after such a long and difficult adjustment period,” says Nuno Amado, chief executive of Millennium bcp, Portugal’s largest bank by market value. “Portugal is in a much better position than other countries in that respect.”
“Portugal is like Spain, but with less political risk,” Ralph Solveen, an analyst with Commerzbank, says in a recent report. “Markets are increasingly recognising that the Spanish economy has now bottomed out and is on the road to recovery. It is often overlooked that the same also applies to Portugal, where reforms are working.”
The Portuguese economy began to recover in 2013 and since early 2014 growth in gross domestic product (GDP) has been above the eurozone average. After growth of 0.9% last year, economists at Berenberg forecast the economy would expand by 1.7% this year and 2.3% in 2016.
Remaining doubts
However, on the ground, in many companies and homes, there is little sense of a burgeoning recovery. “I think the main factor now is at least in part psychological,” says Mr Amado. “People aren’t ready to believe that the economy is recovering. Businesses remain doubtful about taking investment decisions that are critical for the future. They want to wait a bit more and that is understandable.”
However, Pedro Siza Vieira, head of the Lisbon office of law firm Linklaters, says Portugal is becoming increasingly attractive as an investment destination. “A lot of investment decisions and transactions are taking place that are not reflected in the overall growth figures. We can expect to see changes in the capital and shareholding structures of a lot of significant businesses in a positive trend towards replacing owner-managers with professional management.”
Portugal’s growth is seen by some to be an average of two contrasting economies operating in the same country. “On one side, there’s a very dynamic part of the economy that is exporting, investing and creating jobs,” says a senior bank economist in Lisbon. “On the other is the old side of the economy, which is still burdened by deficient business models, high levels of debt and a lack of ambition.”
This failing sector includes many so-called 'zombie companies', which borrow just to service existing debt, rather than to invest or expand. How to deal with these ailing firms poses a significant challenge to banks, legislators and regulators.
Debt burden
Combined household and corporate debt in Portugal peaked at close to 230% of GDP in 2013, falling back towards 200% last year. “The economy is being held back by the fact that households and companies are still paying down substantial debts accumulated before the financial crisis,” says Mr Solveen. “The process of debt reduction continued to accelerate until recently and, unlike in Spain, there are no signs yet of any easing in this growth-inhibiting phenomenon.”
The recovery is being driven partly by exports, which are growing strongly on the back of Portugal’s improved competitiveness in global markets, and partly by domestic demand. The components of domestic demand are also evolving positively, with investment-linked imports replacing Portugal’s pre-crisis inclination for consumer goods. In the 12 months to September 2014, spending on machinery and equipment rose 10%.
A deceleration of external demand is one of the biggest risks for Portugal, which sells 70% of its exports to other EU countries and has seen a slowdown in the emerging markets into which exporters have been diversifying. But the strong recovery in Spain, Portugal’s biggest single export market, will help support exports, which Berenberg expects to grow at a net rate of 0.8% this year and 0.7% in 2016. The fall in the euro will also help exports, particularly in traditional sectors such as textiles, footwear and clothing, where Portugal is often competing with lower cost producers in emerging markets.
Unemployment has been falling steadily too, from a peak of more than 17% in early 2013 to 13.3% in January this year, but still remains at historically unprecedented levels. Youth unemployment is above 33%, while a wave of emigration has depressed the jobless figures. Charging the government with allowing the pace of reform to slacken since exiting the bail-out, the IMF says fresh policy initiatives are needed to further lower the jobless rate.
Fiscal consolidation
Big strides forward have been made in fiscal consolidation, with the government reducing its primary budget deficit by about 3% of GDP in both 2011 and 2012. Enthusiasm for further consolidation has since waned. But Portugal’s government borrowing costs have fallen to recorded lows and will be further eased by the European Central Bank’s quantitative easing programme.
“The state is still too large and not efficient in certain areas and that means that reforms must continue,” says Mr Amado of Millennium. “This will, naturally, affect economic and employment growth. Even so, I am confident that over the medium term we will start to see a virtuous cycle that will create the conditions for a stronger pick-up in economic activity.”
