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Advertisement reads ‘With the IMF, it’s you who pays’ as Portugal comes to terms with the effects of its international economic bailout

The effects of the international economic bailout of Portugal will be felt through the country, but some see the measures as an opportunity for the country to emerge as a more competitive, export-friendly entity.

Difficult years lie ahead for Portugal and Portuguese banks after the country was forced to follow Greece and Ireland in seeking an international economic bailout, under intense pressure from markets and other EU governments.

Ricardo Salgado, chief executive of Banco Espírito Santo (BES), Portugal’s third largest bank by loans and deposits, has warned of up to four years of recession if adequate reforms are not introduced to discipline public finances and increase productivity.

Beyond the immediate pain, however, bankers, companies and policy-makers see the crisis as an opportunity to address the underlying causes of the country’s economic woes: weak growth and a lack of international competitiveness.

“The key question is whether Portugal can avoid another lost decade of low growth,” says Emilie Gay, an economist with research consultant Capital Economics. The bailout was triggered by immediate concerns over the government’s ability to finance its debt.

But Portugal’s more fundamental problems, says Ms Gay, include “high household and corporate debt levels, an uncompetitive export sector, poor education standards, high regulatory burdens and deep-seated rigidities in labour and product markets”.

Same problem, different causes

The three rescued economies on Europe’s periphery owe their plight to varying causes. Greece manipulated its public accounts over several years, and Ireland was hit by a property crash that led to a banking crisis. Portugal, in contrast, has been brought down by persistently weak economic growth and a sharp loss of export competitiveness. “The core of the country’s economic troubles lies in low productivity growth,” says Antonio Garcia Pascual, an economist at Barclays Capital Research.

Between 2000 and 2009, average wages in the country grew by 37.9%, the biggest increase in Europe after Spain, Ireland and Greece. But productivity growth over the same period was 5.9%, well below the eurozone average of 7.2%.

The result was a 30% increase in unit labour costs, pricing Portuguese goods out of export markets, with no possibility of reverting to the country’s pre-euro practice of devaluing its currency to restore competitiveness.

Portugal’s boom years came immediately before joining the euro, as EU structural funds, the prospect of a strong currency and falling interests rates lifted domestic demand. But, in sharp contrast to Greece and Ireland, the fastest-growing eurozone economies from 2001 to 2007, Portugal’s boom turned to downturn inside the euro, with average annual growth of only 1.1% over the past decade, the weakest in the single currency bloc.

Neither selling nor saving enough to finance its borrowing, the country has seen its public debt-to-gross domestic product (GDP) ratio soar to a forecast 97% this year, compared with about 63% before the global financial crisis. The current account deficit, at more than 10% of GDP, is also one of the highest in the eurozone.

Call for export growth

BES's Mr Salgado believes the only way of out Portugal’s vicious circle of low growth and debt is through export growth. “Exports currently account for about 32% of GDP,” he told a recent BES conference on innovation. “A 10-point increase would expand national output by 11% and cut the external deficit by about four percentage points.”

Exports as a percentage of GDP - 2010 comparison

Portuguese industry is dominated by small and medium-sized enterprises, a total of 330,000 companies, of which only 5% are exporters. "Any progress for our economy has to come from overseas, through innovation, internationalisation and exports," says Mr Salgado.

Banks are leading the way. International business is currently contributing almost 60% to the consolidated net profits of lenders such as BES and Banco BPI, Portugal’s fourth largest listed bank, up from an average of about 25% over the previous three years. Oil-rich Angola and, to a lesser extent, Mozambique, former Portuguese colonies, are the biggest overseas markets for both banks.

But lifting industrial exports will require robust reforms to make labour markets more flexible, raise educational standards and improve the business environment. “Without a strong structural reform agenda, it is very unlikely that the country can grow out of its indebtedness,” says Mr Pascual of Barclays Capital.

José Sócrates, Portugal's outgoing prime minister, began to push through controversial labour market reforms before opposition parties defeated his minority Socialist government in a key vote on austerity measures in March, triggering an early election on June 5.

These and other reforms, aimed at closing the competitiveness gap separating Portugal from more developed EU countries, will form the basis of an adjustment programme negotiated with the European Commission, the European Central Bank and the International Monetary Fund in return for bailout loans expected to total about €80bn.

U-turn on economic policy

Portugal needs to make “a complete U-turn” in its economic policies, according to Jan Kees de Jager, the Dutch finance minister, expressing the determination of Europe’s more fiscally conservative governments to impose tough conditions on the Lisbon government.

Rui Constantino, chief economist at Banco Santander Totta, Portugal’s third largest private sector bank, said the bailout agreement with the EU and the IMF would help ensure that structural reforms were rapidly introduced, with the Lisbon government having to present quarterly progress reports on which the continuing disbursement of funds would depend.

Shortly before his austerity package was voted down, Mr Sócrates reached an agreement with employers and one of the country’s two trade union federations to reduce compensation payments and notice periods for dismissed workers, currently among the most generous in Europe. Inflexible employment practices, including collective wage bargaining, are seen as one of the main causes of Portugal’s loss of competitiveness over the past decade, giving unions the power to push through pay increases above productivity gains.

Mr Sócrates was also preparing to implement measures to encourage more wage bargaining at the firm or sector level as well as greater flexibility over working hours and the temporary suspension of work contracts during business crises. Unemployment benefits, still high compared to those of Greece or Ireland, may also be cut further.

Similar reforms are almost certain to be included in the EU and IMF adjustment programme for Portugal, but could meet increased resistance from unions as unemployment climbs to 12.4% in 2012, according to IMF forecasts, the highest level in the country for more than 30 years.

During his six years in office, Mr Sócrates lifted government spending on education to 6% of GDP, the highest level among peripheral EU countries. But the economic benefits of recent progress in raising education standards will not be felt until the generations currently at school or college begin work. At the moment, the bulk of the workforce has the lowest level of post-secondary level educational achievement in the eurozone.

Poorly educated workforce

Rui Martins dos Santos, a senior economist at BPI, believes productivity will increase only gradually as workforce skills improve. “Productivity is about as high as it could be in the current conditions,” he says. “Portuguese workers are not lazy or undisciplined or lacking in commitment. They simply haven’t had the educational opportunities that others have had.”

More pressing for the EU and the IMF will be to ensure that Portugal meets its deficit-reduction commitments. These envisage almost halving the deficit from 8.6% of GDP in 2010 to 4.6% this year, with further cuts to 3% of GDP next year and 2% in 2013. This will require austerity measures that are expected to be even tougher than the package defeated in parliament. Further tax increases, public sector wage freezes or cuts and a special levy on pensions are among the most politically sensitive measures under consideration, along with sweeping privatisations.

The inevitable result will be at least two years of recession. The IMF forecasts that Portugal will be the only developed country with negative growth in 2012, with output declining 0.5% after a projected fall of 1.5% this year.

Pushing through difficult structural reforms in this climate will not be an easy task. Bankers, like many other business leaders and economists, are urging Portugal’s main political parties to put aside their quarrels and ensure that the government selected in the June election has broad majority support. “Given the gravity of the situation, I’m confident that our political leaders will rise to the challenge,” Mr Salgado told Portuguese television.

Portugal's unit labour cost and productivity compared with EU15


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