Portugal seeks to make a clean break

In Lisbon, a large digital clock installed by Paulo Portas, Portugal’s deputy prime minister, in the headquarters of his conservative Popular Party is counting down the minutes to midnight on May 16, 2014, the hour when the country’s punishing international bail-out officially ends.

The Portugal that emerges from three years of painful austerity measures as part of a €78bn rescue programme agreed with the 'troika' of the European Commission, International Monetary Fund and European Central Bank will still face years of tough fiscal consolidation and far-reaching reform. But with economic growth beginning to pick up at one of the fastest rates in the eurozone, pulling Portugal out of its deepest recession for more than 40 years, there are signs that the bail-out has accelerated a long-sought-after transformation to a more productive economy in which exports rather than domestic demand drive growth.

“The adjustment programme has gone a long way to restructuring the economy and making it more competitive,” says Nuno Amado, chief executive of Millennium BCP, the country’s largest listed bank by assets. “We are starting to see signs of real growth and many companies are ramping up their activities, particularly in export markets.”

New growth star

According to the centre-right coalition government of prime minister Pedro Passos Coelho, exports will account for 41% of gross domestic product (GDP) this year, compared with 31% in 2010. Export growth of 24.2% in the four years to December 2013 has helped deliver Portugal’s first current account surplus in two decades. The trade balance is also moving steadily towards a surplus next year.

“Strong export growth reflects the tremendous resilience of Portuguese firms in the face of tough conditions that would leave many other European companies struggling,” says Pedro Siza Vieira, managing partner at the Lisbon office of global law firm Linklaters. “The Portuguese as a whole have shown themselves ready to make sacrifices that I don’t think many other people would support.”

Exports have been driving growth at a pace that, according to Commerzbank analyst Ralph Solveen, makes Portugal “the biggest positive surprise” among peripheral eurozone countries. Year-on-year growth of 1.6% in the final quarter of 2013 surpassed the performance of every other member of the currency bloc, including Germany. Overall, however, the economy contracted by 1.4% in 2013, the country’s third consecutive year of recession.

In recognition of Portugal becoming the “eurozone’s new growth star”, as Berenberg senior economist Christian Schulz puts it, the troika concluded its penultimate quarterly review of the bail-out programme on a positive note in March, lifting its growth forecast for 2014 to 1.2%, up from 0.8%. It also projected a significant turnaround in investment, which it expects to grow by 3.1% this year, having previously forecast a 6.5% contraction. Unemployment, which has soared to recorded highs of more than 17%, was projected to fall to 15.7% this year.

“The key issue for the future is the sustainable growth rate that Portugal can achieve,” says Joaquim Souza, chief executive of Caixa-Banco de Investimento, the investment banking arm of state-owned Caixa Geral de Depósitos, Portugal’s largest lender by assets. “Are we going to be growing at 2% or 1% a year? The difference is very big in terms of job creation and bringing down public debt to a manageable level.”

Tough measures

Public debt as a percentage of national output has risen exponentially during the crisis, peaking at just less than 129% of GDP in 2013. As Rui Constantino, chief economist at Banco Santander Totta, Portugal’s fifth largest bank, points out, maintaining debt on a downward trend towards a sustainable level will require annual economic growth of 1.5% to 2% over the long term, as well as continued fiscal consolidation. “The process of adjustment will have to continue for many more years after the bail-out ends,” he says.

Further public spending cuts and tax increases are a daunting prospect for the Portuguese after a bail-out programme that has left deep scars. Tens of thousands of small businesses have gone under. An estimated 200 emigrants, many of them among the brightest and the best of Portugal’s young graduates, have been leaving the country every day, propelled by youth unemployment of almost 35%. Many public sector workers have seen their incomes cut by about 30% over the past three years.

“It is debatable whether [the adjustment programme] went too far in some aspects and in some areas, or if austerity could have been fine-tuned with more sensibility to avoid the very strong social impact it has had,” says José Maria Ricciardi, chief executive of Espirito Santo Investment Bank. “But the [budget] deficit and the dramatic situation of our public debt required tough measures and difficult decisions.”

Fiscal consolidation has already been extensive. Between 2011 and 2014, the government will have implemented deficit-reduction measures totalling more than €26.5bn – the equivalent of 16% of GDP. Spending cuts will account for 55% of the reduction and increased revenue, including what the government itself has described as “enormous tax rises” for the remainder. This consolidation has delivered Portugal’s first primary budget surplus (excluding interest rates) since the mid-1990s. The country has also become a net external lender for the first time in two decades.

Continuing to hit budget deficit targets agreed with bail-out lenders means Lisbon will still face what Mr Schulz calls “significant fiscal headwinds”. But the strength of the economic and fiscal turnaround, coupled with a positive change in debt market sentiment towards peripheral eurozone countries, has enabled Lisbon to consider making an Irish-style 'clean exit' from its rescue programme in May, without the safety net of a precautionary credit line. This marks a significant turnaround from only a few months ago when many investors and Brussels policy-makers feared Portugal would need a second full bail-out.

Culture shock

Encouraging economic signs and the upbeat mood of investors towards the eurozone periphery has seen the yield on Portugal’s benchmark 10-year government bonds fall to less than 5% this year, the lowest level since 2010 and down from a peak of more than 18% at the height of the eurozone debt crisis in January 2012. Increased investor appetite has also enabled Lisbon to tap the capital markets successfully, swapping €6.6bn in government bonds for debt with longer maturities in December and issuing €3.25bn in five-year debt in January. The public debt agency has now covered all the country’s financing requirements for 2014, and begun to build a cash cushion for 2015, easing the way for a full post-bail-out return to the market.

The improving economy has also triggered renewed interest from foreign direct investors. “Three years ago, anything Portuguese was treated like toxic waste,” says Mr Siza Vieira of Linklaters. “Now investors are actively looking for opportunities here.” One of the main attractions, he says, is a relatively highly skilled workforce combined with comparatively low wage costs. “Is there any other country in Europe where you can pay an engineer with 10 years' experience €1000 a month?” he asks.

According to government figures, more than 400 structural reforms aimed at improving competitiveness and making Portugal an easier place to do business have been introduced over the past three years as part of the adjustment programme. These range from adding seven days to the working year and speeding up civil court decisions, to liberalising energy markets and restricting collective bargaining.

“We need to change our culture and establish an ecosystem that encourages wealth creation,” says Mr Souza of CaixaBI. “You cannot waste two or three years in court if you go bankrupt. You also need stable tax laws and fiscal regulations, a flexible labour market and institutions willing to lend to start-ups.

“We have made a start,” he says. “Now that the economy is improving and we are moving away from the cliff edge, the biggest danger is that Portugal will lose the impetus to reform.”