As I mentioned yesterday, the results of the third EU-IMF mission to Lisbon to assess Portugal’s implementation of its €78bn bailout were to be release today. Amongst mounting speculation that the country is struggling to meet the specified targets, remembering it only met the 2011 targets by using one-off pension transfers from banks to the state , the report appears relatively positive.
The program is on track, but challenges remain. Policies are generally being implemented as planned and economic adjustment is underway. In particular, the large fiscal correction in 2011 and the strong 2012 budget have bolstered the credibility of Portugal’s front-loaded fiscal consolidation strategy. Financial sector reforms and deleveraging efforts are advancing, while steps are taken to ensure that credit needs of companies with sound growth prospects are met. Reforms to increase competitiveness, growth, and jobs have also progressed, although many reforms still await full implementation. The broad political and social consensus that is underpinning the program is a key asset.
Looking ahead, the Portuguese economy will continue to face headwinds. In 2012, trading partner import growth is expected to weaken further, while domestic demand adjusts, and unemployment and bankruptcies are rising. As a result, GDP in 2012 is expected to decline by 3¼ percent, following a fall of 1½ percent in 2011. In 2013, a slow recovery should take hold, mainly supported by private investment and exports. External adjustment is proceeding.
The fiscal deficit target for 2012 remains within reach. The deficit target of 4.5 percent of GDP is expected to be met with current policies, provided that downside risks to the economic outlook do not materialize. To contain fiscal risks, the government needs to strengthen measures to prevent arrears accumulation and implement a strategy to settle existing arrears. The government has also agreed an adjustment program with the autonomous region of Madeira and will continue to reform state-owned enterprises, further strengthen tax administration, and streamline public administration.
Further progress on protecting the banking system and ensuring orderly deleveraging has been made. The rules for providing public capital to banks have been clarified, and plans to ensure that capital buffers of individual banks meet end-June 2012 targets are being finalized. Given the recent monetary policy decisions by the ECB, banks’ liquidity constraints are expected to ease further. Furthermore, the authorities are considering a range of measures to mitigate funding strains for sound companies, including appropriate measures to discourage ever-greening of doubtful loans. Any such steps should avoid risks on public finances. Developments will be kept under close review to ensure that the inevitable deleveraging does not deprive dynamic enterprises of credit.
The issue is, however, that just like Greece, the 2013 target for a return to growth appears highly optimistic given recent data. While core Europe is scheduled to have a ‘mild’ recession, the latest figures from the OECD show Portugal’s economy shrank by 2.6% YoY in the fourth-quarter 2011. On top of that, the attempt by the government sector to reduce spending and raise taxes at a time when the private sector is also attempting to deleverage in an environment where the external sector does not provide a surplus is leading to the same outcomes we have seen in Greece:
Rising unemployment:
Falling industrial output:
Which ultimately means, as the latest figures from Portugal’s national bank show, the level of debt in the economy continues to grow while the economy deflates:
At the end of 2011, the non-consolidated debt of the non-financial sector amounted to around EUR 715 billions, corresponding to 418% of GDP (402% in 2010).
At that time, the non-consolidated debt of the non-financial public sector was of EUR 236 billions (138% of GDP). The consolidated Maastricht public debt3 net of deposits of the central government corresponded to 99% of GDP.
At the end of 2011, the non-consolidated debt of the non-financial private sector amounted to EUR 479 billions, representing 280% of GDP (281% in 2010). Private corporations registered a level of indebtedness of 178% of GDP (177% in 2010) while for private individuals the level was 103% of PIB (104% in 2010). The level of debt of private individuals in 2011 represented 121% of disposable income
The latest economic climate indicators from statistics Portugal also clearly show the problem:
So is it a surprise that the IMF’s report appears highly optimistic ? Not really. The IMF has an atrocious record of predicting the outcomes of Europe and the effectiveness and success of its own programs. Here is what Dominique Strauss-Kahn had to say about Europe’s future back in early 2010:
The head of the International Monetary Fund believes Greece will resolve its debt crisis without an IMF bailout, and today dismissed fears that other European nations will be engulfed by the crisis.
Dominique Strauss-Kahn insisted this morning that other eurozone countries with large public deficits would not be forced into the same predicament as Greece. Speaking to Reuters in Nairobi, Strauss-Kahn said the wider European economy was still strong – despite fears that Greece might default on its debts. While the IMF is poised to assist Greece if needed, Strauss-Kahn remains confident that Europe’s leaders could resolve the issue.
“The eurozone wants to deal with the problem itself, and I can understand that,” he said. “I think they can do it … and we’re just here to help.”
Strauss-Kahn also argued that those who claim that Spain or Ireland could suffer a debt default are simply trying to “scare” the financial markets.
“We have a problem with Greece. We don’t have a problem with Spain to date. The eurozone has to deal with the Greek problem. They are doing this,” said Strauss-Kahn.
“No one knows what’s going to happen tomorrow morning but there’s no reason why the spillover to Portugal or to Spain will take place,” he added.
And speaking of Spain:
Spain ended 2011 with its strained public finances in much worse shape than first thought, with the public deficit 8.51 percent of output, way above the 6.0-percent target, Finance Minister Cristobal Montoro said Monday.
Missing the 2011 target will make it harder for Spain to meet its public deficit goal for this year of 4.4 percent of Gross Domestic Product as it seeks to get nearer to the EU ceiling of 3.0 percent.
The public deficit — the broad shortfall between spending and revenues — was 9.3 percent in 2010.
Prime Minister Mariano Rajoy’s conservative government said shortly after it came to power in December that the 2011 public deficit would be around 8.0 percent, far above the 6.0-percent target agreed with Brussels by Spain’s previous socialist government.
The government has announced spending cuts of 8.9 billion euros ($11.5 billion), frozen public sector wages, and hiked taxes on income, savings and property to bring in 6.3 billion euros as part of efforts to rein in the deficit.
The Bank of Spain is predicting the economy will shrink by 1.5% in 2012, but with unemployment over 20% and still rising it is likely that we are seeing overly optimistic estimates.
So once again we appear to be seeing the effects of backwards policy in Europe. There is no doubt that periphery Europe requires structural reform but to attempt it while also forcing highly deflationary policy on a country is a recipe for economic disaster. The blame for the failure of the Greek IMF/EU program has been able to be pushed back onto Greece for its lack of implementation, but Portugal is another story. Portugal is the “model student” yet, as far as I can see from the data, the program is heading down a very similar path because any plan based around “austerity first, reform second” while servicing existing debts has a funny way of killing the patient before the medicine kicks in.
Given recent comments by Mario Monti, I am fairly sure he understands this. Let’s hope he has convinced the rest of Europe to change strategy before Italy gets the dreaded knock on the door. “Hi, I’m from the IMF , I’m here to help”.