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Portugal’s government presses the economic self-destruct button

Portugal’s government presses the economic self-destruct button Mindful Money

Today the Portuguese government will receive the details of the latest troika (IMF,ECB,European Commission) or men in black review of their economy. There is little or no danger of them concluding that Portugal is not doing her best to hit the fiscal targets given to her as in Portugal there has been virtually no dissent. It is as if her political class has borrowed their opinion on this subject from the film The Stepford Wives.

However this does not mean that the project is not in trouble as closing your mind to the consequences of your actions does nothing to prevent them from happening. As an illustration I would like to take you back to Friday evening and the address to the nation by Portugal’s Prime Minister Pedro Passos Coelho.

What did the Prime Minister announce?

The drumbeat here was that Portugal was in danger of falling behind the fiscal deficit targets that the troika had set her. These are 4.5% of her Gross Domestic Product this year and 3% in 2013. Accordingly in an example of The Stepford Wives logic discussed above Portugal needs more of the prescribed medicine rather than a change of course.

The precise dose was a 7% increase in social security contributions from 11% to 18% for all employees from 2013. As a compensating factor employers will find that their social security contributions will be reduced from 23.75% to 18%.

The latter change was presented as an aid to employment in a country with a 15% unemployment rate and as a stand-alone move that would be true. But where is the demand for the goods to employ people going to come from when employees face a 7% rise in social security contributions? We already know that domestic demand is plummeting in Portugal as it fell at an annual rate of 7.9% in the second quarter of this year and such a move is only likely to make this worse. The only hope is for a boost to exports but how will this offset falling domestic demand, particularly in the current economic environment?

However Portugal’s government will see a benefit as revenues will rise from employees more than they fall from (private-sector) employers.

Why is this happening to a country which we keep being told is ”on track”?

In essence it boils down to falling government receipts which is in spite of the increase in taxation imposed. In the year to July Portugal’s tax revenue is 3.5% lower than that at the same stage in 2011. Whilst she has reduced her state expenditure by 0.7% as you can see the position is worse than that last year.

You would not guess this by the deficit numbers presented as it has fallen from 6.56 billion euros to 3.98 billion. But tucked away in the numbers is another one-off move as Portugal has a capital revenue improvement of just under 3 billion. If I remember rightly this is the pension transfer coming in in yet another “one-off” move. The underlying situation however is worse and not better.

One factor rarely discussed with Portugal is that if you include the one-off measures she has just about reached a primary balance as this deficit has only been 40 million euros in 2012 so far. The catch is that we need to include her regions and some other parts but on a state government basis default and devaluation becomes feasible at least if you are willing to ignore the one-off transfers!

What has driven this?

This part is simple, it is the decline in Portugal’s economy which has contracted by 3.3% over the last twelve months and by 1.2% over the last three months. We see here that austerity applied to a weakening economy has led to yet another turn of the austerity wheel which will beget more economic weakness and probably repeat. The clearest signal of this is in Value Added Tax (sales tax) revenues which in spite of increases in the rate at which it is being applied has fallen by 1.1% in the year to July.

What is the latest news on Portugal’s economy?

The Service Sector

As the largest part of any modern economy numbers from this sector are the most significant and these ones speak for themselves.

The services turnover index, adjusted for calendar and seasonal effects, registered a year-on-year change rate of -10.6% in July (-10.0% in the previous month). The year-on-year change rates of the indices of employment, wages and salaries, and number of hours worked adjusted for calendar effects were -7.5%, -8.2% and -6.3%, respectively.


A much smaller sector but it is often the first to show signs of a turnaround.

The index of production in construction decreased by 18.8% in the quarter ending in July 2012, in year-on-year terms (3 months moving average, working days and seasonally adjusted), up by 0.6 percentage points from the rate observed in June (-19.4%). Employment and wages and salaries registered year-on-year change rates of -18.2% and -19.0%, respectively.

These are again depression type numbers and they have another significance. Ordinarily this is a sector that does respons to monetary policy and as the ECB has been pressing the monetary stimulus button again and again in recent times it might have expected at least some beneficial effect. But yet again we see that the monetary transmission mechanism from the financial to the real economy is broken.

What about trade?

This is a better picture for Portugal and let me open with the best part of it.

In the quarter ended in July 2012, exports of goods increased by 8.3%

To the obvious question of what she is exporting more vehicles and machinery. If we ask to where? We get the interesting reply that the growth is outside the European Union with her ex-colony Brazil proving to be a good market for her agricultural products. So good news with two implications. One is that if we look at the agricultural exports to Brazil we are seeing another example of the change of status in the economic relationship between her and Portugal. The second is that the Euro was supposed to provide trade advantages and yet Portugal is seeing more export growth to countries outside it.

The other side of the trade figures is not so optimistic

imports decreased by 6.5% vis-à-vis the period May 2011 through July 2011.

This simply reflects the fall in domestic demand which feeds directly into the import numbers.

The role of the International Monetary Fund

I have written in the past about this change. If it had not taken place then Portugal would be in a different position as we would be reviewing improvements in her trade balance- the IMF’s previous modus operandi- rather than a deterioration in its new politically inspired one of a fiscal defict and the consequent further turn of the austerity screw.

So Portugal would facing the prospect of a relaxation in her economic straitjacket rather than a tightening.


At the time of the last review of Portugal’s economy the troika felt themselves able to make pronouncements like this from the IMF.

On current policies and prospects, the deficit target of 4½ percent of GDP still looks achievable

The mission welcomed the authorities’ renewed commitment to achieve their deficit objective of 3 percent of GDP in 2013.

You may note the change in language as there was already no mention of the 2013 target being achievable. I would imagine the IMF was already considering the implications of the various one-off moves which have helped reduce Portugal’s fiscal deficit or as it puts it in very euphemistic fashion.

The migration of contingent liabilities to the sovereign balance sheet (notably from SOEs outside the general government) also remains a persistent high risk factor to the debt trajectory.

The reality is that this previous review clutched the straw of Portugal’s surprisingly good GDP performance in the first quarter of this year. The current one cannot do that after the latest numbers. So there are real challenges for the 2012 numbers ahead which mean that the 4.5% target looks likely to be exceeded and possibly substantially. Maybe 6-7% might be more realistic now.

This leaves us with the problem of 2013 starting from such a bad base. If we add in that 2012 benefitted from a one-off move we see the scale of the problem. The sugar soaped reviews so far have seen such issues swept under the carpet and in addition to this they will have to face the prospect of Portugal’s economy contracting in 2013 too. If they apply the same formula to Portugal as they did to Greece then she will continue to spiral downwards and 2013 will be as bad as 2012.

So what can we expect today? It is likely that we will see a relaxation of the targets that Portugal faces and that may give her a little relief. But in return Portugal will have to impose more austerity and the grim cycle will begin again. As to whether this will be genuine relief or Portugal will find her pain extended will depend on developments elsewhere but I fear for the next year for her.

This article was originally published on Mindful Money under the title: Portugal’s government presses the economic self-destruct button

Tags: central banks , EU , euro , Euro zone Crisis , European Central Bank , European Monetary Union , eurozone , eurozone Crisis , financial crisis , GDP , General Economics , IMF , Portugal , Portugal economy , recession , regulation , Sovereign crisis , sovereign debt
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