The poster child of austerity is lost

While we wait for tonight’s announcement from the German constitutional court, there are some interesting developments in the Troika’s latest review of Portugal:

The program remains broadly on track. In 2012, despite headwinds from abroad, real GDP growth remains in line with projections, exports are performing better than expected, and the fast reduction in the external deficit is contributing to alleviating the external financing constraint. Nevertheless, higher unemployment, lower disposable incomes, and a shift in tax bases away from more highly-taxed activities are weighing on revenue collection. Against this backdrop, policy choices need to strike a balance between advancing the required fiscal adjustment and avoiding undue strains on the economy. Swift progress on structural reforms remains key to put the economy on a sustainable growth path. Maintaining broad political and social support for the revised adjustment program will also be important.

Growth will remain weak into 2013. In 2012, economic activity is projected to decline by 3 percent. Reflecting weaker import growth in euro area trading partners and additional budget consolidation measures, GDP growth is now expected to turn positive only in the second quarter of next year, resulting in a projected GDP decline by 1 percent for the year as a whole.

The fiscal deficit path has been adjusted, particularly for 2013. While spending in 2012 performs somewhat better than budgeted, revenues are lagging significantly behind budget plans. To allow partial operation of automatic fiscal stabilizers, the deficit targets were revised upward to 5 percent of GDP in 2012 and from 3 percent to 4.5 percent in 2013. The 2014 deficit target, at 2.5 per cent of GDP, remains below the threshold of the Stability and Growth Pact of 3 percent. This revised path will allow the government to design and implement structurally sound fiscal measures, while easing the short-term economic and social cost of fiscal adjustment.

But reaching the new deficit targets will require additional consolidation efforts. Agreement was reached on a range of permanent spending and revenue measures to underpin the deficit target in 2013, which also make up for the one-off measures in 2012. Continued efforts to strengthen public financial management, bolster tax compliance, reduce losses of state enterprises, bring down the costs of public-private partnerships, and streamline public administration will also contribute to the needed fiscal adjustment. As part of the measures to compensate for the Constitutional Court decision on the public wage and pension cuts, the government also plans to lower employers’ social security contributions, a measure that will improve competitiveness and support employment. Steps will be taken to soften the adverse impact on low-income workers.

So even Portugal, the “poster child” of austerity, is failing in its attempts to meet budget goals imposed under a 78-billion-euro bailout deal. The country has been granted an extra year and targets have been revised down due to the recession that is now engulfing the Eurozone. The Troika now expects a government deficit of 5% this year and 4.5% in 2013, up from 2.5% and 3% respectively.

Portugal’s economy shrank by 1.2% in Q2  and 3.3% yoy, mostly attributed to a decline in internal demand of 7.6% and collapsing investment, down 18.7%. Household consumption fell 6.0% while government spending fell 3.9%. The plan to internally devaluae and become export driven is having some success with exports up 4.3% in Q2, but this is nearly half of the growth that came in Q1 and, as the IMF stated above, import growth in euro area trading partners and additional budget consolidation measures are likely to sink this going forward. In other words, everyone is trying the same trick.

Like France, there is now some expectation of growth to return in 2013, but I have no idea why. Possibly on the expectation of some form of global stimulus, although it is may just be a date far enough in the future that people won’t challenge it.

In the meantime, as with Spain, when things look bad its time to double down:

Prime Minister Pedro Passos Coelho said he would cut public employees’ salaries, requires that all workers to pay more for social security, and raise taxes on the rich—the latest belt-tightening steps aimed at meeting Portugal’s obligations under an international bailout program.

Mr. Passos Coelho made the announcement on television late Friday as viewers were absorbed by a World Cup qualifying match between Portugal and Luxembourg that was to start minutes later. He cast the measures, effective next year, as an attack on the country’s 15% unemployment rate, which has been rising as a result of previous cuts in public spending.

Employees will be required to pay 18% of their salaries to social security, up from 11%, allowing companies to cut their contributions from 23.75% to 18%. “We will reduce substantially the costs of labor, providing incentives to investment and job creation,” the Portuguese leader said.

Public workers will lose one paycheck out of the 14 they receive each year. Mr. Passos Coelho had scrapped an attempt to cut two months’ salary after a court ruled in July that it discriminated against public employees. His speech Friday offered no legal rationale for the more modest cut.

Given the country has just been granted another year in order to meet targets they will require additional funding to do so. Under normal circumstances, as we’ve seen with Greece, you would expect this to mean a re-negotiation of not just the length of time, but also the amount of the support program. Even though the economy is in a worse state than otherwise expected by the authorities, Portugal is still expected to return to the private markets in September 2013.  That all suggests to me that the Portuguese government will be attempting to hide under the umbrella of the ECB’s new Outright Monetary Transactions (OMT) program when it does make its return to the markets.

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  1. A question for you DE. With the ECB effectively being the bond holder of last resort, and I’m assuming regardless of the German court decision today, the ECB will take on that role, how does this change the face of the bond market in general?

    The discipline the bond market had on sovereigns meant something, and now the ECB has it’s conditionality that ,in the case of Greece, is already out to deceive. A serious part of the ECB’s role is in question IMO if they ignore Greece so the way it looks to me is that the ECB is not independent.

    I just thought about this today when I read about views on the FED which say that they don’t need foreigners to buy UST’s as the FED can take it all on its balance sheet.

    Where is this all going to end?

    • a63,

      my issue with all this ‘easing’ is what it means to assets in general. The time value of money has been completely thrown out the window, which in essence is core of all things finance. I’m too stupid to know what this means long term but the mispricing of risk and money was a cause of these problems so I’m sure that there will be consequences.

  2. a63 Do you have a link for that re the FED!

    Where is it all going to end?
    Well when the Fed buys all the UST the end is nigh!!! Unless I’ve missed something!!!!! These things always take about 3 decades longer than I reckon!
    Also by ‘nigh’ I’m meaning sometime within the next decade!

    • I don’t have one at hand, but have seen it in several posts over this year.

      It just occurred to me that it’s what the ECB is planning to do in an environment where the bond market had all but given up on the EZ.

      • > It just occurred to me that it’s what the ECB is planning to do in an environment where the bond market had all but given up on the EZ.

        ……. and the European banking system refuses to realise its losses on debts that cannot be repaid.

        • true. I’d expect a lot less than 6000 EZ banks in a few years, and for now who’d be interested in M&A unlike what happened in the US post GFC.

        • DE At the stage where the FED buys all the UST with no foreign buyers, the foreign buyers would have to be buying REAL US Assets no?
          Or alternately buying our assets with which we would then pay for our imports.

          However the USD would be fast be coming a totally unwanted currency? One can’t imagine the US handing over all their resources while they have however many Carrier battle groups!
          That’s the point where very high inflation or even maybe hyper-inflation sets in. My bet is on just very high inflation but once it starts who knows!