Five risks to Portugal’s bailout success

February 24, 2014 12:46 pm

Five risks to Portugal’s bailout success

By Peter Wise in Lisbon/ Financial Times / http://www.ft.com/intl/cms/s/0/1199dc50-9d4b-11e3-a599-00144feab7de.html?siteedition=intl#ixzz2uGD96r7c

Talks this week between Portugal and its bailout lenders are expected to be strained after Lisbon rejected a call for further wage reductions and dismissed concerns that the country’s export growth may be unsustainable.

Officials from the “troika” of the European Commission, International Monetary Fund and European Central Bank are beginning their penultimate quarterly review of Portugal’s €78bn rescue programme, which is due to end in May after three years of punishing austerity.

Lisbon has been buoyed by falling government borrowing costs in the eurozone. But separate new reports by the commission and the IMF highlight several remaining risks that could prevent Portugal achieving the goals of its painful adjustment programme:

1. Wage levels remain too high. Nominal unit labour costs have fallen 5.3 per cent since 2010, but the commission says Portuguese wages are “still overvalued” by between 2 per cent and 5 per cent. It urges “continued wage moderation over the medium term” to ensure the continued adjustment of external imbalances and to absorb unemployment.

However, Paulo Portas, deputy prime minister, has emphatically rejected any further private-sector wage cuts in response to the commission’s recommendation. “Let me underline this,” he said on Sunday. “We do not believe in development based on low wages. The private sector has already made the necessary wage adjustments.” His response appeared to leave open the question of further cuts in public sector wages.

2. Export growth could prove unsustainable. Portugal has achieved a huge turnround in its current account balance, from a deficit of 12.6 per cent of national output in 2008 to a small surplus last year. But the IMF warns that the adjustment may not be sustainable without further gains in competitiveness. It points out that a 5 per cent increase in exports in the first 10 months of 2013 was “driven mainly by fuel exports” while imports have begun to rise in line with a recovery in domestic demand.

Mr Portas, who is responsible for co-ordinating economic policy, responded that almost 23,000 export companies were behind the country’s “sustained growth in exports”, which now accounted for 45 per cent of gross domestic product, up from 28 per cent five years ago.

3. Structural reforms have not been deep enough. The IMF says Portugal still needs to “address decisively” the persistence of excessive rents in energy, transport infrastructure and other areas crucial to external competitiveness. “In the absence of such reforms, the burden would fall excessively on the labour force,” it warns, adding that “it will be important to ensure that a sense of complacency about structural reforms does not take hold”.

4. Companies need more credit. Portugal needs to step up efforts to “reduce the overhang of private debt and free up credit for lending under better terms” to help increase private sector investment, says the IMF. The Commission highlights the “substantial losses” reported by the banking sector in 2013 and warns that increasing levels of bad debt are “a significant source of vulnerability” for Portuguese lenders. However, it also notes that improved liquidity and lower funding costs are “slowly feeding through to lower lending rates”.

5. More reforms could be blocked by the constitutional court. The IMF warns that legal challenges to fiscal measures have intensified in recent months with “key elements of the 2014 budget law being submitted to the constitutional court” for vetting. This “undermines the quality” of fiscal adjustment and introduces “high policy uncertainty”, it says, with a negative impact on output and unemployment, which “remains at unacceptable levels”. Portugal also remains susceptible to abrupt changes in bond market sentiment, the Fund says.

In response to the IMF report, Público, a leading daily newspaper, said the Fund had “criticised the results of the [bailout] programme without assuming any responsibility for the outcome . . . as if it had nothing to do with it”.