Politicians battle over Portuguese bail-out

Campaigning for Portugal’s June 5 general election has exposed sharp differences between the two main political parties over how the next government should implement the country’s €78bn bail-out deal.

Both the Socialists of José Sócrates, caretaker prime minister, and the centre-right Social Democrats (PSD), the main opposition party, have signed up to a package due to be approved today by the European Union and the International Monetary Fund.

But divergences over how to achieve the targets set out in the three-year programme of tough austerity measures and economic reforms have raised concerns over how successfully and at what pace they will be carried out.

In a hard-fought campaign, with the two main parties virtually level in opinion polls, Mr Sócrates accused the PSD of using the EU-IMF deal as a pretext for proposing “the most radical rightwing programme ever put forward” in Portugal.

PSD plans to privatise state broadcasters, transport companies, financial institutions and water utilities and to “open state education and healthcare to private enterprise” went far beyond the bail-out agreement, said Mr Sócrates.

A PSD victory would put “social justice and equality of opportunity at risk”, he said at the weekend.

But Pedro Passos Coelho, PSD leader, said his election manifesto intentionally went “further and deeper” than the EU-IMF package in an effort to lift Portugal out of “the cycle of poverty” created by six years of socialist government.

Mr Sócrates’s election programme was based on the same policies that had brought the country to “the brink of bankruptcy”, he told PSD supporters in the Azores islands at the weekend.

Policy disagreements over painful deficit-reduction measures have been intensified by the latest EU economic forecasts. Portugal is the only European country projected to be in recession in 2012, with unemployment reaching a record 13 per cent and public debt exceeding 100 per cent of gross domestic product for the first time.

According to José Pacheco Pereira, a historian and senior figure in the PSD, the Socialists plan to “sidestep, postpone, evade and, in some circumstances, simply not apply” the bail-out deal.

Voters who wanted to “resist [the EU-IMF programme] and who believe that is possible” would vote Socialist, he wrote in a newspaper column.

Those who understood that it would have a “remedial impact on the role of state” and was, “in effect, Portugal’s last chance” would support the PSD.

Concerns over how effectively the next government will execute the bail-out agreement have been heightened by opinion polls suggesting that neither the PSD nor the Socialists would gain a clear majority in the election. Most polls give the Socialists a lead of 2-3 percentage points over the PSD, but the difference is within the margin of statistical error.

Mr Passos Coelho has ruled out serving in a government coalition with the Socialists. But the polls indicate his that preferred coalition with the small conservative Popular party would not command an overall majority in parliament.

Political analysts fear that attempts to form a majority coalition government after a close election result would involve protracted negotiations, possibly resulting in an impasse or another weak minority administration.

Mr Sócrates’s own minority government was defeated in parliament in March, triggering the political crisis that he says forced Portugal to ask for a bail-out.

Copyright

The Financial Times Limited 2011

@FT: Portuguese parties battle over labour costs

By Peter Wise in Lisbon

A fiscal “devaluation” included in Portugal’s €78bn bail-out package to cut labour costs has become one of the most disputed issues in the country’s election campaign.

T

he centre-right Social Democrats (PSD), the main opposition party, have embraced the measure to make companies more competitive by cutting social security contributions as part of their manifesto for the June 5 vote.

But the Socialists of José Sócrates, the caretaker prime minister, question how the reduction, and subsequent shortfall in public revenues, will be financed, estimating that it would need a three percentage point increase in the main value added tax rate to 26 per cent.

Although both parties have voiced support for the rescue package agreed last week with the European Union and the International Monetary Fund, the election row has exposed differences over how the three-year programme should be implemented.

The bail-out package envisages cutting corporate social security contributions by the equivalent of 3 to 4 per cent of gross domestic product over the next four years.

“This is a potential game changer,” said Poul [correct] Thomsen, head of the IMF negotiating team. “It replicates a currency devaluation by significantly reducing the labour costs of enterprises in one go.”

The level of reduction was “very, very dramatic”, he told the Financial Times last week.

According to the rescue agreement, the measure is to be financed in a “fiscally neutral” way through public spending cuts and tax increases to be “calibrated and developed in detail” over the next three months.

Eduardo Catroga, expected to become finance minister if the PSD wins the election, said on Monday the party proposed to lower employers’ contributions four percentage points in four years to below 19 per cent of workers’ wages.

Some goods and services would be moved to higher VAT rates to fund the measure, he said, but there would be no change in the basic rate.

The cut was targeted mainly at export companies in an effort to lift growth and create jobs, he added. Less competitive telecommunications, energy and other utility companies would be required to pass on the benefit in lower prices.

Francis Assis, a Socialist leader, warned that the PSD proposal would have a negative social and economic impact if VAT rates were increased. He did not say how his party would finance the make up the shortfall.

Pedro Passos Coelho, the PSD leader, said his party’s election programme went much further than the EU-IMF agreement in terms of public spending cuts and economic reforms.

Proposals not part of the rescue package include steps to privatise one of Portugal’s two state television channels, reduce the number of MPs from 230 to 181 and impose “peremptory limits” on the length of criminal investigations.

Copyright

The Financial Times Limited 2011.

FT: Portugal delays pain it knows is inevitable

Tuesday’s Portuguese rescue deal is being sold as a way to buy time. The €78bn ($116bn) package, agreed with the European Union and the International Monetary Fund, is welcomed because Portugal will gain a few more years to delay fiscal adjustment. But the victory will be short-lived, for fiscal problems alone are not what ails Portugal’s economy.

(SV comment: I wonder how many times people will repeat this until someone actually hears and has the guts to do something about it)

The IMF’s acronym is said to stand for “It’s mainly fiscal”. This maxim has certainly been applied by the IMF and the EU to Portugal, just as it was to the other struggling eurozone states. However, Portugal’s problem is one of foreign debt. Its ratios of public debt and deficit to gross domestic product are similar to France’s, yet France is not close to a fiscal crisis. This is because Portugal’s crisis is born not of public borrowing, but the debt of its private sector, in particular banks.
The limited importance of public debt alone is clear in Italy and Belgium. Both have high debt ratios, yet both pay smaller risk premiums because they run smaller current deficits. The case of Belgium is notable: the country has been without a government for the past year, yet faces a risk premium only fractionally above eurozone average.
The issue for Portugal is therefore avoiding more foreign debt. At the moment it is running a large current account deficit, likely to be 8 per cent of GDP this year. This implies that to avoid further external debt, Portugal (like Greece) must reduce consumption of foreign goods by about 20 per cent of GDP.
It is, of course, possible that Portugal will magic up an export boom, which would constitute a better solution. But while this path is preferable, it seems unlikely: Portugal’s biggest external market is Spain, which has its own problems. Exports could also be boosted by cuts in nominal wages – an internal devaluation – but this would take years to have an effect.

Here the experience of the Baltic countries shows what needs to be done. All experienced major capital inflows during the credit boom, which dried up when the 2009 crisis began. Latvia was hit especially badly, but recovered and can now access capital markets at reasonable rates. Having kept its policy of parity with the euro unchanged, it managed this feat by reducing labour costs by 17 per cent over two years. This created the base for export-led growth, but the bulk of the current account adjustment – a swing of more than 20 per cent of GDP – was achieved through an impressive contraction in domestic spending.
A similar contraction in Portugal is unlikely, however, so long as its households can still obtain credit from their banks. Given the ECB is refinancing banks in Portugal (as in Greece) at 1.25 per cent, mortgages there are cheaper than in Germany. The risk is that households will pay higher taxes, but continue consuming on credit. Because eurozone banks can refinance themselves cheaply through the ECB, they can keep lending, thus adjustment will be delayed.

This is why it is a mistake to believe that Portugal’s path to solvency comes only, or even mainly, through fiscal adjustment. Instead, as in Latvia, a reduction in private consumption is needed. To achieve this Portugal must tax consumption credit and introduce a temporary surcharge on value added tax.
Policies aimed at reducing consumption are, of course, highly unpopular. The Portuguese government has already shown that it prefers a “soft” adjustment, which preserves short-term political unity and delays pain for its citizens. But these policies only put off the day of reckoning. Continued external deficits will just increase foreign debt. Financial markets will then see the problem is not being solved, and thus will be even less likely to fund the country in future.

The ECB looks likely to finance Portugal for a while, but it already has enough potential losses on its book and thus cannot do this for long. And when it pulls the plug, as it almost certainly will, and the European funds run out, Portugal will then have to accept the inevitable. When it does, the adjustment will be even more painful, because its debt will have crept higher. Looking back, it might well come to regret not taking the pain today.

The writer is the director of the Centre for European Policy Studies, a Brussels-based think-tank