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
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
No comments:
Post a Comment