Portugal Meets Economic Targets

Sources:
FT: Portugal Announces More Austerity Measures
International Workers Association: About the Austerity Measures and the Last General Strike
Washington Post: International Lenders Say Portugal is Making Good Progress on Implementing Bailout Program
WSJ: Portugal Bailout Seen on Track

The European sovereign debt crisis has affected almost every corner of the globe and resulted in economic problems for many European countries. In 2010, Portugal adopted a set of austerity measures (spending cuts and tax increases) to combat its own debt problems and hopefully avoid the need for a future bailout. Unfortunately, these austerity measures were insufficient, due to the country’s large debt and slowing economy, and a bailout was necessary. The three major credit rating agencies also downgraded Portuguese debt to junk status, signaling that the ratings agencies lost confidence in Portugal’s ability to pay its debt. The rating agencies’ negative views on Portugal spread to investors, resulting in Portugal being required to pay a much higher interest rates to borrow money (higher risk makes an investor demand a higher interest rate because the increased interest income will offset the higher possibility of loss). Because Portugal was forced to pay higher interest rates on its debt, the country had difficulty making its debt payments and moved very close to default.

To fight off default, eight months ago Portugal agreed to a €78 billion ($104.5 billion) bailout with the IMF. To receive bailout funds Portugal must meet economic benchmarks and implement additional austerity measures. Thus far, Portugal has received €34.2 billion ($45 billion) of the bailout. Before the IMF disburses the next portion of the bailout, it must first complete an analysis of the country’s economic position to determine if additional austerity measures are required. The IMF recently completed its analysis and decided that the country is on track to meet the bailout’s economic benchmarks, meaning Portugal does not need to take further action now to receive the next €14.6 billion ($20 billion) of bailout funds.

Portugal’s austerity measures have included labor market reforms aimed at making it easier to hire and fire workers, along with numerous cuts to the public sector including requiring state employees to work additional hours without additional pay, eliminating some paid holidays, and forfeiting bonuses worth more than one month’s pay. The combination of these measures reduced public sector wages by an estimated 20% in 2011 as compared to 2010. Outside the labor markets, the austerity measures have also included a 25% increase in the cost of using public transportation and an increase in the value-added (sales) tax.

Based, in part, on the above austerity measures, Portugal has successfully reduced its deficit-to-GDP (gross domestic product) ratio. In 2010, the ratio was 9.8%—well above the Eurozone maximum of 3%. While exact numbers are not yet available, Portuguese officials believe the ratio will be approximately 5% in 2011—below the 5.9% target set by the IMF. The reduction in the deficit is one of the main positive factors in the IMF’s report.

Even though Portugal will likely meet IMF benchmarks, its economy is not strong. Financial experts project the country will end 2012 with an economic contraction of 3.3%—down from a previous forecast of 2.8%—and currently has an unemployment rate of 14%, which experts project will peak at 14.5% later this year. However, the IMF believes the country’s economic problems will subside in 2013 thanks to increased private investment (leading to the creation of new jobs) and increased exports (increased demand creates a need for more workers to meet that demand).

The IMF’s report is a good sign for the European Union (EU), as it shows that Portugal’s economy is moving forward. However, Portugal is still in the midst of an economic recession and may face future debt problems. If Portugal continues to meet its economic targets, it may avoid the need for a second bailout and additional austerity measures, which will hopefully lead to a faster recovery for the country.