1 Portugal s Adjustment Program: Where are We? Albert Jaeger International Monetary Fund Presentation: Austrian Business Circle Lisbon, January 24, 2014
2 Overview Looking back: Four questions Growth and unemployment: What happened? Fiscal adjustment: Was speed right? External adjustment: Mission accomplished? Structural reforms: Will they stick? Looking forward: Four challenges Corporate debt overhang: Clean-up still ahead Switching growth models: Learning to grow through trade Sovereign debt: Durable access ahead? Politics and spreads: Moving to a better equilibrium?
3 Program: Plans vs. outcomes Portugal: Key economic indicators Real activity GDP growth (%) Program Now Unemployment rate (%) Program Now Sources: June 2011 IMF CR 11/127; November 2013 IMF CR 13/324. * Excluding one-off bank pension funds transfer.
4 What happened to growth? The big picture Portugal: Medium-term growth paths (log scale) Convergence trend (convergence speed 2%) Observed Trend ( ; little convergence) Actual real GDP (forecasts ) % % Trend = 3.6% Trend = 2.3% Trend = 2.0%
5 Why was GDP growth below plan during ? External factors Headwinds to exports (unexpected euro area recession) Fragmentation of lending rates in euro area Internal factors Higher fiscal multipliers Drag from high corporate leverage (see picture)
6 Change in Unemployment Rate (Percent) What happened to unemployment? The big picture Portugal: Okun s Law suspended during Growth of 2.7% needed to keep UR constant Real GDP Growth (Percent)
7 What happened to unemployment? During normal cycles, firms treat labor as quasi-fixed input In a time of crisis, firms switch to treating labor as a more flexible input factor Overshoot of unemployment (given Okun s law) reflects: Size of shocks to firms output and financing costs Level of firms debt leverage Labor market institutions Unemployment in 2013 and 2014: Did firms overdo labor shedding? Labor market reforms (already) having positive effects?
8 Program: Plans vs. outcomes Portugal: Key economic indicators Real activity GDP growth (%) Program Now Unemployment rate (%) Program Now Fiscal indicators Fiscal deficit (% GDP) Program Now 7.8* Public debt (% GDP) Program Now Sources: June 2011 IMF CR 11/127; November 2013 IMF CR 13/324. * Excluding one-off bank pension funds transfer.
9 Fiscal adjustment: The speed debate Portugal s fiscal problem: Large fiscal adjustment unavoidable. Only question was speed of adjustment. Higher speed if: Public debt is very high Country has low credibility Available financing is constrained Slower speed if: High fiscal multipliers Risk of high structural unemployment Implies low quality of fiscal adjustment Damage to social and political consensus Two principles: Balance the pros and cons Revise speed if balance of pros and cons changes 9
10 Fiscal adjustment: The speed debate Speed measure: by how fast is the difference between last year s fiscal deficit and the medium-term deficit target (2% of GDP) reduced this year? Reasons why speed was lower than planned: Two relaxations of deficit targets (balance of pros and cons changed) Original program (May 2011) 8th/9th Review (November 2013) Lower GDP growth and shifts in Okun s Law Larger-than-expected automatic fiscal stabilizers 10
11 Program: Plans vs. outcomes Portugal: Key economic indicators Real activity GDP growth (%) Program Now Unemployment rate (%) Program Now Fiscal indicators Fiscal deficit (% GDP) Program Now 7.8* Public debt (% GDP) Program Now External indicators Current account deficit (% GDP) Program Now Net Foreign Liabilities (% GDP) Program Now Sources: June 2011 IMF CR 11/127; November 2013 IMF CR 13/324. * Excluding one-off bank pension funds transfer.
12 External adjustment: Mission accomplished? No Current Account* Total Consumption* Net Investment* % -14 t-1 t t+1 80 t-1 t t+1-5 t-1 t t+1 Current account has indeed adjusted very fast (as during the two previous IMF programs) But consumption overhang remains large (above 100% of economy s disposable income) * In percent of economy s net disposable income. As a consequence, net investment is negative (and far below levels in previous two IMF programs)
13 Structural reforms: Strong start, but will reforms stick? A large number of important reforms adopted: Labor market: e.g. overtime, severance pay, dismissals Product market: e.g. rental market, electricity tariff deficit Judicial system: e.g. law on arbitration; new civil procedure code Business environment: e.g. insolvency rules; competition law Fiscal reforms: e.g. commitment control law; tax compliance measures Implementation: Statutory vs. effective reforms Adoption is often only the first (and easy) step of a structural reform Implementation phase decides whether reforms are effective How do small open economies develop a habit to reform? Reach social/political consensus that country needs to be competitive High transparency of policy making Separate politics and public administration Good economic results reinforce habit to reform (virtuous circle)
14 Corporate debt overhang: Clean-up still ahead Facts Firms have too much debt But differences across firms Micro firms: evidence hard to read ( lifestyle companies ) SMEs: leverage ratios indicate serious distress Large companies: seem less distressed Bad habits of debt-ridden firms Firms won t invest (even if project profitable) Firms focused on financial survival instead of producing/selling Risk of tunneling (transfer of assets or profits out of firm to the benefits of those who control firm) Macroeconomic consequences Mis-allocation of capital Slow growth
15 Switching growth models: Growing through trade Portugal: Uses of output, 2005 (Percent of total sector output) Domestic uses Exports Tradable sectors (exports average=37.0) Total economy (exports average=13.3) Non tradable sectors (exports average=3.6) Ireland: Uses of output, 2005 (Percent of total sector output) Domestic uses Exports Total economy (exports average=38.5) 0 Tradable sectors (exports average=78.0) Non tradable sectors (exports average=18.9)
16 Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep year Portuguese bond yield (percent) Policy uncertainty indicator (mean = 100) Public debt: A volatile ride to market access 10-year Portuguese bond yield Economic policy uncertainty indicator* Lehman Greek Program Portuguese Program Irish Program Greek PSI 2012 Budget TSU 2013 Budget Gaspar/Portas Resignations * The indicator tracks economic policy uncertainty using monthly counts of specific economic terms in newspaper articles.
17 Reform Effort & Fiscal Prudence Low High Politics, Reform Effort, Fiscal Prudence, and Spreads High effort and prudence Good equilibrium (good politics) Program Low effort and prudence Bad equilibrium (bad politics) Crisis Low Financial Spreads High