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Portugal: Economic Recovery But Massive Debt And A Fragile Banking System Remain

November 2011, protests against austerity measures before the Portuguese Parliament in Lisbon.

In November of 2015, Antonio Costa the incoming Socialist Prime Minister of Portugal, was able put together a government, by aligning himself with the far left. There were many who felt this political coalition would be short-lived, since it seemed unworkable.

His campaign pledge had been to reverse the punishing austerity measures but, to also meet quite challenging fiscal targets.

Due to an improving economy and fiscal discipline, the government under the leadership of Prime Minister Costa, was able to reduce the budget deficit by more than 50% in 2016. The government shortfall has been trimmed to just under 2.1% of GDP (Gross Domestic Product).

Antonio Costa Prime Minister of Portugal 2015-

The public budget deficit is now below the new guidelines set by the European Union. These have been reduced again from 3% to 2.5%. This will be the first time the government of Portugal, will be in compliance with the Euro-zone rules.

It is also the lowest level of a primary budget deficit, since the return to democracy in 1974.

The declining level of deficit spending has been made possible, by the fact the domestic economy has been growing steadily for a total of 13 quarters. At the end of 2016, the economy was expanding at a respectable 2%.

Ongoing economic growth, has allowed the Prime Minister to fulfill the second part of his program. This was a restoration of state pensions, regular public wages and the previous working hours that had existed before the financial crisis.

Debt as a percentage of the economy of Portugal, compared to Euro-zone average.

The fiscal crisis that hit Portugal, was the result of the Great Recession and the earlier global financial crisis of 2007 and 2008.

By September 2009, the public deficit had reached 9.4% ,one of the highest in the Euro-zone and well above the agreed upon limit of 3%.

Two months later, the risk premiums on Portuguese bonds were at lifetime Euro highs, as both creditors and investors feared the country would default on its sovereign debt. The yield on the 10 year government bond reached 7%. This would now force Portugal to seek outside help to avoid bankruptcy.

The following year, Portugal was at record level of unemployment of nearly 11%, a rate not seen in over twenty years. At the same time, the number of public employees was at an exceptional high level.

Portugal along with Greece and Ireland, were all near insolvency by 2010. It was the beginning of the European sovereign debt crisis.

To complicate matters further, was the shaky domestic banking sector.

During the years 2008 and 2009, it became known that two Portuguese banks Banco Portugues de Negocios (BPN) and Banco Privado Portugues (BPP) had been accumulating a series of losses for a number of years, due to bad investments. On further investigation, accounting fraud and outright embezzlement were discovered as well.

The BPN was a far more serious issue, due to its actual size and market share of the domestic economy. The CEO would later be arrested and charged with fraud and a number of other crimes. The personal relationship the CEO of the bank enjoyed with certain members of the government was a further complication.

Portugal’s GDP growth evolution (PPP) from 1980 to 2014.

To avoid a banking collapse, the government eventually decided to give the BPN a bailout, that would end up being financed by the taxpayers.

In the summer of 2010, Moody’s Investors Service, a autonomous credit rating business, would cut Portugal’s sovereign bond rating. It would be reduced a total of two notches from an Aa2 to an A1. The decision was made as a result of the rapidly rising debt, which would put additional pressure on government finances.

The Portuguese government had reached the conclusion, that additional spending was necessary as a stimulus to the economy. This of course, led to a sharp rise in national debt to the GDP (Gross Domestic Product) ratio.

Portuguese national debt, in percentage of GDP since 1991.

The GDP to debt ratio had increased from 71.7% in 2008 to 96.2%, just two year later. By 2012, it was over 120% and by 2013 onward, it has remained around 130%.

Servicing this debt will become quite difficult when the next economic downturn arrives.

During 2010, the government of Portugal was unable to repay or refinance its debt, without aid from other sources. To prevent bankruptcy, the country went to three different financial institutions for assistance. The IMF (International Monetary Fund), the EFSM (European Financial Stabilization Mechanism), and the EFSF (European Financial Stability Facility) together loaned Portugal 78 billion Euros.

The latter two are part of the European Commission and the European Central Bank.

The bailout loans were requested and the equivalent of $87.77 billion USD (United States Dollar) were made through November 2014.

José Sócrates
Former Prime Minister of Portugal 2005-2011.

Prime Minister Jose Socrates would then have to resign in June 2011, when a no confidence vote was put through by the Parliament, over proposed spending cuts and tax increases. He had been in office since 2005. He fell from power, as the result of the rejection of the legislature to his program of austerity.

The former Prime minister would later be arrested on charges of corruption, tax evasion and money laundering.

The next Prime Minister Pedro Passos Coelho, was left with the responsibility to enact the austerity measures, demanded by the three main bailout creditors. He was from the more conservative center to right, Social Democratic Party.

The national unemployment rate rose to over 15%, by the second quarter of 2012, as the recession griped the nation.

Pedro Passos Coelho
Former Prime Minister of Portugal 2011-2015.

Prime Minister Coelho spent the first part of his time in office striving to regain full access to the financial markets. By the beginning of 2012, Portugal’s 10 year bonds had peaked at 17.3%, after the rating agencies had cut the country’s credit rating to non-investment grade (junk status).

By November of the same year, the bond rate had dropped to 7.9%. The austerity measures taken by the government had restored the confidence of creditors and investors.

In the parliamentary elections of October 2015, the ruling conservatives failed to gain a working majority. The financial crisis and the conditions of austerity agreed to by the government, had created a social crisis in Portugal during the years 2011 to 2015.

The electorate judged the conservatives to have mismanaged the ongoing austerity, and therefore they narrowly lost their quest for re-election.

Portugal (dark green) on a map of Europe. The European Union is shaded light green.

An anti-austerity bloc was able to garner 51% of the vote and a 53% majority in the legislature. At first the President of Portugal, refused to let them govern. He instead invited a minority conservative coalition to form a government. It would last a mere 11 days.

The Socialists would then create a government under Antonio Costa, the present Prime Minister.

There have been a number of economic trends that have worked in the favor of the Socialist government, which is now ahead of the opposition conservatives by 10%, in recent public opinion polls.

The economy had grown near 3% in 2016, over the previous year. It is up 21%, from the recent record low, seen in 2012. The GDP was $259 billion USD last year. It is still below the peak of $262.01 billion USD reached in 2008.

Graph showing the economic data (Surplus/deficit, Public sector debt, GDP growth) of Portugal, the EU and the Euro-zone for 2009, from Eurostat

Unemployment was 9.5% last month, more than 8% lower than the all time high reached in 2013. However, it is still slightly above the average, since the country returned to democracy 43 years ago. It remains rather high, since the last recession ended in 2013.

Last year Portugal witnessed another year of rising debt. There has now been 14 years of continuous increases in debt to GDP ratios. This has been the ongoing direction, since the country adopted the Euro.

In 2016, the combined sovereign and personal debt in Portugal reached 390% to GDP ratio. This is the 5th largest in the Euro-zone.

The government of Portugal wants the European Union to free the country from the excessive deficit procedure still in place. This is a disciplinary system that has been used to enforce the fiscal rules of the Euro-zone.

Lisbon, the capital of Portugal.

This would allow Portugal to join Ireland and Spain, in a successful turnaround of their financial situation.

Almost all credit rating agencies still classify Portugal’s sovereign debt as junk. This has not changed since the country left the bailout program in 2014. This continues to burden the government with higher borrowing costs.

Interest rates, absorb more of the country’s budget resources than any other nation in the European Union.

Headquarters of the Caixa Geral de Depósitos bank.

The European Union remains reluctant to change the status of Portugal, because of the particularly high level of sovereign debt, which continues to rise. European officials still fear, that the country remains quite vulnerable to any financial or economic disturbance.

The European Commission remains concerned over the solvency of Portugal’s banks. The government is planning to dispense 2.5 billion Euros or $2.7 billion USD to recapitalize the country’s largest bank. This would be the state owned Caixa Geral de Depositos.

The sale of Novo Banco, the lender that emerged from the collapse of Banco Espirito Santo in 2014, will also be concluded this year. There is likely going to be some final liabilities involved in the selling of this institution.

The NOVA SBE, one of the Portuguese world class business schools

The above governmental actions are likely to add to the deficit in 2017.

Prime Minister Costa still blames the European Union and the IMF, for failing to provide sufficient aid to the flagging Portuguese banking sector. His government has already spent 4.4 billion Euros ($4.91 billion USD) in trying to alleviate the problem. It is likely, they will need to spend more, in the near future.

The present government policy of providing more support for domestic demand through a looser regime of austerity, has seemed to pay off up to this point. Whether it will continue depends far too much on the economic growth of their trading partners.

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