Debt-laden Portugal is unlikely to avoid a recession this year despite government forecasts for some economic growth, but the contraction may be modest enough to ensure a crucial budget deficit target is met.
Slashing the deficit is vital to convincing investors that Portugal can solve its public finances and debt problems on its own without seeking a bailout as Ireland and Greece did.
However, over the longer term a return to decent rates of growth will be central in determining whether its plan for bringing down borrowing is credible and analysts say it will take time for growth-boosting strategies to have an effect.
Painful austerity measures like public sector wage cuts and tax hikes adopted this year to meet the fiscal gap target of 4.6 percent of GDP are set to decimate internal consumption, while investment has been hammered by prohibitive interest rates on credit, analysts say.
The government says it beat its 7.3 percent budget deficit target for last year, but that was on the back of estimated economic growth of at least 1.3 percent as well as a one-off pension fund transfer to state coffers.
The government is banking on continued export growth, especially to new markets in fast-growing emerging economies, to eke out an expansion of 0.2 percent this year.
Analysts say exports surprised on the positive side last year and should continue rising. However, they warn that export diversification will take time to bear fruit, while Portugal’s main trading partner and neighbor Spain is itself implementing tough austerity.
“So I guess the main question is what happens to domestic demand — and with salary cuts and higher taxes, it’s pretty obvious that there will be a contraction,” said Silvio Peruzzo, a Royal Bank of Scotland economist in London.
Private consumption accounts for two-thirds of GDP, while exports account for less than a third.
Meanwhile, unemployment is at a three-decade high of about 11 percent and contraction would only increase the number of jobless, inflate the state’s welfare benefits bill and reduce tax revenues.
The Bank of Portugal earlier this month painted a much gloomier picture than the government’s — and most analysts’ — outlook, expecting a contraction of 1.3 percent this year before a return to modest growth next year.
Peruzzo said he expects a much smaller drop in economic activity of 0.5 percent this year.
“I’d say it is possible to meet the budget deficit goal even with this contraction,” he said, adding though that additional austerity measures could still be on the cards — either as means to avert a bailout or as part of a possible rescue deal.
Diego Iscaro of IHS Global Insight consultants, whose forecast for this year’s contraction is 0.4 percent, added: “The deficit goal is ambitious and difficult, but not impossible.”
He said, however, that more austerity would further depress the economy.
“If Portugal receives a bailout it will not come for free — the conditions are likely to be further fiscal measures and also structural reforms. In the short term, this may have negative implications on the economy,” Iscaro said.
The government has been adamant about not requiring foreign aid and Portuguese Finance Minister Fernando Teixeira dos Santos has criticized the practice of European bailouts saying they have so far failed to solve any problems.
Portugal held a presidential ballot yesterday and was expected to give a second term to Portuguese President Anibal Cavaco Silva, bolstering the country’s drive to avoid a bailout. Investor concerns about Portugal’s creditworthiness have made the country’s borrowing costs soar in the past year.
“Their debt burden is not really sustainable at current rates of 7 percent, if you add inflation of about 2 percent. It means there is some need for external support,” Peruzzo said, adding though that borrowing costs could fall if the EU agrees to bolster its safety net.
European leaders have called on the eurozone weakling to adopt strategies to boost competitiveness, including by making the labor market more flexible so that companies can fire and hire more easily depending on the economic situation.
“I don’t think the difference between modest growth and a small contraction this year is that important,” said Filipe Garcia, head of Informacao de Mercados Financeiros consultants.
“What is important is to change the structure of the economy, to make it more sustainable with less state weight and more exports,” the Porto-based economist said.
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