Eurozone Ernst & Young Eurozone Forecast Summer edition June 2011 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain
Ernst & Young Eurozone Forecast Summer edition June 2011 Outlook for Portugal 17 Eurozone countries Finland Estonia Ireland Netherlands Belgium France Germany Luxembourg Austria Slovenia Slovakia Italy Spain Portugal Greece Malta Cyprus Published in collaboration with Contact: José Gonzaga Rosa Tel: +35 121 791 2292 Email: jose.gonzaga-rosa@pt.ey.com
Highlights Terms of financial aid package to prolong recession into 2012 Portugal s 78 billion Memorandum of Understanding (MoU) was finalized with the EU and International Monetary Fund (IMF) on 3 May 2011, with emphasis on tackling the country s long-standing structural problems, strengthening fiscal policy and ensuring the stability of the financial sector. The EU has pledged a total of 52 billion and the IMF s contribution will amount to 26 billion. The funding will be available for a period of three years, up to 2013. The MoU reiterates the fiscal measures that were already in place in Portugal. However, to give Portugal some breathing space, the budget deficit reduction targets have been relaxed and the deadline for reducing the deficit to 3% of GDP has been extended by one year. But with the deficit for 2010 being raised from an initial estimate of 7.3% of GDP to 9.1%, these targets still represent a significant challenge and require austerity measures equal to more than 10% of GDP. A total of 12 billion has been earmarked for the banking sector; and additional requirements for banks core Tier 1 capital ratios have been outlined in the aid package. While Portuguese banks remain fundamentally sound, they are facing reduced levels of liquidity as a result of contagion from the sovereign debt crisis. Further structural economic reforms include reduction in unemployment benefits and increased privatizations. Requesting financial aid was inevitable for Portugal, but only provides a short-term solution for meeting its upcoming debt redemptions. The country s underlying problems of weak competitiveness and low economic growth remain unchanged, and the risk of debt restructuring, once the international money runs out in 2013, is still significant. The fiscal measures outlined in the MoU will have an adverse effect on growth in the near term, before the structural reforms aimed at boosting the economy s growth potential begin to yield results. We have, therefore, lowered our growth forecast in the twoyear horizon and now expect GDP to decline by 2% in 2011 and 1.7% in 2012 (compared with our earlier projection of a decline of 1.7% in 2011, and growth of 0.4% in 2012). The annual rate of Consumer Prices Index (CPI) inflation on both the national and EU harmonized measures was 3.7% in Q1 2011 a sharp increase of over 1 percentage point (ppt) from Q4 2010, largely resulting from higher oil prices. With CPI (on the national measure) posting yearly growth of 4.1% in April, inflation is likely to increase further in Q2. Rising inflation, while growth in nominal wages remains muted, will damage households real incomes and be an additional drag on consumer spending. With the rate of GDP growth averaging just 1% over the past 10 years, Portugal s main problem is largely structural. Indeed, boosting productivity and competitiveness is the key to resolving Portugal s economic troubles, failing which the country faces, at best, low growth for many years to come. Ernst & Young Eurozone Forecast Summer edition June 2011 Portugal 1
Terms of financial aid package to prolong recession into 2012 Portugal finalizes MoU terms Portugal s 78 billion MoU was finalized with the EU and IMF on 3 May 2011, with emphasis on tackling the country s long-standing structural problems, strengthening fiscal policy and ensuring the stability of the financial sector. The EU has pledged a total of 52 billion and the IMF s contribution will amount to 26 billion. The funding will be available for a period of three years, up to 2013. The interest rate on IMF loans has been set at 3.25% for the first three years and 4.25% after that. that focus on fiscal reforms The MoU reiterates the fiscal measures that were already in place. They include a freeze on wages and pensions until 2013, a reduction in civil staff numbers, suspension of all new public-private partnerships and large infrastructure projects; and streamlining of spending on state-owned enterprises, local and regional government and defense. However, to allow Portugal some breathing space, the deficit reduction target is more lenient than had been set by the previous Government. Portugal must now reduce the budget deficit to 5.9% of GDP this year (compared with the earlier target of 4.6% of GDP), while the deadline of achieving a budget deficit of 3% of GDP has been extended by one year to 2013. But with the budget deficit for 2010 being raised from an initial estimate of 7.3% of GDP to 9.1%, these targets still represent a significant challenge and require austerity measures equal to more than 10% of GDP. as well as financial and structural reforms A total of 12 billion in the MoU has been earmarked for the banking sector. As a result of contagion from the sovereign debt crisis, Portuguese banks are having trouble accessing funding from financial markets resulting in reduced levels of liquidity and increased dependence on the European Central Bank (ECB). Indeed, borrowing by Portuguese banks from the ECB jumped by about 23% on the month in April, reaching its highest level since August 2010. In return for this funding, Portuguese banks are required to maintain a core Tier 1 capital ratio of 9% by end 2011 (up from the target of 8% recently set out by the Bank of Portugal) and 10% by 2012. Banks are unlikely to be able to raise the extra capital required from the market and so will probably need capital injections from the Government. However, given the absence of a housing bubble in the years before the crisis, the funds set aside in the MoU should provide the necessary liquidity to see the Portuguese banking sector through the worst of the crisis. This is crucial to ensure availability of financing for investment to enable the economy to restructure and grow over the medium term. Other structural reforms in the aid package include cuts in unemployment benefits to encourage people back into work and increased privatizations to raise more than 5 billion. Table 1 Portugal (annual percentage changes unless specified) Source: Oxford Economics 2010 2011 2012 2013 2014 2015 GDP 1.3-2.0-1.7 1.0 1.7 1.7 Private consumption 2.3-4.1-3.1 0.5 1.3 1.1 Fixed investment -4.9-7.1-5.0 1.3 4.5 4.3 Stockbuilding (% of GDP) 0.0 0.1 0.5 0.8 0.3 0.0 Government consumption 1.2-6.1-2.6-0.6 0.4 1.2 Exports of goods and services 8.8 4.3 3.5 4.8 5.3 4.6 Imports of goods and services 5.1-5.0-0.5 3.6 3.8 3.6 Consumer prices 1.4 3.8 1.0 1.5 1.9 2.0 Unemployment rate (level) 11.0 12.9 13.4 13.5 13.2 12.8 Current account balance (% of GDP) -9.9-7.0-6.9-6.1-5.5-5.0 Government budget (% of GDP) -9.1-6.0-4.4-3.1-2.8-2.2 Government debt (% of GDP) 83.4 89.7 95.0 96.1 95.9 94.8 ECB main refinancing rate (%) 1.0 1.3 2.3 3.1 3.5 3.9 Euro effective exchange rate (1995 = 100) 120.7 122.4 121.8 119.5 115.2 113.3 Exchange rate ($ per ) 1.33 1.42 1.38 1.33 1.27 1.24 2 Ernst & Young Eurozone Forecast Summer edition June 2011 Portugal
Financial assistance provides only a short-term solution Unsustainable costs of borrowing meant that resorting to financial assistance from the EU and IMF was inevitable for Portugal. However, the MoU merely provides a short-term solution for meeting the upcoming debt redemptions, while the country s underlying problems of weak competitiveness and muted economic growth remain. Though borrowing costs declined in the weeks after the MoU terms were finalized, they are once again back to elevated levels. Indeed, 10-year government bond yields on 31 May 2011 stood at 10%. These levels are clearly unsustainable and, therefore, the risk of debt restructuring, once the international money runs out in 2013, is still significant. and will prolong the recession into 2012 The fiscal measures outlined in the MoU will have an adverse effect on growth in the near term, before the structural reforms aimed at boosting the economy s growth potential begin to yield results. GDP posted a quarterly fall of 0.7% in Q1 2011, and the pace of decline is expected to accelerate over the next few quarters. We have therefore lowered our growth forecast in the two-year horizon and now expect GDP to decline by 2% in 2011 and 1.7% in 2012 (compared with our earlier projection of a decline of 1.7% in 2011, and growth of 0.4% in 2012). The outlook for consumer spending remains very depressed and consumer confidence fell to a record low in April 2011. Indeed, retail sales declined 2.3% on the quarter in Q1 2011 posting their largest fall in over two years and unemployment (on the International Labor Organization measure) remained elevated at 12.4% in Q1 2011. With more job cuts expected in the public sector, while the private sector is also likely to cut staff levels in order to reduce costs, unemployment is expected to rise further reaching 13.5% in 2013. Moreover, households remain highly indebted and an increase in interest rates by the ECB is adding to their debt burden, while higher taxes and a freeze on public sector wages will erode disposable incomes further. We therefore expect consumption to decline by 4.1% in 2011 and 3.1% in 2012. Investment is also expected to remain downbeat. The banking sector is having difficulty in accessing market funding at a reasonable cost and, according to April s Bank Lending Survey (conducted by the Bank of Portugal), credit conditions have tightened further. Therefore, even those companies wanting to invest will find it difficult to obtain funding. Investment is forecast to fall by 7.1% in 2011 and 5% in 2012. Figure 1 Figure 2 Bond spread over Bunds Government balance and debt Basis points % of GDP 400 2 % of GDP Forecast 100 Government balance (left-hand side) 350 300 250 0 90-2 80-4 70-6 60 200 150 100 50 0-8 50 Government debt (right-hand side) -50 40-10 -100 1995 1997 1999 Source: Haver Analytics 2001 2003 2005 2007 2009 2011 1990 1994 1998 2002 2006 2010 2014 Source: Oxford Economics Ernst & Young Eurozone Forecast Summer edition June 2011 Portugal 3
Terms of financial aid package to prolong recession into 2012 Inflationary pressures remain elevated Portugal s annual rate of CPI inflation (on both the national and EU harmonized measures) was 3.7% in Q1 2011 a sharp increase of over 1ppt from Q4 2010, resulting mainly from higher oil prices. With CPI (on the national measure) posting yearly growth of 4.1% in April, inflation is likely to increase further in Q2. Rising inflation, while growth in nominal wages remains muted, will damage households real incomes and be an additional drag on consumer spending. Furthermore, inflation remains well above the Eurozone average of 2.8% (as of April 2011), and is leading to erosion of Portugal s already weak competitiveness. and Portugal is in great need of boosting competitiveness With the rate of GDP growth averaging just 1% over the past 10 years, Portugal s main problem is largely structural. Indeed, the real effective exchange rate has been consistently appreciating since 2000, while relative unit labor costs in 2009 were over 50% higher than in 2000. In this regard, the Government is considering a sharp reduction in social security contributions by about 3% 4% of GDP, which will help to reduce labor costs significantly and make goods produced in Portugal more competitive abroad. Regulatory reform and accelerated privatization will help to increase competition in sectors such as electricity, transportation and telecommunications, and reduce excessive profits. Further information regarding the measures outlined in the MoU is as yet limited, making it difficult to assess how successful the aid package will be in boosting Portugal s productivity and competitiveness. This, however, remains the key to resolving the country s economic troubles, failing which it faces, at best, low growth for many years to come. Figure 3 Contributions to GDP growth Figure 4 Prices and earnings % year 10 Forecast % year 30 Forecast 8 Domestic demand 25 Average earnings 6 4 GDP 20 15 Producer prices 10 2 5 0 0-2 -4 Net exports -5-10 Consumer prices -6 1990 1994 1998 2002 2006 2010 2014-15 1990 1993 1996 1999 2002 2005 2008 2011 2014 Source: Oxford Economics Source: Oxford Economics 4 Ernst & Young Eurozone Forecast Summer edition June 2011 Portugal
Follow the Eurozone s progress online Please visit www.ey.com/eurozone to: View video footage of macroeconomists and Ernst & Young professionals discussing the future of the Eurozone and its impact on businesses Use our dynamic Eurochart to compare country data over a five-year period Download and print the Ernst & Young Eurozone Forecast and forecasts for the 17 member states Or follow our ongoing commentary on Twitter at http://twitter.com/eynews Ernst & Young Eurozone Forecast Summer edition June 2011 Portugal 5
Ernst & Young Assurance Tax Transactions Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 141,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com 2011 EYGM Limited. All Rights Reserved. EYG No. AU0881 In line with Ernst & Young s commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content. This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. The views of third parties set out in this publication are not necessarily the views of the global Ernst & Young organization or its member firms. Moreover, they should be seen in the context of the time they were made. About Oxford Economics Oxford Economics was founded in 1981 to provide independent forecasting and analysis tailored to the needs of economists and planners in government and business. It is now one of the world s leading providers of economic analysis, advice and models, with over 300 clients including international organizations, government departments and central banks around the world, and a large number of multinational blue-chip companies across the whole industrial spectrum. Oxford Economics commands a high degree of professional and technical expertise, both in its own staff of over 70 professionals based in Oxford, London, Belfast, Paris, the UAE, Singapore, New York and Philadelphia, and through its close links with Oxford University and a range of partner institutions in Europe and the US. Oxford Economics services include forecasting for 190 countries, 85 sectors, and over 2,500 cities sub-regions in Europe and Asia; economic impact assessments; policy analysis; and work on the economics of energy and sustainability. The forecasts presented in this report are based on information obtained from public sources that we consider to be reliable but we assume no liability for their completeness or accuracy. The analysis presented in this report is for information purposes only and Oxford Economics does not warrant that its forecasts, projections, advice and/or recommendations will be accurate or achievable. Oxford Economics will not be liable for the contents of any of the foregoing or for the reliance by readers on any of the foregoing. EMEIA MAS 132.0611