Eurozone Ernst & Young Eurozone Forecast Spring edition March 2012 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain
Ernst & Young Eurozone Forecast Spring edition March 2012 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 Need for additional financial assistance now almost inevitable Since the onset of the Eurozone debt crisis, Portugal s economic prospects have worsened progressively, with 10-year bond yields remaining high at over 13%, making the chances of a return to financial markets in mid-2013 very low. The country will almost certainly require more financial assistance from the European Union (EU) and the International Monetary Fund (IMF), which will inevitably come with stringent fiscal and structural requirements that will in turn further undermine growth in the short-term. Against this background, we have lowered our growth forecast and now expect GDP to decline by 4% in 2012 and 2.1% in 2013. This forecast assumes that the Eurozone authorities will be able to prevent financial contagion stemming from Greece to Portugal and other peripheral Eurozone countries. Given the uncertainty surrounding this assumption, downside risks dominate the outlook. Credit rating agency Standard and Poor s downgraded Portugal s sovereign debt to junk status in January, bringing an adverse reaction from investors. Although bond yields have declined since then, they remain at unsustainably high levels. Moreover, yields on Portugal s 3-year government bonds are now higher than those on 10-year bonds, reflecting a significant decline in investor confidence in the Government s creditworthiness. Despite strict fiscal austerity, Portugal has been unable to achieve its ambitious fiscal targets. The aim of lowering the budget deficit to 5.9% of GDP in 2011 was only met due to a one-off transfer of banks pension funds to the state, in the absence of which the deficit would have been around 7.5%. According to its fiscal targets, the Government needs to lower the deficit to 4.5% of GDP in 2012. As a result, it has unveiled a very tough budget for 2012, which will take a further toll on domestic demand. But continued tight fiscal policy for a prolonged period poses a significant risk of becoming self-defeating. The Government s efforts to lower spending and raise revenues through measures such as a reduction in public sector staff, a freeze in general government wages and an increase in VAT on products such as gas and electricity will take a toll on consumer spending. Indeed, consumer confidence is already at a record low, while unemployment has been increasing steadily. We expect consumer spending to decline by 6.2% in 2012 followed by a contraction of 3.1% in 2013. The outlook for investment is also very bleak. Weak demand from consumers is forcing companies to cut production. Coupled with very weak business confidence, this will lower firms propensity to invest. Meanwhile, the availability of credit has become progressively weaker, making it difficult for firms to access bank loans. We therefore expect investment to decline by 12.7% in 2012 and 6.4% in 2013. One of the main issues highlighted by the IMF and EU is the need to make the labor market more flexible. In this regard, Portuguese employers and unions have agreed on a number of changes to the labor laws, such as a relaxation of curbs on hiring and firing as well as cuts in the number of holidays and redundancy compensation. Other structural reforms are also progressing, such as competition framework and telecommunications, aiming at increasing the competitiveness of domestic production and allowing a reduction in non-tradable process. Although encouraging, these reforms deal with macroeconomic imbalances and structural weaknesses that have accumulated over more than a decade, so they will take time to translate into improving growth prospects. Ernst & Young Eurozone Forecast Spring edition March 2012 Portugal 1
Need for additional financial assistance now almost inevitable Growth forecast lowered Since the onset of the Eurozone debt crisis, Portugal s economic prospects have worsened progressively. With investors increasingly concerned about the sustainability of public finances, government bond yields have remained high, at over 13% for several months. In order to be able to return to financial markets by mid-2013, when the international money runs out, bond yields need to decline by some 800 900 basis points (bp). Given sluggish progress in consolidating public finances and little improvement in competitiveness, this seems highly unlikely. In our view, Portugal will almost certainly require additional financial assistance from the EU and the IMF and the possibility of some debt restructuring can no longer be ruled out. Financial assistance will inevitably be dependent on even stricter fiscal austerity and structural reforms that will adversely affect growth in the short term. We have therefore made a significant downward revision to our GDP forecast. We now expect the economy to contract by 4% in 2012, followed by a further decline of 2.1% in 2013. This forecast is based on the assumption that the Eurozone authorities are able to prevent the debt crisis in Greece from spiraling out of control and spreading to other peripheral Eurozone countries. But given the level of uncertainty surrounding this assumption, downside risks dominate the economic outlook. Indeed, some of the potential negative outcomes of the Eurozone crisis (such as a disorderly default by Greece) would have grave consequences for the Portuguese economy. and adverse developments in bond markets In January, credit rating agency Standard and Poor s downgraded Portugal s long-term sovereign debt by two notches from BBB-to BB. The downgrade reflects its expectation of the impact of deepening political, financial and monetary problems in the Eurozone. Portugal is now the only Eurozone country, other than Greece, whose sovereign debt has been downgraded to junk territory by all three main credit rating agencies. The downgrade brought a sharp reaction from investors, with 10-year government bond yields rising by 220bp overnight. Bond yields have come down since then, but still remain unsustainably high. Yields on Portugal s 3-year government bonds are now higher than those on 10-year government bonds. Paying more to borrow for shorter periods reflects a significant decline of investor confidence in the Government s creditworthiness. Table 1 Portugal (annual percentage changes unless specified) Source: Oxford Economics 2011 2012 2013 2014 2015 2016 GDP -1.5-4.0-2.1 0.2 1.7 1.9 Private consumption -3.6-6.2-3.1 0.4 1.1 1.2 Fixed investment -10.8-12.7-6.4-1.3 3.0 3.8 Stockbuilding (% of GDP) -0.2 0.4 0.6 0.5 0.4 0.5 Government consumption -3.3-4.0-2.3-0.1 0.9 1.7 Exports of goods and services 7.0 2.7 4.5 4.6 4.8 3.5 Imports of goods and services -4.0-4.1 1.2 3.8 3.6 3.3 Consumer prices 3.6 3.1 1.6 1.2 1.8 1.8 Unemployment rate (level) 12.7 14.1 14.9 14.8 13.6 12.3 Current account balance (% of GDP) -6.7-4.5-3.6-3.1-2.8-2.6 Government budget (% of GDP) -5.9-5.1-4.7-4.6-3.8-3.2 Government debt (% of GDP) 99.5 107.5 113.4 116.0 115.9 114.9 ECB main refinancing rate (%) 1.2 1.0 1.0 1.6 2.6 3.9 Euro effective exchange rate (1995 = 100) 120.8 115.6 119.8 117.6 115.6 115.3 Exchange rate ($ per ) 1.39 1.26 1.30 1.27 1.24 1.24 2 Ernst & Young Eurozone Forecast Spring edition March 2012 Portugal
Ambitious fiscal targets repeatedly missed Despite strict fiscal austerity, Portugal has not made sufficient progress in consolidating its public finances. The target of lowering the budget deficit to 5.9% of GDP in 2011, from 9.8% in 2010, was only met due to a one-off transfer of banks pension funds to the state. If this action had not been taken, the budget deficit would have been 7.5%. Although this one-off transfer was acknowledged as a short-term solution by the EU and IMF in their latest review of the Portuguese economy, they maintained that Portugal is still on track to meet the agreed targets. As a result, the Government has received its second tranche of funding, totaling 2.9b. Portugal needs to cut the deficit to 4.5% of GDP in 2012 in order to continue receiving funds from its 78b bailout package. The Government has therefore announced a very tough budget for 2012. Labor costs form a significant part (0.4% of GDP) of the planned savings, with measures including a reduction in the compensation of employees, a freeze in general government wages, a reduction in public sector staff and the streamlining of other expenses such as overtime and travel. Other spending cuts are due to come from a sharp reduction in social transfers. On the revenue side, the Government announced the abolition of various tax benefits and an increase in the VAT rate on products such as gas and electricity. Although the Government has little choice but to consolidate the public finances in the current circumstances, there is a significant risk that tight fiscal policy for a prolonged period will become self-defeating, and push the economy into a vicious downward spiral. and austerity to weigh on domestic demand The price for fiscal austerity will continue to be high. Measures such as higher taxes and a freeze in public sector wages will damage consumers spending power. This is also likely to reinforce the weakness in consumer confidence, which could push up household savings rates. As a result, consumer spending is forecast to take a severe hit. We expect declines of 6.2% in 2012 and 3.1% in 2013. As a result of declining demand, industry will be forced to lower production. The squeeze in company profits and uncertainty surrounding the outlook are damaging business confidence, while tight credit conditions are restricting firms ability to borrow to invest, with banks being forced to restrict lending in order to bolster capital ratios. As such, a steep investment decline is in prospect. We forecast a fall of 12.7% in 2012, followed by a decline of 6.4% in 2013. Figure 1 Figure 2 Contributions to GDP growth Bond spread over German Bunds Basis points % year 10 Forecast 1200 Domestic demand 8 1300 1100 1000 6 GDP 900 4 800 700 2 600 0 500 400-2 300 Net exports -4 200 100-6 0-100 -8 1990 1993 1996 Source: Oxford Economics 1999 2002 2005 2008 2011 2014 1995 1997 1999 2001 2003 2005 2007 2009 2011 Source: Haver Analytics Ernst & Young Eurozone Forecast Spring edition March 2012 Portugal 3
Need for additional financial assistance now almost inevitable Export prospects are also poor in the short term due to weak demand in Portugal s main trading partners, such as Spain, Germany and France. Although exports are expected to continue rising, they will not do so by anywhere near enough to offset the negative impact of weak domestic demand. Overall, we expect GDP to fall by 4% in 2012 and by a further 2.1% in 2013. Structural reforms under way Under the planned structural reforms, Portugal s labor market remains one of the key areas that need to be improved. According to the OECD s employment protection index, Portuguese workers are the most heavily shielded against dismissal in the Eurozone. The ratio of the minimum wage to the average wage is above 50%, suggesting that unskilled labor is expensive, which is one of the reasons why Portugal suffers from such poor competitiveness. In order to address these issues, employers and unions recently agreed on a number of changes to the labor laws. These include a relaxation of curbs on hiring and firing, as well as reductions in the number of holidays and layoff compensation. This has created some unrest, with one of the biggest trade unions leading the protests. An escalation of the protests poses some threat to the economy, but so far the impact has been limited. Other structural reforms are also progressing, such as competition framework and telecommunications. The revised Competition Law, now in public consultation, has been harmonized with EU law and strengthens the powers of the Competition Authority to open investigations related to anti-trust and merger control, improving its ability to prosecute competition cases successfully. Although encouraging, these reforms deal with macroeconomic imbalances and structural weaknesses that have accumulated over more than a decade, so they will take time to translate into improved growth prospects for Portugal. Figure 3 Government balance and debt Figure 4 Consumption and investment % of GDP % of GDP % year 2 0 Government balance (left-hand side) 120 110 20 15 Forecast -2 100 10-4 90 5 Consumption 80 0-6 70-5 -8 60-10 Investment -10 50-15 -12 Government debt (right-hand side) Forecast 40-20 1990 1994 1998 2002 2006 2010 2014 1990 1994 1998 2002 2006 2010 2014 Source: Oxford Economics Source: Oxford Economics 4 Ernst & Young Eurozone Forecast Spring edition March 2012 Portugal
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