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					                                                               Portugal
                                                               Structural weakness
                                    The Portuguese economy was impacted on a relatively limited scale by the
                                    global recession and is not being affected by the aftermath of a burst real estate
                                    bubble. While government finances are weaker than desired, they are not nearly
                                                                                       as bad as in some other European countries.
Figure 1: Limited recession, but low growth                                            Investors are nonetheless worried. Their con-
     %                                                                        %        cerns are justified considering the pre-existing
 6                                                                                6
                                                                                       structural weaknesses and extremely high for-
 4                                                                                4
                                                                                       eign debt of the country as a whole.
 2                                                                                2

 0                                                                                0    Back to recession
                                                                                       The GDP volume in Portugal decreased by
-2                                                                                -2
                                                                                       0.3% in the fourth quarter of 2010 compared
-4                                                                                -4
                Average annual GDP growth in stated periods,                           with the previous quarter. We expect that GDP
                actual and forecast
-6                                                                                -6   will continue to contract in the first half of
         IE    GR     FI     ES    AT     NL     BE     FR     DE   IT   PT
                                                                                       2011, which will drive Portugal back into re-
              2003-2007               2008-2010                2011-2012
                                                                                       cession. This is being caused first of all by the
Source: NIESR, Rabobank
                                                                                       steady decline in consumer confidence that
                                                                                       began in the autumn of 2009. By the end of
                                    2010 consumer confidence had fallen back to the lowest point reached during
                                    the worst phase of the global recession. As a result the decline in consumer
                                    spending that occurred in the second half of 2010 is set to continue in the first
                                    half of 2011. This downward course is reinforced by high unemployment and
                                    limited prospects for a jobs recovery in the short term.


                                    Also, a range of austerity measures was introduced last January aimed at further
                                    reducing the budget deficit. The VAT rate was raised, public sector employee
                                    wages were lowered and pensions were frozen. Spending cuts directly limit eco-
                                    nomic growth through lower government spending. There will also be little rea-
                                    son for businesses to make additional investments in light of considerable unuti-
                                    lised production capacity and a poor outlook for domestic demand. Growth in
                                    exports will only be able to compensate for this on a limited basis, particularly
                                    considering the extremely slow pace at which growth in wages adapts to eco-
                                    nomic conditions in Portugal. Last but not least, the banking sector is facing
                                    funding difficulties, making it hard for businesses that want to invest to obtain
                                    loans. This all points to a poor economic outlook for Portugal in the year ahead.


                                    Over the past three years, the Portuguese economy actually held up quite well.
                                    It was one of the better performing countries in the eurozone (figure 1) in terms
                                    of average growth in 2008-2010. The relatively mild recession nonetheless had a
                                    substantial effect on unemployment. The unemployment rate rose from 7.5% in
                                    the first quarter of 2008 to 11.1% in the third quarter of 2010. We illustrated in
                                    Rabobank Outlook 2011 that this is attributable to low labour market flexibility.




                                    March 2011                                         Rabobank   Economic Research Department             1
                                                            Portugal

                                Structurally lagging behind
                                While Portugal performed relatively well in 2008-2010, the country had a history
                                of lagging behind in Europe during the years preceding the global recession. We
                                expect Portugal to once again slip to the rear of the European peloton (figure 1).
                                As a result of lagging economic growth, national income per capita remains
                                markedly lower than the EU-27 average despite years of European economic
                                integration and participation in the euro (figure 2). Notwithstanding all the Euro-
                                pean subsidies and considerably lower interest rates due to participation in the
                                euro, Portugal has still not succeeded in climbing economically to the European
                                average level. The case of Slovenia shows how differently things could have
                                turned out. Per capita income in Slovenia was more or less the same as in Por-
                                tugal in 1995. But in 2009 Slovenia had gained a major lead over Portugal. Slo-
                                vakia and Estonia, which is the newest eurozone member, have also shown im-
                                pressive convergence since 1995.


                                The fact that Portugal is structurally lagging behind is due to a lack of structural
                                reforms. There are numerous regulations and extensive legislation that limit the
                                economy’s performance, while too little has been invested in infrastructure, edu-
                                cation and innovation. Employee protection regulations have furthermore led to
                                limited labour market flexibility. This has resulted in high growth in wages in re-
                                lation to the growth in labour productivity and makes adapting the economy
                                from contracting to growing sectors difficult. The chart in figure 3 shows the
                                number of improvements that need to be made to the economic structure in
                                eleven countries according to the IMF. These points for improvement involve la-
                                bour market flexibility, legislation and regulations for business start-ups, the
                                educational level of the working population and the quality of the infrastructure
                                and innovation. The chart reveals that there is considerable room for improve-
                                ment in Portugal.




Figure 2: Portugal fails to catch up                                                 Figure 3: Structural weakness

      %   Gross National Income Per Capita in purchasing power parity,   %           20                                                                            20
105       % of EU-27 average                                                 105
100                                                                          100     18
                                                                                                No. of improvements that need to be made to the economic
                                                                                                                                                                   18
 95                                                                          95                 structure according to the IMF’s ‘structural reform gaps heatmap
 90                                                                          90      16                                                                            16
 85                                                                          85
 80                                                                          80      14                                                                            14
 75                                                                          75
 70                                                                          70      12                                                                            12
 65                                                                          65
 60                                                                          60      10                                                                            10
 55                                                                          55       8                                                                            8
 50                                                                          50
 45                                                                          45       6                                                                            6
 40                                                                          40
 35                                                                          35       4                                                                            4
      95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
                                                                                      2                                                                            2
      Greece                    Portugal                     Spain
      Slovenia                  Slovak Republic              Estonia                  0                                                                            0
      Czech Republic                                                                      GR   IT    PT     ES     FR    BE     AT      IE    DE      FI    NL

Source: Reuters EcoWin                                                               Source: IMF, Rabobank




                                March 2011                                         Rabobank    Economic Research Department                                   2
                                                              Portugal

                                  More borrowing, but not for investment
                                  In addition to the economy’s structural weakness, investment in fixed assets has
                                  barely increased since 2000. Expanding the stock of buildings and machinery
                                  could have contributed to higher economic growth. The fact that this failed to
                                  occur despite sharply reduced interest rates thanks to participation in the euro
                                  can be considered a missed opportunity. This is not, however, to say that low
                                  interest rates were not used to take on more debt. Portugal as a whole has, in
                                  fact, borrowed more and more from abroad (figure 4). The government has
                                  been spending more than it receives in taxes for years. The sharp deterioration
                                  of the balance on the current and capital account of the balance of payments
                                  has, however, been caused by the increasingly greater demand of businesses for
                                  external financing . While this could be attributed to rising business investments
                                  in the second half of the 1990s, businesses have since 2003 taken on more debt
                                  without there being a proportionally large increase in investments.


                                  A further examination of the income and expenditure of Portuguese businesses
                                  points to three causes (figure 5). First, the gross operating result fell from more
                                  than 38% of added value in 2002 to 35% in 2008 due to a sharp rise in wages.
                                  Secondly, an increasingly greater proportion of added value minus wage and
                                  interest payments has been paid out in dividend. Dividend payouts rose from
                                  less than 30% in 2002 to more than 70% in 2008. This reveals that businesses
                                  chose to finance an increasingly smaller portion of investments with retained
                                  earnings. Thirdly, interest payments on previous debt rose sharply from 2005.
                                  Due to the increased use of external financing, Portuguese businesses have be-
                                  come very sensitive to changes in interest rates. This is clearly demonstrated by
                                  the increased interest expenses since 2005. More generally speaking, it must be
                                  remembered that interest and instalments still have to be paid even in the event
                                  of disappointing returns on investment.




Figure 4: Deficits at corporations and government                                          Figure 5: Borrow for wages, interest and dividend

      %                                                                        %                 %                                                                         %
 20                                                                                20       12                                                                                 12
          Current account balance and capital account balance of the
          balance of payments and contributions of the institutional sectors                10                                                                                 10
 15       (households including NPISH), % GDP                                      15        8                                                                                 8
                                                                                             6                                                                                 6
 10                                                                                10
                                                                                             4                                                                                 4
  5                                                                                5         2                                                                                 2
                                                                                             0                                                                                 0
  0                                                                                0        -2                                                                                 -2
                                                                                            -4                                                                                 -4
 -5                                                                                -5
                                                                                            -6                                                                                 -6
-10                                                                                -10      -8       Change in companies’ net borrowing and contribution of the                -8
                                                                                           -10       determining factors as percentage of gross added value, last              -10
-15                                                                                -15               three-years of the given period compared with the first three-years
                                                                                           -12                                                                                 -12
-20                                                     -20                                           1995-2000         1998-2003          2001-2006         2004-2009
                                                                                                 compensation of employees                      net interest and dividend
     95 96 97 98 99 00 01 02 03 04 05 06 07 08 09                                                net capital transfers                          investment
  households corporations financial corporations government                                      other                                          total

Source: Reuters EcoWin                                                                     Source: Reuters EcoWin, Rabobank




                                  March 2011                                             Rabobank           Economic Research Department                                   3
                                                                  Portugal

                                    In that case either dividend payouts or wages can be lowered. However, that
                                    does not solve the problem, but rather only shifts it to the households that
                                    would see their disposable income decrease.


Figure 6: Problems in the banking sector                                             Banking sector is the weakest link
    %                                                                        %       The Portuguese banking sector forms an im-
9                                                                                9
8                                                                                8   portant link between foreign investors and
         Nonperforming loans at Portuguese banks and ECB
7        liquidity provision to Portuguese bans as a percentage
                                                                                 7   Portuguese households and firms. As a result
6        of the balance sheet of the Portuguese banking system                   6
5                                                                                5
                                                                                     it is the first to run the risks connected with
4                                                                                4   the unfortunate macroeconomic debt position.
3                                                                                3
                                                                                     The 2009 recession led to an increase in the
2                                                                                2
1                                                                                1   number of non-performing loans. And during
0                                                                                0   the Greek and Irish debt crises, investors also
    99    00     01    02     03    04     05    06     07    08   09   10
                                                                                     expressly abandoned Portuguese banks, forc-
               non performing loans, % of total, corporations
               non performing loans, % of total, households                          ing the banks to obtain an increasingly greater
               ECB refinancing, % of balance sheet total
                                                                                     part of their financing from the European Cen-
Source: Reuters EcoWin, ECB, Rabobank
                                                                                     tral Bank (figure 6). The new recession will
                                                                                     spur a further increase in the number of de-
                                    faults. This situation will also lead to a heightened risk for government finances.
                                    Investors anticipate that the government will bail out large banks should they
                                    run into trouble, as previously was the case in Ireland and Spain. This can trig-
                                    ger a further and rapid rise in government debt. The risks of the national debt
                                    position will therefore ultimately fall largely on the shoulders of the government.


                                    It will take time to adjust
                                    While the deficit on the current account of the balance of payments will decrease
                                    further this year, Portugal will continue to live far beyond its means. This will
                                    lead to a further accumulation of national debt. In addition, little is being done
                                    to strengthen the economic structure. As long as the sizeable debt position con-
                                    tinues to exist and the country does not succeed in improving the economic
                                    structure, the accompanying risks will also remain. It will be difficult for the Por-
                                    tuguese government to find a solution in the short term to the debt position that
                                    has been built up over many years. As a result it will also be hard to convince
                                    investors of the soundness of government finances. It is therefore probable that
                                    the country will ultimately need financial aid from its European partners. This
                                    will accelerate the adjustment process and the structural reforms in the same
                                    way that this is already happening in Greece. While this will lead to a deeper
                                    recession in the short term, it would be the best solution for Portugal in the
                                    longer term. Without painful measures the adjustment process will take place
                                    slowly and the country will remain highly dependent upon external financing. In
                                    that case the risk of a financial crisis will continue to exist.




                                     Tim Legierse
                                     T.Legierse@rn.rabobank.nl




                                    March 2011                                       Rabobank   Economic Research Department           4

				
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