On June 5, Portugal holds parliamentary elections that will shape its future for years to come. If the country is to recover from its current financial crisis, these elections will have to return a government that can deliver reform and rebuild market confidence.
Recent events highlight just how crucial the need for change has become. On April 6, Portugal was forced to seek an estimated €80bn in financial aid from the European Union. This was the culmination of a long-term loss of market confidence in the government’s ability to improve external competitiveness, restore public and banking sector creditworthiness and get the economy growing again.
Turning this situation around is difficult but not impossible, if Portugal focuses its energy on growth. The country’s problems have built up over a number of years as it spent too much, and earned too little, running annual current account and budget deficits often close to 10 per cent of gross domestic product. The crucial difference with other eurozone countries is that macroeconomic imbalances were underpinned by a decade of meagre growth. The disappearance of private savings created a vicious circle between public and external debt.
Reducing costs through an austerity programme is urgently necessary. The most effective, and fairest, way to achieve this is through a leaner and more efficient public sector. Portugal needs to restructure general government, state-owned enterprises and public-private partnerships and concessions that do not provide value for money and are not economically productive. The three previous government austerity packages (not implemented as agreed) and the fourth (unanimously rejected by parliament) were focused too much on austerity for ordinary citizens, rather than reducing the size of the state.
Raising revenues is also critical, although only in the context of enabling growth. A simple example illustrates this point. Two weeks ago Portugal released first-quarter budget figures, which showed a narrowing deficit that was mostly due to earlier tax rises. Raising the tax take on the existing revenue base – rather than seeing tax income grow as a function of GDP growth – is not a sustainable strategy in the long term.
Which leads us back to growth. Fiscal consolidation, while necessary, is not enough to deliver long-term budget stability and debt reduction. In the medium to long term, economic growth is the only solution to Portugal’s fiscal problems.
The financial assistance package being negotiated with the EU, the International Monetary Fund and the European Central Bank is a vital, if depressing, step. Portugal’s cost of borrowing, which stood at over 8 per cent on five-year bonds the day before the vote on the latest austerity package, and has since risen to more than 11 per cent, was unsustainable. The assistance package is necessary to provide the liquidity the country needs to meet short-term funding requirements.
However, it is only a short-term measure that buys some time. The money is still owed, and must be paid back. This is why growth is all. It will be achieved by lowering costs in the short-run and bringing about productivity gains in the long-run; and it must be more export-driven. This means strengthening existing export markets and expanding to new ones, especially in Africa, Asia and Latin America.
The country needs a productivity boost from lower labour and other regulated costs, such as energy, that have a direct impact on the tradable sector; and structural reform has to lead to a more qualified labour force, greater accountability and effective conflict resolution.
Underlying all of this is the matter of transparency. Markets rely on confidence and certainty, and one reason investors have been pricing in a bail-out for Portugal since 2010 has been the lack of both in budget figures. These fears have been borne out with the budget deficit twice revised upwards in recent months.
The next government has to be committed to complete transparency on the real budgetary and contingent debt situation. This is essential to ensure effective fiscal consolidation and guarantee that Portugal will not remain reliant on financial assistance from abroad. The next prime minister will need to have the determination to bring about change and the willingness to reach out across ideological divides that will allow Portugal to deliver growth while honouring its international debt commitments.