In our preliminary reaction to the IMF/EU/ECB €78 billion bailout for Portugal we thought it looked like too little, too late and too soft. We promised then a full verdict once the details of the program were known. This is the first part covering fiscal consolidation.
In contrast with Greece, at the outset, the Portuguese program has only two criteria of quantitative performance – a General Government deficit of €10.3 billion in 2011 to be reduced to €7.6 billion in 2012 and a ceiling on the overall stock of General Government debt of €175.9 billion in 2011 and €189.4 billion in 2012. With nominal GDP forecasted to decline by 1.1% it will be only €170.6 billion in 2011.
Under the IMF projections the program of fiscal stabilization will cut the deficit from an average of 9.6% of GDP (€16.5 billion) in 2009-2010 to 3% in 2013. This is achieved through a projected growth of revenues equivalent to 0.8% of GDP and a reduction in spending equal to 5.4% of GDP. The increased revenue target of €2 billion will be achieved mostly through VAT rises and reductions in tax benefits. The bulk of the €9 billion in expenditure cuts will be achieved by freezing the nominal wages of civil servants until 2013, an average cut of 3% on pensions above €1500 (a similar cut was already made to civil servants wages), downsizing the central government, saving in healthcare and education, cutting public sector investment and reducing transfers for loss making state-owned enterprises.
The program of fiscal consolidation must be judged on three fronts – compliance probability, future sustainability, burden sharing and macro-economic impact.
The targets seem to have been set deliberately low so that they can be met. We have estimated that only to roll back the excess spending of the Socialist Governments Portugal needs cuts amounting to at least 8% of GDP. Yet, there are still some uncertainties that are worth noting. On the revenue side the fiscal neutrality of the cut in payroll taxes is not certain. However, it is on the expenditure side that the resistance is going to be greater. In particular, in terms of downsizing the government, controlling health costs and reducing transfers to state-owned enterprises.
In terms of future sustainability the targets are not only timid but uncertain. For instance, the program of privatizations is targeted at raising only €5.5 billion. So, the IMF forecasts still assume a significant rise in public debt to 115% of GDP in 2014 in an economy that is not expected to grow at more than 2% in the post-recession period. In the context of continuing speculation against the weak links in the Euro Area this will not allow Portugal’s return to the market at reasonable interest rates. Moreover, three of the major public finance problems (unknown payment arrears, off-balance sheet debt and guarantees to banks and PPPs and the need for a full fiscal reform) are only left for further study.
In what concerns the fairness of burden distribution, the program is clearly biased against the lower and upper middle classes and the civil servants. Moreover, it barely touches the subsidization of privatized monopolies and other special interest groups. Again, these are only left for further study.
Finally, the macro-economic consequences of the fiscal adjustment point to a negative contribution to growth of 1.4% in 2011 and 1% in 2012. This seems a little optimistic especially when compared to a 2.9% negative contribution of private consumption (which includes civil servants and pensioners). The IMF attempt to avoid a sharper recession is reasonable, but it is unlikely to succeed given the foreseeable slowdown in the global economy and the generalized lack of confidence in the long term growth prospects of the country.
In conclusion, a timid program of fiscal consolidation in a context of global uncertainty might allow the country to get by in the next two years. Whether it will be enough to avoid the need for another future bailout and or debt restructuring is doubtful.