The world’s media has its mind fixed on the so-called fiscal cliff issue in the United States. However if we cross the Atlantic to the Iberian Peninsular we find a country which has a much more genuine fiscal cliff to face as 2012 opens and it does so from a much weaker base. She will impose swinging tax increases on her economy in an attempt to get closer to the Euro area austerity target of a fiscal deficit on 3% of her economic output as measured by Gross Domestic Product. At least the US economy has some forward momentum to perhaps lose whereas the latest numbers for Portugal showed us this.
The Portuguese Gross Domestic Product (GDP) registered a year-on-year change rate of -3.5% in volume in the 3rd quarter 2012 (-3.1% in the previous quarter), corresponding to a downward revision of 0.1 percentage point comparing with the Flash Estimate.
That was the eighth quarter in a row recording a decline and this comes on the back of weak overall growth in the Portuguese economy in what were supposedly the good years.
What is happening in Portugal now?
If we look into the detail of the GDP statistics above we see two clear influences. Firstly domestic demand is in a depressionary situation.
The domestic demand recorded a less negative contribution for the year-on-year change rate of GDP, which shifted from -8.7 p.p. in the 2nd quarter 2012 to -7.4 p.p. in the 3rd
It is a bit grim when -7.4% is considered an improvement! Against this the external sector has done well although it is now slowing.
The contribution of net external demand decreased to 3.9 p.p. (5.6 p.p. in the 2nd quarter 2012),
If we look into this we see that whilst Portugal has exported more much of the improvement here has come from falling imports due to her weak domestic demand levels.
Households are deleveraging
Reflecting a strong reduction in consumption, the household savings rate reached 11.2%, 1.1 percentage points (p.p.) more than the observed in the year ended in the 2nd quarter
Companies are investing less
The net borrowing of non-financial corporations was 3.7% of GDP, decreasing by 0.6 p.p., mainly reflecting the contraction of both investment and compensations of employees
The impact on the Government’s fiscal deficit has been limited
In the first three quarters of 2012 the General government’s net borrowing stood at 5.6% of GDP, while in the same period of 2011 it was 6.7%.
The problem is that the improvement has involved several one-off measures. In the UK that is usually likened to selling off the family silver. The main move has been a transfer of bank pension funds to the state which has continued to benefit the numbers in 2012. The Portuguese government also hopes that Eurostat will allow it to use the money raised from last week’s sale of airport operator ANA to reduce the deficit. But of course as time passes there will be fewer and fewer such opportunities and eventually Portugal will have to face up to a position which on an underlying basis is worse than the one being presented.
What happens on January 1st?
As of tomorrow income tax rates will rise in Portugal. There are various increases set to start but overall the income tax take is set to rise on an average from 9.8% to 13.2%. This is not in itself that high if we look at international comparisons as if we allow for social security contributions the total take rises to around 25%. However there is a problem highlighted by the most recent data on public revenue from the third quarter of 2012.
The evolution of revenues was primarily affected by the significant reduction of taxes and social contributions. In fact, social contributions decreased 6.8%, taxes on income and wealth declined 5.6% and taxes on production and imports declined 4.9%.
As you can see tax revenue is already falling so raising tax rates looks likely to disappoint in terms of raising extra revenue. Put another way Portugal may already be on the diminishing returns section of the Laffer curve as for example the revenue from the rises in Value Added Tax (main rate now 23%) have disappointed too.
Also this represents something of a strategic retreat by the Portuguese authorities as the original bailout plans involved spending taking the brunt of the pain and as you can see taxes are now at the front of the list.
The Housing Market is weakening too
On Friday I examined the problems faced by the housing market in Spain and we can see from the numbers below that Portugal has its crisis brewing.
The average value of housing bank appraisals in Portugal diminished 0.5% in November when compared with the previous month, standing at €1021/sq meter. The year-on-year change rate was -6.2% (-6.1% in the previous month).
This is in spite of the fact that for existing mortgages the cost of borrowing is often very low.
The interest rate implicit in all contracts of mortgage loans to households for house purchases was 1.701% in November,
However in a familiar theme banks seem to be charging a lot more for new mortgages.
For the contracts signed over the last 3 months, the implicit interest rate was 3.532% in November
Government bond yields have fallen
One relatively bright spot for Portugal has been the rises in the price and fall in the yields on her govenrment debt. Her benchmark ten-year yield is now 7% which compares with over 13% at the beginning of the year which then rose to over 17%. She even managed a bond swap which reduced the amount of the bond next to mature.
So as I review prospects for Portugal and her economy for 2013 I fear that she will continue on the same trajectory as she did in 2012 with a contraction of 3/4% looking quite possible again. The official view of a 1% decline (European Commission and IMF) seems very optimistic to me.
So her population can expect yet more economic pain and the objectives of getting her fiscal deficit and national debt under control seem as far away as ever. It is a very sad story to which we seem likely to add another grim chapter. Like a dog chasing its tail the ruling class in Portugal seem to have lost all sense of perspective.
Moving into 2013
On a happier note overnight has seen a better purchasing managers survey for China. However if we look back to this time last year we see that the world economy faces many of the same challenges that it did last year. In my home country the progress made on the subject of bank reform can be summed up by this announcement.
Hector Sants has been an outstanding leader of the Financial Services Authority during the most challenging of times.
Yes ignoring the Libor scandal amongst others apparently makes you not only eligible for but actually to receive a knighthood. Not to forget moving to a job at one of the main players in the Libor scanadal Barclays. If you wished to make it look like our system is corrupt that is pretty much the way to go about it….
I have emailed my Member of Parliament Jane Ellison to enquire as to whether there are any plans to give Fred Goodwin a Peerage? I will let you know if and how she replies.
I will be back on Wednesday and in the meantime would like to wish all my readers a Happy New Year.