Why the bailout package as announced by Portugal’s Prime Minister will fail

Yesterday evening the Portuguese Prime Minister Jose Socrates gave a speech on Portuguese television to announce that he had achieved a bail out deal with the European Union/European Central Bank/International Monetary Fund troika. Mr. Socrates further said that this was a “good” but “demanding” deal for Portugal. How he could say this when he was unable to declare the interest-rate that will have to be paid on the money merely illustrates his usual combination of hyperbole and disregard for reality.

The interest-rate is important on two counts. Firstly one would regard any individual who takes a loan without asking what the terms will be as somewhat financially illiterate.To do so on a national scale is breathtaking. Secondly if we look at the bailouts that have taken place so far in the Euro zone the interest-rate that is supposed to be paid has changed fairly regularly! If we take the case of Greece it was originally estimated at 5.23% was then expected to maybe rise to 5.8% to match the proposed rate for Ireland and was recently plans were introduced to reduce it to more like 4.25%. The interest-rate for Ireland was supposed to be 5.8% but the Irish government is trying to renegotiate this as frankly under such a rate she still looks insolvent. Indeed under the interest-rates charged so far every country has looked insolvent! So as the character Turkish points out in the film Snatch ” I fail to see the link between this and a good deal”.

What are the terms that we do know?

Portugal will borrow some 78 billion Euros for a three-year term from the EU/ECB/IMF troika. In return for this Portugal has agreed to an austerity programme which will have as targets a fiscal deficit of 5.9% of its economic output for this year and 4.5% next year and 3% the year after.

How does this compare with previous plans?

Back on the 5th of April this was the plan for Mr. Socrates’s government.

Moreover, both the government and the main opposition party have already reaffirmed their commitment to the budgetary targets 2011-2013, namely 4.6%, 3% and 2% of GDP. Therefore, those targets will be maintained.

If you compare these numbers to the new targets we can see what is being referred too by Mr.Socrates as a “good” deal. The new targets are 1.3%,1.5% and 1% of GDP lower than before. However let us grab Mr.Socrates hand before he slaps himself on the back as there are sevral problems with calling this a good deal.

1. If the original targets were required for Portugal’s future why are they now being abandoned.

2. We now see that maintaining something can mean less than a month! This is hardly going to leave potential investors with the idea that Portugal is secure in the longer-term.

3. If we recall that Eurostat had looked at Portugal’s fiscal defict figures and re-written them the fact is that the original plan was now unviable. So yes Mr.Socrates is trying to misleadingly take the credit for a sequence of numbers which may look better to the uninitiated but in fact show that Portugal’s position has deteriorated yet again.

For the year just ended Mr. Socrates’s government had originally declared a fiscal deficit of 6.8% of GDP and declared it a great success as this number beat its target of 7.3% of GDP. Unfortunately for his numerical fantasies Eurostat then looked at the numbers and decided that the true number was 8.6% and then upon a closer examination decided it was 9.1%. Some might call this an attempt at misrepresentation whereas Mr.Socrates’s government calls it a “methodological dialogue.
The fiscal deficit figures for the previous three years were also revised upwards which working backwards from 2009 were raised by 0.5% of GDP and 0.5% and 0.4% respectively. Where the full impact of such revisions was felt was in the ratio of Portugal’s national debt to its GDP. Previously this was estimated at 83.1% of GDP whereas Eurostat’s revisions raised it to 92.4%. This is quite a material amount particularly when we consider all the boasting that had gone on from Portugal’s government about the previous figure.

In other walks of life people would be put in jail for this sort of misrepresentation.

What Mr.Socrates will not do

You might think that Mr.Socrates would be primarily discussing what is required but I am grateful to the Portuguese economist Pedro Barros for pointing out that he has in fact given us a list of what he will not do. You might think that such political posturing is somewhat bizarre but here it is.
- no pay general pay cuts, not even wages paid with public debt
- no change in pensions below 1500 euros
- no wage cuts to civil servants
- no reduction in minimum wage
- no constitutional revision
- no privatization of the public bank (CGD)
- no change in copayments of the National Health Service
- no change in publicly-funded schools
- no dismissals in civil service
- no dismissals without cause in companies
- no privatization of social security
- no caps in social security
- no increase in retirement age
To my mind if someone is that comprehensive they are trying to hide what is in the list of what they have to do! As ever this will no doubt be leaked in time. Furthermore according to Google translate Mr.Socrates also said this.

The international institutions recognize, therefore, that the Portuguese situation is far from being like that of other countries and far from the house as some wished to describe.

A rather odd thing to say as your hand is stretched out for a bailout is it not? Or you could read the bit that the Portuguese situation being different from other countries as in fact being rather accurate!
Comment
It would appear that the Euro zone is determined to repeat its previous mistakes and is not an organisation which seems to learn from them. There are three glaring errors with this rescue plan as it stands.
1. An interest-rate which makes Portugal look solvent in the long-term should have been applied to these loans and announced at the beginning. Say 4% for example. Instead we have no announced interest-rate ( If a year into these bailouts the Euro ozne does not know what it should charge….)
2. After having to extend the three-year term for loans to Greece and talk about this for Ireland the Euro zone has yet again offered a three-year term for a programme. Yes the same three-year term that has not and will not work the two times it has been tried. Rather ironically at a similar time to Jose Socrates public address and adviser to the Greek Prime Minister was giving a talk at the london School of Economics suggesting that Greece needs “rescheduling — or re-profiling as it is called sometimes”.
3. The programme does not directly address the fundamental problem which Portugal faces which is a lack of economic competitiveness. This has dogged her for the past twenty years and accordingly was a feature of her economy way before the credit crunch hit. Looked at like this where it is plain that a long-term solution needs to be applied it is even plainer that the three-year term of the package is a combination of a mistake and a fantasy.
What is the true Portuguese situation and what can be done?

One of the features of this crisis is the way that political leaders have ignored reality. Back on the 27th of April 2010 I pointed out four main problems for Portugal on my “old” Notayesmanseconomics blog.

Since joining the Euro Portugal has had the slowest growth rate of the euro zone nations which contrasts her strongly with Greece who was growing (assuming you believe the numbers) at around 3/4% per annum over this period. Portugal has had an average rate of less than 1% over this period. This has been caused by several factors.

1. There has been a “brain drain” where many educated Portuguese emigrate although because of EU rules it is hard to get exact numbers.

2. Portugal had and has quite a few industries which are price competitive and these have been affected by the growth of price competitive manufacturing in China and the Far East as well as in Eastern Europe.

3. Portugal had a privatisation programme for many utilities but it would appear that there has been a form of “soft corruption” where ex-politicians rather than businessman have been appointed to the boards of such firms making them inflexible and the reverse of dynamic.

4.Portugal has rigid labour laws, which there is little political will to reform and she has one of Europe’s toughest employee-protection regimes.

These need to change and you may notice that the implication of Mr.Socrates list of what he will not do was exactly the reverse of this. the bailout as announced does not address any of these. Indeed looking back to the 5th of May 2010 I see a point I made then which now looks rather prescient about  Greece and now applies to Portugal going forwards.

Another issue is how exactly will Greece put herself in a position to repay these loans? There is no real answer to this so the begged question that is forming in people’s minds is what will the replacement aid package look like?

Conclusion

I like Portugal so I say this next bit sadly, this package will fail as it does not address Portugal’s true problems. Also I am concerned about the democratic legitimacy of a caretaker government which had its policies rejected in Parliament in effect setting bailout terms for Portugal. This is the job of a new elected government not the job of one which has lost most of its legitimacy.

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  • Drf

    Of course this bail out attempt will fail, as will all of the others. The fundamental problem is that governments around the world have profligately accumulated too much debt, as a result of inane promises made to increasingly dumbed-down democratic electorates. They will not cut their public spending to levels which are sustainable. As a result, their debts continue to increase and there is now little chance of them ever paying off these debts, unless they can generate sufficient inflation. The Eurozone countries, like Portugal, are hamstrung however, since they cannot create inflation by debasing their currencies, since the Euro block does not allow it. See http://www.telegraph.co.uk/finance/comment/damianreece/8490943/Why-Bank-of-England-policymakers-dont-want-to-raise-interest-rates.html

    However, when the markets eventually wake up, and realise the true long-term implications of this situation, all hell will break loose; once they fully understand what the outcome must now be they will realise that even situations like being able to borrow funds at 0.5% and lending them back to the UK government in Gilts at 3.6% are not attractive against a backdrop of default, hyperinflation and economic depression. Interest rates will then be forced up quickly, and this will just exacerbate the difficulties. Here comes a new Weimar type collapse I fear, but not on a Nationwide scale this time, but a global scale.

  • Anonymous

    Is it really feasible to have an “independent” currency? Can it really be controlled by users? I am sceptical!
    http://www.springwise.com/financial_services/bitcoin/

  • NA

    Good post, particularly the mentions of the revolving doors ‘soft corruption’ of Portugal’s privatisations, the revised-revised-revised GDP figures, plus the biggest problem that differentiates Portugal from Ireland/Greece/Spain: complete stagnation (beyond subsidies) for well over a decade.

    Portugal is a lovely country in terms of climate, wine and geography, but a basket case in political, economic and social mobility terms. Further scruitiny should perhaps also be made of…

    (i) in the short term, Portugal’s increasing lack of business competitiveness with its neighbour Spain: exacerbated by the new 23% VAT regime, high road tolls, onerous vehicle registration taxes (that nearly double the cost of purchasing vehicles), plus high fuel taxes (Spain has 20% VAT, 25 eurocents-a-litre cheaper fuel etc.); forget China: Portugal’s SMEs cannot compete with next-door;

    (ii) the mid-term impact for Portuguese public finances in the battle for EU subsidies from 2013-2020 (with new EU Members jockeying for position); the new countries do not have the Greek/Portuguese record of subsidy evaporation and a huge underground economy; is an EU subsidy better invested in Poland/Czech Republic or Portugal/Greece?

    (iii) the heavy role of the EIB and EIF in bankrolling major strategic projects in Portugal in the past five years (esp. renewables, a supposed ‘success story’ of the Socrates government); is this sustainable?

    (iv) the hangover from ECB’s recent role in funding Portuguese bank to buy up Portuguese sovereign debt… in essence, mini-bailouts that postponed this big one; this debt carousel is likely to unravel in the next few years, as this bailout rolls over into the next one;

    (v) the upcoming need to maintain/overhaul the major1990s/2000s infrastructure developments: road/rail/airports are already showing their teeth;

    (vi) any short-term impact of contractual penalties from cancelled mega-projects (transeuropean TGV networks, Lisbon airport expansion, etc.), together with the long-term impacts of not building these projects.

    The more I get to know about the Portuguese economy in the pages of Expresso and the Diario de Noticias, the more I realise that the surprise is not the Portuguese bailout post-2008, but how Portugal could have blagged its way out of consistent underperformance during the boom decade that preceded the bust.

  • http://profiles.google.com/joao.mcc.magalhaes João Magalhães
  • Expatin BG

    If the answer is debasing the currency and creating inflation, then the question is wrong. Currency / value debasement by inflation has a similar effect to default – investors lose out. Either way I’d expect future borrowing costs to increase. Controlling inflation is difficult. Look at the 8.75 interest rates Brasil is paying to bring down inflation (they have been much higher). How many European countries could afford 8.75 % ?

    A default of one of the PIIGS would cause pain within the country, but it would force that government to control the budget because no more money can be borrowed. Ultimately the root cause is borrowing to live beyond one’s income. Who will come out worse bankrupt Latvia & Iceland or bailed out Greece, Ireland & Portugal. Time will tell.

    As to borrowing money at 0.5% and receiving 3.6% – I make that 3.1% differential on zero money invested, sounds like “Money for nothing”

  • Anonymous

    Hi EBG “and your cheques for free”. Ok, ok I Know the original lyric said chicks which lets face it is a more likely theme for a rock band…

    Central banks are declaring the differential as a profit and I will have more to say on this in future articles as I am doing some analysis on this subject.In a way it also relates to KG’s comment below as some Central Banks are debasing their own currency and declaring a profit for themselves….

  • Anonymous

    Hi KG I cannot vouch for that scheme either way! However I do have some thoughts for you.

    If you could jump into Doctor Whos Tardis and go back 5 or 6 years the number of mentions of such things would be extremely rare. Why is it more common now? To my mind some central banks are choosing to ignore a prime function which is to protect their currency/coinage. In fact some are in effect debasing it. Both the Bank of England and the Federal Reserve have implicitly pushed policies to expand the level of base money and reduce their exchage rate.

    Accordingly alternatives start to look more attractive…

    To get off the ground someone trusted and large would need to be involved. My first thought would be a supermarket in the UK (I am not saying all supermarkets are to be trusted..) as they sit in a position where a currency of theirs might gain traction. With central bank credibility shrinking away it is not so hard to conceive of organisations which have higher credibility. Actually the real problem I think is why they would want to do it!

  • Johnny

    Italy grew less than Portugal. There was no brain drain (look at the boost in high-tech growth in Portugal) – there is now but there wasn’t one till 1 year ago. Portugal has amongst the highest number of young students finishing a degree in europe

    http://www.bbc.co.uk/news/education-11203790

    1 – Finland (63%)
    2 – Iceland (57%)
    2 – Slovakia (57%)
    4 – Poland (50%)
    5 – New Zealand (48%)
    6 – Denmark (47%)
    7 – Ireland (46%)
    8 – Portugal (45%)
    9 – Netherlands (41%)
    9 – Norway (41%)
    11 – Sweden (40%)
    12 – Japan (39%)
    13 – United States (37%)
    13 – Czech Republic (36%)
    15 – United Kingdom (35%)
    Percentage of young people who are first-time graduates from university, 2008. Source: OECD

    if you like Portugal you should at least show some optimism! an article everyone should read:

    http://www.nytimes.com/2011/04/13/opinion/13fishman.html

    and ponder on. Enough with this PIIGS thing. It’s a myth .

  • Anonymous

    There are degrees and degrees! Not all are of equal quality. And being in the middle of a list does not make you one of the highest. And where is Germany on the list?
    Let’s be frank, Portugal is a poorly-performing country. I know, I used to live there. Lovely, but not exactly dynamic. Graduates may help one day if they are graduating in something useful and with high quality degrees, but the country needs help now, not in a decade’s time. And the country will get nowhere if it mops up all the graduates into the civil service. State employment is not the way to get a country out of a rut.

  • Johnny

    those are just the first 15. If you think it’s poorly performant then you’re not looking at figures correctly. No matter whatever good figures portugal presents they’ll be played down because people have prejudice towards portugal and the portuguese and investors betting on the default of piigs countries will be playing on that to scare away investors… I like people’s I like Portugal but….

  • Johnny

    and by the way since 2008 the 2 out 1 in rule is being applied in state jobs. The state is losing strength which should help boost the labour market + the measures predicted pre-bailout which are actually also are present in the agreement with the troika.

  • Jimbob

    Shaun, with self confessed very little economic knowledge, I checked the exchange rates this morning, and the Euro is getting stronger against the pound, but the other news indicates the Portuguese cost of borrowings is increasing again already. This would indicate a lack of faith in the ‘bail out’ and therefore in my mind another failure of the Eurocrats. How does that correlate with the exchange rate? Does this indicate the UK position worsening?

  • Anonymous
  • Shaun Richards

    Hi Johnny and welcome to my blog
    I do like Portugal and have had and indeed have Portuguese friends. However I feel that one of the current problems around the world is that what is in effect a political class has led things in the wrong direction. For example I think that purely quoting the number of people with a degree implies that a higher number or percentage is better. I do not need to involve Portugal here as whilst for individuals and families it is nice to go to university the truth of the UK’s expansion is that it has not brought the success hoped for and that there has been an element of inflation as polytechnics were regraded as universities.

    Moving onto Portugal itself and its problems let me quote from some work by the Portuguese economist Alvaro Santos Pereira from a year ago.

    If the story ended here, it could be argued that there was nothing really new in the recent wave of emigration from Portugal, since in the 1960s and in the 1970s low-skilled emigration was also dominant (although the recent wave of emigration is allegedly more “temporary” in nature than in the 1960s and 1970s).
    Unfortunately, the story does not end here. Thus, perhaps more surprising, it is interesting to verify that, in all the OECD, Portugal has one of the highest emigration rates of workers with a university education. Simply put, in terms of emigration of the highly skilled, no country in the OECD sends a higher percentage of its university-educated workers to foreign countries as much as we do, with the sole exception of Ireland.
    A recent study by Docquier and Marfouk (2006) has estimated that Portugal is one of the 30 countries in the world most affected by the brain drain of its university-educated workers (more precisely, of all the countries with more than 4 million people). Hence, since the 1990s, Portugal has “exported” about one fifth of its university graduate workers, a rate that puts us at par (in relative terms) with countries such as Afghanistan, Togo, Malawi, and the Dominican Republic.
    In turn, another study that analyzed the education levels of emigrants to the 6 biggest receiving countries in the world (Australia, Canada, France, Germany, the UK, and the United States) shows similar results (Defoort 2008). Of all OECD countries, Portugal has one of the worst brain drains. Simply put, and once again, worst than us only Ireland. Not even the Eastern European countries have a brain drain as high as ours

    Such work influences my thoughts and partly expalins my differences with the NY Times article you quote from. For example the author is perfectly free to write “Portugal had strong economic performance in the 1990s and was managing its recovery from the global recession better than several other countries in Europe” just as I am free to think that he is indulging a fantasy and not a reality.

  • Shaun Richards

    Hi Jim and welcome to my blog
    What a difference half a day makes! Since you wrote this the Euro has dropped substantially against the pound and the dollar. At one point we were threatening to maybe break 1.10 and yet now it is 1.126. However overall the Euro exchange rate is still strong and the answer I believe is as follows. The strong stance of the European Central Bank on inflation has made it look like the son of the Bundesbank and accordingly markets have for a while treated the Euro like it is the Deutschemark. If there was a DM right now it would be very strong in fact probably too strong but that’s another story…

  • Anonymous

    Hi Johnny and welcome to my blog
    I do like Portugal and have had and indeed have Portuguese friends. However I feel that one of the current problems around the world is that what is in effect a political class has led things in the wrong direction. For example I think that purely quoting the number of people with a degree implies that a higher number or percentage is better. I do not need to involve Portugal here as whilst for individuals and families it is nice to go to university the truth of the UK’s expansion is that it has not brought the success hoped for and that there has been an element of inflation as polytechnics were regraded as universities.

    Moving onto Portugal itself and its problems let me quote from some work by the Portuguese economist Alvaro Santos Pereira from a year ago.

    “If the story ended here, it could be argued that there was nothing really new in the recent wave of emigration from Portugal, since in the 1960s and in the 1970s low-skilled emigration was also dominant (although the recent wave of emigration is allegedly more “temporary” in nature than in the 1960s and 1970s).
    Unfortunately, the story does not end here. Thus, perhaps more surprising, it is interesting to verify that, in all the OECD, Portugal has one of the highest emigration rates of workers with a university education. Simply put, in terms of emigration of the highly skilled, no country in the OECD sends a higher percentage of its university-educated workers to foreign countries as much as we do, with the sole exception of Ireland.
    A recent study by Docquier and Marfouk (2006) has estimated that Portugal is one of the 30 countries in the world most affected by the brain drain of its university-educated workers (more precisely, of all the countries with more than 4 million people). Hence, since the 1990s, Portugal has “exported” about one fifth of its university graduate workers, a rate that puts us at par (in relative terms) with countries such as Afghanistan, Togo, Malawi, and the Dominican Republic.
    In turn, another study that analyzed the education levels of emigrants to the 6 biggest receiving countries in the world (Australia, Canada, France, Germany, the UK, and the United States) shows similar results (Defoort 2008). Of all OECD countries, Portugal has one of the worst brain drains. Simply put, and once again, worst than us only Ireland. Not even the Eastern European countries have a brain drain as high as ours”

    Such work influences my thoughts and partly expalins my differences with the NY Times article you quote from. For example the author is perfectly free to write “Portugal had strong economic performance in the 1990s and was managing its recovery from the global recession better than several other countries in Europe” just as I am free to think that he is indulging a fantasy and not a reality.

  • Anonymous

    Hi NA
    Thank you and welcome to my blog.

  • Anonymous

    Hi Jim and welcome to my blog
    What a difference half a day makes! Since you wrote this the Euro has dropped substantially against the pound and the dollar. At one point we were threatening to maybe break 1.10 and yet now it is 1.126. However overall the Euro exchange rate is still strong and the answer I believe is as follows. The strong stance of the European Central Bank on inflation has made it look like the son of the Bundesbank and accordingly markets have for a while treated the Euro like it is the Deutschemark. If there was a DM right now it would be very strong in fact probably too strong but that’s another story…

  • Anonymous

    Hi Joao
    Thank you for posting this and welcome to my blog.