11th September 2012

Today the Portuguese government will receive the details of the latest troika (IMF,ECB,European Commission) or men in black review of their economy. There is little or no danger of them concluding that Portugal is not doing her best to hit the fiscal targets given to her as in Portugal there has been virtually no dissent. It is as if her political class has borrowed their opinion on this subject from the film The Stepford Wives.

However this does not mean that the project is not in trouble as closing your mind to the consequences of your actions does nothing to prevent them from happening. As an illustration I would like to take you back to Friday evening and the address to the nation by Portugal's Prime Minister Pedro Passos Coelho.

What did the Prime Minister announce?

The drumbeat here was that Portugal was in danger of falling behind the fiscal deficit targets that the troika had set her. These are 4.5% of her Gross Domestic Product this year and 3% in 2013. Accordingly in an example of The Stepford Wives logic discussed above Portugal needs more of the prescribed medicine rather than a change of course.

The precise dose was a 7% increase in social security contributions from 11% to 18% for all employees from 2013. As a compensating factor employers will find that their social security contributions will be reduced from 23.75% to 18%.

The latter change was presented as an aid to employment in a country with a 15% unemployment rate and as a stand-alone move that would be true. But where is the demand for the goods to employ people going to come from when employees face a 7% rise in social security contributions? We already know that domestic demand is plummeting in Portugal as it fell at an annual rate of 7.9% in the second quarter of this year and such a move is only likely to make this worse. The only hope is for a boost to exports but how will this offset falling domestic demand, particularly in the current economic environment?

However Portugal's government will see a benefit as revenues will rise from employees more than they fall from (private-sector) employers.

Why is this happening to a country which we keep being told is "on track"?

In essence it boils down to falling government receipts which is inspite of the increase in taxation imposed. In the year to July Portugal's tax revenue is 3.5% lower than that at the same stage in 2011. Whilst she has reduced her state expenditure by 0.7% as you can see the position is worse than that last year.

You would not guess this by the deficit numbers presented as it has fallen from 6.56 billion Euros to 3.98 billion. But tucked away in the numbers is another one-off move as Portugal has a capital revenue improvement of just under 3 billion. If I remember rightly this is the pension transfer coming in in yet another "one-off" move. The underlying situation however is worse and not better.

One factor rarely discussed with Portugal is that if you include the one-off measures she has just about reached a primary balance as this deficit has only been 40 million Euros in 2012 so far. The catch is that we need to include her regions and some other parts but on a state government basis default and devaluation becomes feasible at least if you are willing to ignore the one-off transfers!

What has driven this?

This part is simple, it is the decline in Portugal's economy which has contracted by 3.3% over the last twelve months and by 1.2% over the last three months. We see here that austerity applied to a weakening economy has led to yet another turn of the austerity wheel which will beget more economic weakness and probably repeat. The clearest signal of this is in Value Added Tax (sales tax) revenues which in spite of increases in the rate at which it is being applied has fallen by 1.1% in the year to July.

What is the latest news on Portugal's economy?

Continue reading…


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