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Economic Bulletin - Autumn 2011: Projections for the Portuguese economy in 2011-2012

  1. The year 2011 signs the beginning of the unavoidable adjustment process of the Portuguese economy. This process shall be characterized by a fiscal consolidation, a gradual but significant deleveraging of the private sector, including the banking sector, and a strengthening of institutions conducive to innovation, competition and the reallocation of resources in the economy. This adjustment - framed by the Program of Economic and Financial Assistance – entails high economic and social costs in the short term, but is an inescapable imperative to ensure sustainable economic growth in the medium and long term.
  2. The most recent indicators point to a global economic slowdown deeper than anticipated, particularly in advanced economies. In the case of the euro area, the sovereign debt crisis intensified and spread to some of the largest economies in the area. The generalized increase in risk aversion was reflected in rising financing costs in debt markets, particularly in the case of countries with structural weaknesses, such as perceived by international investors. In this context, the monetary and financial conditions of the Portuguese economy deteriorated considerably during 2011 – despite the high level of recourse to Eurosystem funding – and the foreign demand directed to the Portuguese economy decelerated more than anticipated.
  3. The current projection points to a contraction of economic activity of 2.2 percent in 2012, after a decline of 1.9 per cent in 2011. The adjustment of the macroeconomic imbalances will remain as an important determinant of the evolution of domestic demand. Additionally, the international environment will imply a slowdown in exports in 2012. The projections point to a significant adjustment of external imbalances. In particular, a decline of about 6 percentage points in the current and capital account deficit is projected in these two years. Focusing on the supply side, it is particularly striking that employment dropped steadily since late 2008, a path that will tend to persist over the projection horizon.
  4. The trajectory of the Portuguese economy in the near future is surrounded by a high level of uncertainty, related in particular to the features of the institutional resolution of the current sovereign debt crisis in the euro area, as well as to the magnitude and persistence of the global economic slowdown. Additionally, the risks surrounding the projection are tilted to the downside for economic activity and balanced for inflation. This risk assessment reflects factors related to the evolution of the international environment, as well as to the fiscal consolidation process, in particular as regards the specification of additional measures required to fully meet the current fiscal targets. Recall that these projections follow the rules of the Eurosystem projection exercises, considering only the fiscal policy measures already approved or with a high probability of approval, and specified in sufficient detail.
  5. The fulfillment of the fiscal targets, from a structural sustainability perspective, is a key element of the economic adjustment. According to the excessive deficit notification of end-September, the target for the budget deficit in 2011 will only be achieved with significant additional measures. If these measures assume a temporary nature, the State Budget for 2012 will be particularly demanding, requiring from the outset the incorporation of a very considerable set of structural measures.
  6. The Program of Economic and Financial Assistance includes a set of actions that aim to protect the financial system, including the strengthening of bank capital and the convergence to a stable market-based funding structure in the medium term. In this context, the medium-term funding and capital plans that the eight major banking groups must submit on a quarterly basis stand prominently. The plans foresee a gradual reduction in the credit to deposit ratio in each institution to 120 percent by 2014, when relevant. In this context, banks should give priority to deleveraging strategies that minimize the impact on new credit flows to the private sector. The Program foresees the need to ensure the consistency of the deleveraging process with the implicit macroeconomic scenario. This consistency will be assessed on an ongoing basis, in particular as regards the principle of ensuring adequate support to the more productive sectors of the domestic economy. This support should be consistent with the expected contraction of economic activity and should not impede the restructuring of the balance sheets of firms and of the economy in general.
  7. The implementation of structural reforms that promote growth is essential to the success of the adjustment of the economy. This process will generate a new institutional framework in which the incentives for agents in different markets promote the efficient allocation of the scarce economic and financial resources available. The existence of important sectors with a very low level of competition and protected from international competition promoted the inefficient growth of non-tradable sectors. On the other hand, the recent implementation of structural measures is still insufficient. The urgent need to implement reforms in the judicial system, in markets such as the labor market and in some key sectors of the national economy (e.g. energy and communications) has been facing lack of understanding on the part of the economic and social agents benefiting from the rents stemming from distortions or low competition in these markets. This heightens the urgency of their implementation.

Signed Articles

This Economic Bulletin includes, as usual, four articles written by economists from Banco de Portugal (in one case co-authored with an external researcher). The articles, of the sole responsibility of the authors, are the following:

  • "Stabilization policy and boom-bust cycles, monetary and macro-prudential rules", by Caterina Mendicino and Maria Teresa Punzi
  • "The impact of the minimum wage on low-wage workers", by Mário Centeno, Cláudia Duarte and Álvaro A. Novo
  • "An analysis of the evolution of the performance of Portuguese students in the OECD’s Programme for International Student Assessment (PISA)", by Manuel Coutinho Pereira
  • "The Quarterly National Accounts in real time: an analysis of revisions in the last decade", by Fátima Cardoso and António Rua

Banco de Portugal, 6 October 2011