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Introductory statement given by Governador Vitor Constâncio - 1999 Annual report

27 July 2000

The Annual Report of the Bank addresses chiefly the analysis of the economic developments of the past year, and is intended to play the role of the most reliable source on that matter. As in the previous year, the Report is published at a relatively belated date, which is due to the delayed publication of some statistical data.

1. This is the first Report of the Banco de Portugal published since we ceased to conduct our own monetary policy. Today, we share monetary sovereignty with the remaining countries of the Eurosystem. A single monetary policy is implemented for the euro area as a whole, but it is decided by a Governing Council in which we participate with voting rights equal to the other members. In addition, decisions are prepared by 13 permanent Committees and a number of working groups, with the active participation of senior experts of the Banco de Portugal. The Eurosystem comprises the ECB and the National Central Banks of the Member States and it really operates in a rather decentralised manner.

The monetary policy conducted by the Eurosystem since January 1999 was the most adequate to the economic environment and has succeeded in supporting economic recovery. In April 1999, the interest rate on refinancing operations was lowered by 50 basis points to 2.5%, the lowest level by historical standards. As the economy started to pick up and the inflationary risks increased further, the interest rates went up in November 1999, in March 2000 and again in April and June. Nonetheless, the real refinancing rate stands today at levels close to those recorded in early 1999. This means that monetary policy was exclusively determined by the European environment and has supported the economic recovery in the euro area, without prejudice to the primary objective of price stability.

The oil price increase and the consolidation of economic recovery led to an inflation rate occasionally above 2% (2,4% in June), but the monetary strategy adopted by the Eurosystem has a medium-term target for inflation, thus accommodating temporary deviations. However, I would like to point out that the interest-rate policy shall ensure that inflation in the euro area will stand at a stable level below 2%.

2. As regards the Portuguese economy, no new data have been provided since the release of the Economic Bulletin in May that might change our view of the situation. Therefore, I will simply make some comments. The economy had a good performance in 1999 with an above European average growth rate of 3%, recording an inflation rate of 2.2% and an unemployment rate of 4.5%. Real wages increased by 3.0% and the disposable income rose by 2.2%. In this first half of the year, the economy has maintained the same pace of growth, while inflation accelerated in the latter part of the period.

As I have stressed in May, on the occasion of the presentation of the Economic Bulletin, the problem lies in the fact that growth has been based on the buoyancy of domestic demand, which in turn is underpinned by a growing indebtedness of the economic agents. This is reflected in an external deficit that reached 6.6% of GDP in 1999 and, according to our projections, will stand at approximately 9% this year. However, I would like to stress that a third of the deficit deterioration forecasted for the current year will be exclusively due to the deterioration of the terms of trade, associated with the oil price increase and may therefore be of a temporary nature, should the oil average price drop in 2001. In the meantime, the loss in terms of trade reflects a reduction in the country’s real income, which will have to be recognised.

In any case, the growth pattern of recent years was not sustainable and, therefore, a necessary deceleration of domestic expenditure and an increase of net exports has already started. The interest-rate increase has contributed to the deceleration of demand and the European recovery has been behind the performance of those exports. This year, growth will be identical to last year’s, but its composition will be more favourable.

3. The deceleration of domestic expenditure must be further fostered by the economic policy. The growth rate of credit to households has decreased from 34% in June 1999 to 23,6% today, which is still a very high level. Banks’ financing requirements will affect their own capacity to further expand credit at its present pace. Nonetheless, it is necessary to take measures in order to induce a faster deceleration of credit. It has recently been decided that the share of the loans for house purchase in excess of 75% of the value of the house which is the object of the loan, will in the future be considered at 100% (previously at 50%) for the capital ratio of banks. On the other hand, measures are being prepared to raise provisions, with a view to induce the banks to be more rigorous when evaluating credit risks, and therefore to curb credit expansion. The increase of provisions will be of an anti-cyclical nature and, on average, will not affect bank profitability throughout a whole economic cycle. Other regulatory changes will also be introduced on the activity framework of credit institutions, in order to improve their competitiveness potential.

4. The deceleration of domestic demand will also be influenced by further restraint of public expenditure in the context of the ongoing adjustment of budgetary policy. Compliance with the Stability Programme will imply a real annual growth in public expenditure of merely 1%. In parallel with the drop in consumption growth, it might imply that this year and the next, the economy may grow slightly below the European average. This adjustment stage is understandable, in the wake of a 5-year period in which we have recorded annual growth rates 1 percentage point above our European partners’ average.

The Portuguese economy enjoys a full-employment situation, while the euro area still has room for improvement before reaching potential output, given the higher unemployment rate. Achieving higher growth rates in Portugal would require a sudden leap in productivity or higher labour-force inflows, solutions that are difficult to implement in the short run.

On the other hand, the full-employment situation puts some pressure on wage growth, creating one of the risks that we must avoid: a wage and price increase spiral, which would not be beneficial to anyone as it would only raise unemployment and reduce our competitiveness.

As I mentioned in May, a responsible economic management, at this stage, implies that budgetary and wage policies must be consistent with a sustainable pattern of economic growth. 27 July 2000.