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Introductory statement given by Governador Vitor Constâncio - Economic bulletin - September 2000

24 May 2000

As it is usual at this time of the year, the Banco de Portugal discloses in this Economic Bulletin an analysis of the economic developments of the past year and the outlook for economic growth in the current year.

1. Growth in the euro area decelerated in 1999 when recorded a deceleration compared with the previous year. However, towards the end of 1999 the European economy started initiated a strong recovery, which continued in 2000. The creation of the euro and the conduct of monetary policy, in which Portugal participates, contributed to the recovery with an adequate interest rate policy. Interest rate cuts in April 1999 to historically very low levels gave a positive boost to the economic recovery. After a period of consolidation, interest rates were raised again in order to counter inflationary pressures, in line with the primary objective of maintaining price stability. It was thus confirmed that the chief interest in adopting the euro lies in the possibility that Europe has of pursuing its own objectives with an autonomous monetary policy. The euro helped create an area of growth without inflation. The stability of the internal value of the euro, of which no one doubts, is the main factor leading toindicator of success in an economy with a small weight on external trade, like the euro area. The credibility of the low inflation policy, ensured by the euro, has been validated by the markets, which have consolidated long-term interest rates systematically below US rates. Much has been said about the external value of the euro, as if this were the single way of assessing its success. This is a wrong view. The euro has depreciated beyond what is justified by the euro area fundamentals and this excess has led to a sizeable undervaluation, which will eventually be corrected. However, asAs it is known, the Eurosystem has no exchange rate target, although but nevertheless its effects on internal inflation are one of its concerns, whereby which means that it would be preferable to have a higher external appreciation of the euro. Over time, the euro will gain importance and value. Conversely to Europe, the US continues to post high balance of payments imbalances, which will eventually be reflected in the exchange rate of the US dollar. Most important, however, is that the euro can be used to keep low inflation levels and good economic growth conditions in the euro area economy.

2. At to the Portuguese economy, growth also decelerated to 3% in 1999, albeit remaining above the euro area average. Overall, the performance of the Portuguese economy in 1999 can be considered good. Although inflation was higher than the euro area average, the unemployment rate stood at only 4.2% and total employment increased by 1.8%, while real wages rose by 2.8%. On the other hand, Portugal increased its market share by around 1 percentage point in export markets (against a loss of 2.3% in 1998), while the market share of the euro area as a whole recorded a loss.

These positive signs do not invalidate some causes for concern relating to the sustainability of the recent growth pattern of the economy:

A) First, the high indebtedness of economic agents mirrored in the deterioration of the current account to 6.6% of GDP in 1999 and to 8.5-9.5% in the current year.

B) Second, the need to reverse the fiscal consolidation pattern so as to base it on the curb of expenditure to avoid an increase in the tax burden.

The first point is also associated with the problem of the structural deficit of the Portuguese trade balance. Indeed, this implies that the growth of domestic demand is excessively reflected in the rise of imports rather than in domestic output. For instance, in 1999 domestic demand increased by 4.8% but imports net of exports had a negative contribution of approximately 2 percentage points to the growth rate of GDP.

3. For the current year, projections point to a GDP growth similar to that recorded in 1999 or even slightly higher, but with a more favourable composition, as it will rely less on an increase in domestic demand and will have a less negative contribution of the external sector. Even though, imports net of exports will reduce the growth rate of GDP by approximately 1 percentage point. The deceleration of domestic demand relies on the foreseeable moderation of private consumption growth. Indeed, having reached an indebtedness level of 76.5% of GDP dDisposable iIncome, the rise in interest rates and hence, in debt-servicing costs contributes to containing consumer growth, which is already apparent in the drop in the sale of passenger vehicles and in the deceleration of lending for house purchase recorded since June 1999. The indebtedness of households has increased significantly, although it cannot be considered anomalous comparing the 76.5% of dDisposable iIncome recorded in Portugal with 98.7% in the US, 111% in the United Kingdom, 76.1% in Germany, 73% in Spain, 78.8% in Ireland or 91.6% in the Netherlands. The problem lies in the fact that a high indebtedness gives rise to increased vulnerability to possible future economic shocks and increases the risk of a sharp decline in consumption to rebuild savings levels, which may have potentially recessive consequences. Thus, the deceleration of consumption and domestic demand will should preferably be gradual, with a moderation of the pace of the external indebtedness of the economy. In this perspective, it is important that banks will be more selective in the evaluation of credit risks and will contribute to the moderation of the growth of household indebtedness.

4. The fiscal policy will must also play a role in the desirable trend of domestic demand. Thus far, the country has complied with its commitments within the Stability and Growth Pact, but with a pattern based on an increases in tax revenues and a decline in interest payments, followed accompanied by a significant rise in the remaining expenditure items. This pattern has become unsustainable as it is recognised in the new Stability Programme presented by the Portuguese government. Along these lines, the Minister of Finance and Economy has recently declared that it will be necessary "to reduce the current growth rate of government expenditure by half", implying "the reduction of the increase in primary current expenditure to rates below GDP growth". These targets have the support of Banco de Portugal and are consideredbuilt oin the analysis made in this Bulletin. The curbing of government expenditure growth is necessary to help decelerate domestic demand and avoid an increasing tax burden. The next budget will be the decisive occasion to make the adjustments required in Portugal’s policy stance.

5. To grow more rapidly, Portugal needs that its productive structure takes a qualitative leap forward.; Tthis depends essentially on the action undertaken by companies, investing in the country and in technological innovation. Government policies have to provide the adequate infrastructures and incentives. Wage costs in turn have to be adjusted to productivity growth. ThusOnly with these policies, it will obviously be possible to gain market shares in exports and contain the penetration of imports in the domestic market.

In fact, within the framework of Monetary Union, a responsible economic management policy implies that the fiscal and wage policies are conducted as competitiveness factors.

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