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Summary of the address by Governor Carlos da Silva Costa at the debate organised by the Fórum de Administradores de Empresas on the "Financing Model for the Portuguese Economy"

The Governor of Banco de Portugal, Carlos da Silva Costa, participated today, as guest speaker, in a debate organised by the Fórum dos Administradores de Empresas on the “Financing model for the Portuguese economy”.

The Governor discussed the problems of the Portuguese economy in the context of the international financial crisis, the global economic crisis and the sovereign debt crisis that affects the euro area economies.

The current situation of the Portuguese economy results from major structural weaknesses and unsustainable fiscal policies, whose effects were exacerbated and magnified by the international crisis and by an incomplete economic governance model in the euro area.

Globalisation and excess liquidity, resulting to a large extent from an accommodative monetary policy in the United States, translated into credit expansion without adequate risk assessment. These developments were at the origin of the sub-prime crisis and its repercussions for the banking system in northern Europe in 2007-2008, of the subsequent fiscal expansion and of the sovereign debt crisis witnessed today in the euro area peripheral economies.

The euro area economic governance model proved inadequate to address the situation. This model relies on four fundamental assumptions: (i) fiscal sovereignty of the Member States; (ii) “no bail-out” – Member States are prohibited to assume the liabilities of other Member States; (iii) “no-default” – there is no mechanism in place for orderly debt restructuring; and (iv) “no-exit” – the possibility of leaving the Economic and Monetary Union (EMU) is not foreseen. The Stability and Growth Pact, which aimed at supplementing the governance model by imposing vigilance mechanisms and financial discipline, turned out to be insufficiently robust.

This setting has brought to light the weaknesses of the Portuguese economy. These structural weaknesses are evident in the continued accumulation of debt by households, firms and the public sector, and are the counterpart to an economic development and job creation model relying on the expansion of the nontradable goods sector.

In Portugal, in a context of higher risk aversion in the financial markets and an incomplete economic governance model in the euro area, the indebtedness level, low output growth and the territorial coincidence between the sovereign and the banking business resulted in the interruption of market financing to the Portuguese economy, rendering the request for financial assistance from the European Union and the International Monetary Fund inevitable.

The adjustment of the Portuguese economy implies the deleveraging of the financial sector, stronger domestic savings and the rebalance of public accounts, which will necessarily translate into a contraction of domestic demand. Establishing a sustainable growth path requires the development of the tradable goods sector, which in turn calls for the implementation of reforms aimed at improving the quality of public policies and institutions, as well as at diversifying the financing sources of the economy.

On the other hand, at the European level, it is crucial to strengthen the economic governance model through the creation of effective mechanisms to control financial discipline and to preserve competitiveness, guaranteeing the sustainable development of the euro area economies. These mechanisms should be supplemented by others providing liquidity to EMU countries, while coping with confidence crises in international financial markets and preventing liquidity constraints from becoming solvency problems.

Lisbon, 15 June 2011