Portugal Country Report

2014

Group E2
Rajarshi Sahai
Ridhima Khurana
Ritesh Khare
Sourav Singh
Sruthi Dasari















2

Table of Contents

1. Portugal A snapshot
2. Gross Domestic Product Composition
Nominal and Real GDP Growth
Analysis and Expectations
3. Inflation
Consumer Price Deflation
Analysis
4. Current Account trends and analysis
From Deficit to Surplus- How?
Current Account Deficit- Good or bad?
5. Money Supply
6. Portugals Debt
7. Tax Environment
8. Exchange Rates
9. Labour market and Unemployment
Trends
Labour market Reforms
Impact of the Labour Market Reforms
Are Labor Reforms Neccesary?
10. Unemployment
Relationship between Unemployment and Industrial Production
Impact on Minimum Wages
Impact on Job Vacancies
Total Factor Productivity Growth
Labour Cost and Export
11. Conclusion
12. Bibliography

Portugal- A Snapshot

Administrative Details:

Official Name : Portuguese Republic
Capital : Lisbon
Government: Unitary Semi Presidential Republic
President: Anibal Cavaco Silva
Prime Minister: Pedro Passos Coelho

Demographic Indicators:

Population: 10,427,301 (2014 estimate)
Ethnic Groups: 96.87% Portuguese

Economic Indicators:

Currency: Euro
Current Unemployment rate: 18.5% (2014 estimate)
Top 5 Export Destinations:
Spain (20%), France (11%), Germany (11%), Angola (6.7%), and United
Kingdom (4.7%)
Top 5 Export Items: Refined Petroleum (7.4%), Cars (4.7%), Vehicle
Parts (3.7%), Leather Footwear (3.3%), and Uncoated Paper (2.5%)
Top 5 Import Destinations: Spain (27%), Germany (11%), France (6.2%), Italy (5.3%),
and China (4.9%)
Top 5 import items: Crude Petroleum (12%), Vehicle Parts (3.7%), Packaged
Medicaments (3.1%), Cars (3.0%), and Petroleum Gas (2.9%)
Summary of Portugals Macro-Economic Factors
i
:
Annual Data 2013 Historical Averages (%) 2009 13
Population (M) 10.5 Population growth -0.2%
GDP ($B) 220 Real GDP Growth -1.4%
GDP PPP ($B) 268 Inflation 1.4%
GDP per capita ($) 20,935
Real domestic demand
growth
-3.2%
GDP per capita - PPP ($) 25, 459 FDI Inflow (% GDP) 4%

4

GDP Composition

The Portuguese economy was in recession from 2011 to 2013 and, although its near-term
outlook has improved over the past year, the challenges it faces remain stark. Real GDP is
expected to return to weak growth of 0.7% in 2014 before picking up to average 1.3% in 2015-
18. Private consumption will recover slowly, but public consumption will contract each year to
2017. Fixed investment will record modest growth, hampered by continued public-investment
cuts and caution on the part of companies and households over their economic prospects.

Nominal GDP & Real Growth Rate:
Portugals Nominal GDP in 2013 was $220B, with a Real GDP growth of -1.4%. (as
shown in figure 1). The Real GDP growth for Portugal is below the growth rates of
OECD countries and global average that reflects is relatively poor economic condition.
For the years 2014 and 2015, Real GDP is expected to grow weakly at 0.7% and 0.9%
respectively, but it continues to remain below the OECD and World averages


Figure 1: Portugal's Nominal GDP & Real GDP Growth (EIU data)
Analysis and Expectations:

Nominal GDP could increase slowly averaging 1.8% a year in 2014-18. This will serve to keep
debt ratios high, making debt servicing more difficult. Because countries in the monetary union
cannot resort to inflation as a way of reducing debt burdens, Portugal might have only three other
routes to maintain solvency: severe fiscal retrenchment to generate primary surpluses; external
assistance; or default.



235
229
238
212
220
226
216
-2.9%
1.9%
-1.3%
-3.2%
-1.4%
0.7%
0.9%
-10%
-5%
0%
5%
10%
0
50
100
150
200
250
300
2009 2010 2011 2012 2013 2014E 2015E
U
S

$
B

Portugal's Nominal GDP & Real GDP
Growth
Nominal GDP (US$ bn) Real GDP growth (%)
5

Inflation

Consumer price inflation rate was 0.3% in 2013. The largest downward pressure on the
overall annual rate came from decreases in prices of food and non-alcoholic beverages.
Increases in cost of housing, water, electricity, gas and other fuels and alcoholic beverages
and tobacco led to an opposite effect.
Portugals weak inflation may hinder the paying down the debt burden as sustained low
inflation tends to increase the length of erosion of real value of large public and private debts
Inflation is expected to be low in medium-term forecast till 2015 (shown in figure 2), picking
up to a little over 2% by 2018







Consumer Prices Deflation:
In May 2014 consumer prices dropped by an annual rate
of 0.3%, according to Instituto Nacional de Estatstica (INE, the national statistics office). This
was acceleration from the year-on-year dip of 0.1% recorded in April.

Analysis:
Although downward pressure on prices is being experienced across the euro zone, the trends are
more pronounced in Portugal than in most other countries, reflecting the weakness of demand as
the economy moves into a fragile recovery phase. The 0.3% fall in consumer prices recorded in
May compares with an average rise of 0.5% across the euro zone as a whole. Although these
broad disinflationary trends have now become pronounced enough for the European Central
Bank to begin easing its policy stance once again, the steps it has mooted taking are unlikely to
deliver a swift boost to price levels.

Current Account:Trends and Implications
The Current account balance as a percent of GDP provides an indication on the level of
international competitiveness of a country. Current account is calculated as Net Exports + Net
factor income from abroad a declining expenditure but rather households and firms maintained
expenditure and aggregate borrowing increased while the trade balance remained relatively
6



stable. The current account steadily deteriorated since 2004 to a deficit of more than 10 percent
of GDP in 2007. This meant that Portugal experienced a steady deterioration of the current
account as declining transfers did not generate imports, a low saving rates and high personal
consumption rates as a percentage of disposable incomes. Portugal has current account deficit
because it has had relatively higher inflation rates than other Eurozone economies. For example,
rising labor costs are not met by improved productivity. This combination of higher prices and
lower productivity makes its goods less attractive, leading to more imports and less exports.
Hence the very large currents account deficits. If it had its own exchange rate, there would be
devaluation in the currency making exports more competitive and imports cheaper. This would
help reduce the size of the current account deficit. The economy of Portugal was improving on
this front as we saw the current account deficit reducing steadily since 2011, and Portugal
actually reported a current account surplus of 0.5 in 2013. This showed that Portugal had
increased its dependence on foreign investment and export revenues, with high savings ratings
but weak domestic demand.

From Current Account Deficit to Current Account Surplus: How?
1. Reduced Consumer Spending on imports:
The Portuguese Economic crisis stated that Portugal saw the biggest fall in real GDP
(apart from Greece) in the Eurozone in 2009-1010. The increase in tax rates coupled with
the cuts in public spending reduced the disposable income of the Portuguese. With lower
income, Portugal was simply buying less imports, which improved the current account.
2. More competitive exports: One of the reasons for the current account deficit was the
rising unit labor costs in Portugal, which the goods more expensive thus making exports
less competitive. Portugal reduced the prices and costs of goods produced, mainly by
reducing the labor costs, thus making exports more competitive. As seen from the below
graph, the labor costs reduced by 4% from 2009-2012 to a record low of 64.2 in 2010, the
year when the trade balance started improving.
7



In the first quarter of 2012, Portugal saw an 11.6% increase in exports and a 3.3% drop in
imports. This narrowed the trade gap to 2.68bn, 38% lower than the 4.35bn recorded a year
earlier. However, exports seem to be increasing since 2005-06, with the rate of increase higher
since 2010.


Current Account Surplus - Good or Bad?
The reduction in the current account deficit is due to both positive and negative factors. The
negative factors involve the sharp drop in consumer spending as a result of the deep recession, a
16% increase in unemployment and a sharp fall in industry wages.


On a more positive note, there are signs that that Portuguese exports are showing signs of growth
and capturing new markets. Portugal may still have a long way to go in restoring competitiveness
and it is not clear that modest growth in exports can compensate for the dramatic drop in
domestic demand.
8

Money Supply
Since 1999, when the Eurozone was created with its first 11 member countries, the monetary
policies of Portugal are administered by the European Central Bank. While the monetary policies
are centrally managed from Euro Bank, the fiscal policies are still taken care of by Portugals
government. So, a study of Euro Central bank is necessary to understand the money policies
evident in Portugal.

Euro Central Bank Interest Rate:
1. 2001-2003: The Early 2000s Recession was fallout of the recession that had impacted
USA in 1999-2000. Eurozone was newly created and the value of Euro shot up sharply
because of slowdown in US. This in turn caused unfavorable exchange rates for
companies based in europe. This along with the dot-com bust, caused the European
central bank to reduce interest rates to combat the deflation

2. 2006-08: The period of growth. To prevent inflation or over valuation, during this time
the European bank kept increasing the interest rates.


3. 2008-10: Great depression: Along with US, during this time Europe saw a major
depression and recession. As a result, liquidity dried out in the market. The Eurobank
drastically cut down on interest rates to once again encourage expenditure.

4. 2011-13: Eurozone Crisis: Portugal had caused considerable deficits in its budget due to
ill managed state public works and inflated wages for redundant public servants. During
the recession, when liquidity dried down and risky lending went down, Portugals
unmanageable debt structure came to the fore. At the same time, countries like Spain,
Italy, Greece, and Ireland also suffered from similar problems. This is the reason why
Euro Central Bank had to bring down rates even further and almost close to zero.

5. The extent of Portugals debt as we can see that the total debt shot up sharply after 2008,
which finally required Portugal to go for a bailout.
9



Historical changes in Reserve Ratio and M3 Currency Drain Ratio:
The graph shows the effect of Eurozone Crisis on two major M3 ratios. As we can see from the
Currency Drain Ratio, people in eurozone (Portugal included) are holding greater amounts of
currency with them. The banks also had to increase their reserve rates considerably, as the
underlying risks associated with any asset increased during the eurozone crisis.
Portugal Inflation vs Interest Rates:
The major point worth noting in the graph above is that the sustained reduced interest rates after
the recession, led to a high inflation rate in Portugal between 2010 to 2012. During the Eurozone
crisis, when Portugal received the bailout package, it had to bring in austerity measures, which
has brought down the Inflation rate, so much so, that Portugal is now seeing deflation i.e. when
inflation rates fall below 0.

Portugals Debt
In 2013, Portugal ranked 6
th
in the World Debt to GDP scale, and second only to Greece in the
EU. The external debt levels have peaked at EURO 407 Bn in 2010 Q2 and since have been
brought down to EURO 382 Bn in 2014.

The external debt in 2013 stood at 127.8 %
of GDP, showing a steady increasing trend.
However, Portugals successful emergence
from the bailout and a range of fiscal
tightening measures must arrest this trend in
the future and the figure of 126.8%
predicted by INE seems reasonable.
0
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2

Tax Environment
The tax to GDP ratio of Portugal since 2000 has remained in the range of 30% to 33.2% of GDP,
peaking in 2011. Since then, the reliance on taxation has come down with 0.8 percentage points
improvement in 2012, well below the EU-28 average of 39.4%.
ii
The government relies heavily
on indirect taxation to compensate for the relatively lower direct taxes. At 42.9%, Portugal has
the 6
th
highest proportion of indirect taxes in the EU-28 nations (average indirect tax level at
34.5%). Individual tax rates are progressive. The 2013 tax was 14.5% - 48% with an additional
2.5% surcharge on incomes between EUR 80,000 EUR 250,000 and 5% for incomes exceeding
EUR 250,000. The 2013 rate of tax for corporations was 25% with the additional 3% surcharge
for incomes exceeding EUR 1.5 million up to EUR 7.5 million and 5% for income exceeding
EUR 7.5 million and a local tax of up to 1.5%, implying overall taxes in the range of of 29.5% -
31.5% in total.
iii
The government has since announced that there will be no further increases in
taxes till 2015 and instead austerity measures of the order of EURO 1.4 Bn are proposed to meet
the 2.5% budget deficit (per GDP) target.
iv



Exchange Rates
The Portuguese Escudo was the currency of Portugal until the introduction of the euro in 2002.
Prior to its elimination, the exchange rate was 200.482 to one euro.
Euro exchange rate
vs dollar for the last
10 years
In the years
following the Single
European Act, the
EU liberalised its
capital markets, and
the exchange-rate
regime of the euro is
flexible,
or floating.Concerns that the deeply indebted nations of Greece, Portugal, Spain and Italy would
11

be eventually forced out of the European Union, causing it to disintegrate, led the euro to plunge
20% in seven months, from a level of 1.51 in December 2009 to about 1.19 in June 2010. A
respite that led the currency retracing all its losses over the next year proved to be temporary, as
a resurgence of EU break-up fears again led to a 19% slump in the euro from May 2011 to July
2012.
Real Effective exchange Rate:
Real effective exchange rate is defined as a weighted average of nominal exchange rates
adjusted for relative price differential between the domestic and foreign countries, relates to the
purchasing power parity (PPP) hypothesis. As the definition highlights, REER takes price
differential and inflation into account and, therefore, is said to be a better indicator of the
competitiveness of the country in terms of exchange rates.The Real Effective exchange rate of
Portugal was rising up till 2008 and after the crisis started going down which means that the
price of goods and services in Portugal started going up.
Real effective exchange rate index (2000 = 100) in Portugal






Overvalued Exchange Rates in the Euro:
A potential problem of countries in the Eurozone is that there is a danger of running a large
current account deficit due to a decline in competitiveness. Portugal has a current account deficit
of close to 10%. This is because it doesnt have its own exchange rate to depreciate against other
countries.

Labour market
Labour and Human Resource
OECD statistics
v
reveal that Portugal had a total of 1691 average hours of work output per
worker in 2012, down from a high of 1795 in 2001. This can be attributed to the restrictive
labour regulations in the country, featuring as the 6th most problematic factor for doing business
in Portugal as per the Global Competitive Index 2013-14
vi
.
The share of workers educated to tertiary level has increased from 9.5% in 2000 to 19.8% in
2012. Total labour force of Portugal now stands at 5.46 Million down from a pre-crisis high of
5.58 Million in 2008
vii
.
4500000
6000000
Labor force, total
12

That said the current level of labour force educated to at least secondary level is 68%, well below
the average of 75% for developed economies
viii
and a major hurdle in development of service
industries.

Labour market Trends:
1. Portugal has traditionally been a low-cost labour market, with the wage rate in the
business sector around half the euro area average. However, strong increases in the
monthly minimum wage during the last decade eroded competitiveness. The minimum
wage is 565.83 per month in 2014 (paid in 14 payments of 485).
2. Wage bargaining has traditionally taken place at sectoral level, with collective
agreements extended across industries. The lasting recession has significantly weakened
the process in the private sector (particularly banks).

Labour market Reforms:
Labour force participation rate continued to decline, since
weak economic outlook discouraged people from staying
in the labour market. Strict employment protection
legislation favored permanent job contracts, suggesting
that employers were reluctant to hire new staff on a
permanent basis. Consequently, most hirings were done on
short-term contracts, making the labour market highly
segmented. Shortcomings in wage setting mechanism and
strong minimum wage increases in 2007-2010 contributed
to a sharp rise in joblessness. Meanwhile, Portugals
unemployment insurance system was one of the most generous in the EU, providing
disincentives for unemployed persons to seek for a job.

Before the crisis Portugal had the highest protection legislation for
regular workers in the OECD. In order to tackle the ensuing labour
market segmentation, foster job creation and ease the transition of
workers across occupations, firms and sectors, the government
took substantial steps in 2011 towards aligning the legislation with
that of peer countries. (Labour market Reforms)


These steps include the following (Labour Market Reforms):
1. Relaxation of the protection against individual dismissals and the reduction in severance
pay
13

2. Relaxation of protection against fair dismissals
3. Making working hours more flexible and facilitating collective agreements at company
level.
4. Wage Setting: Portugals authorities introduced measures to decentralize wage
determination and working conditions, so as to link wage adjustments more to firm-level
productivity, thereby giving companies more flexibility to adjust to changing market
conditions.
Following the strong minimum wage increases in 2007-2010 (5.3% per year on average)
and a further rise of 2.1% in 2011 (Figure 7), minimum wage increase were effectively
frozen with the commitment that any increase will take place only if justified by
economic and labour markets developments.



Impact of the Labour market reforms on labour productivity and unemployment:

There are some indications that labour market reforms have improved the competitive position of
Portugal. The OECD index for the Employment protection Legislation (EPL) places Portugal
eight positions lower compared to 2008. According to the European Commission Business
Survey, leading indicators of hiring intentions suggested that the rate of deterioration in the
intended demand for labour stabilized. As seen from the graph below, the intended demand for
labour in Portugal over the next three months showed a less dramatic contraction compared to
the one occurring particularly during the last part of 2012.

Are labour market reforms needed?:

All in all, labour market reforms are crucial to help
rebalance Portugals economy and promote growth.
The reforms implemented by the Portugal
government helped reduce the unemployment rate in
2013, and that trend continues. Bouis and Duval,
Economists, OECD found that relaxing employment
protection legislation (EPL) could yield gains of 0.7
percentage points and 1.7 p.p. of labour productivity
at 5 and 10-year horizons, respectively (Table 2).
Furthermore, reforms of unemployment benefit systems could yield a decline in
unemployment of 0.8 p.p. and 1.8 p.p. at 5 and 10-year horizons, respectively
14




Unemployment
The global economic slowdown along with the recession in the euro area triggered a marked
increase in job losses in Portugal. The unemployment rate for the population as a whole, at
17.5% in March 2013, more than doubled since 2008.


.




Unemployment and Industrial Production:
The interesting part in
graph above is the period
in 2010 to 2012, when
unemployment rate is
rising despite a rise in
industrial output. This
would suggest that
during this period the
higher industrial output
was actually not
achieved by growth in
industrial sector and not
much new jobs were
created. Rather it was
just a case of industries
15

going back to pre-recession levels of production by again utilizing their existing capacities to
optimum levels.Once the Euro Crisis started, industrial output again fell down severely and
unemployment rate sharply increased.

Unemployment- Impact on Minimum Wages:

As we can see from the graph above, Portugal has been gradually increasing the minimum wage
rates. We know that rather than helping solve the problem of unemployment, it actually
aggravates it during bad times. Same can be seen here, as between 2008 to 2012, the minimum
wages shot up, which finally increased the unemployment rate too.
Unemployment- Impact on Job Vacancies:

Job vacancies have remained stagnant for most of the recent period in Portugal, except for the
severe drop in it during the Euro crisis. Comparing the job vacancy datas movement with long
term unemployment rate, gives us an idea of short term unemployment which is caused by
market friction rather than any structural flaws.
16


Total Factor productivity growth:
The line in green depicts the TFP growth rate in Portugal. Its a worrying sign as we can see that
mostly the TFP growth rate has been actually negative for Portugal for almost a decade. Looking
at this, we can also conclude that the apparent growth in Portugal before it crashed due to excess
debts was achieved by capital infusion and not technological development.
Labor cost and Export:
With wage growth outpacing productivity, unit labor costs
increased faster than in large euro area countries in the run-
up to the crisis, and Portugal steadily lost external
competitiveness (figure below). Insufficient competition
has resulted in capital allocation shifting away from the
tradable sector to non-tradable, further exacerbating losses
of international market shares
More recently, while unit labor costs have started to
moderate (reflecting the large cuts in real wages) and
international market shares have begun to recover on the
back of strong exports, the external adjustment also
reflects to some extent a contraction in domestic demand
and therefore imports. Further sustainable rebalancing
depends largely on the ability to boost productivity growth
in all sectors of the economy.
The figure below shows the forecast that the real GDP
growth of 0.6% will be driven by net exports and
investments as well as turnaround in private consumption
17

Conclusion
Portugal has ample scope for faster economic growth, given its below-average GDP per head
compared with the rest of the EU. However, a number of (mainly structural) factors have held
back growth, and the sharp rise in credit availability in the years preceding the onset of financial
crisis obscured the need to improve productivity, with debt finance being substituted for
productivity gains.
Industrial relations are expected to be strained, given that the unemployment rate remains close
to historic highs. The public sector is likely to be worse affected, given that fiscal consolidation
has a more direct impact there. Trade-union federations have been extremely active in protesting
against government freezes on hiring and wages for civil servants. The chance of further social
unrest, demonstrations and strikes could be high, possibly with unwanted sporadic violence.
A failure to make significant improvements through further labour-market reforms could force
skilled workers to continue emigrating and could discourage others from looking for jobs at all,
weakening the potential for growth
The challenge now is to persist with structural reforms so that they are given sufficient time for
their short-term adverse impacts to be replaced by longer-term improvements to the Portuguese
growth outlook. The political difficulty of doing this will be highlighted as soon as 2015, when
the next general election is to be held However, the country has shown tremendous progress in
managing debt and often exceeding the targets for structural reforms in its bailout program


Bibliography


i
EIU data; EIU Country Report Portugal, June 2014

ii
http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_
analysis/tax_structures/country_tables/pt.pdf, accessed on 9 July 2014

iii
http://www.worldwide-tax.com/portugal/portugal_tax.asp, accessed on 9 July 2014

iv
http://www.portugal.gov.pt/en/the-ministries/ministry-of-finance/keep-
updated/20140415-mef-objetivos-oe-2015.aspx, accessed on 9 July 2014


v
http://www.oecd-ilibrary.org accessed on 14 June 2014


vii
WDI: World Development Indicators, The World Bank, accessed on June 14, 2014
http://www.ilo.org/wcmsp5/groups/public/---dgreports/---
dcomm/documents/publication/wcms_228208.pdf , accessed on June 15, 2014
Tradingeconomics.com
The Economist Intelligence Unit
http://www.eurobank.gr/Uploads/Reports/56_FOCUS_NOTES_PORTUGAL_LABOUR
_MARKET_REFORMS.pdf