Portugal: Economy

The Portuguese economy experienced boosts when Portugal joined the European Union in 1986 and the European Monetary Union (EMU) in 1999. In recent years, however, it suffered from sluggish to negative growth, a ballooning budget deficit, and low productivity and competitiveness, which, exacerbated by the onset of the euro zone debt crisis, led to record-high spreads on sovereign debt and downgrades in credit ratings. On May 3, 2011, Portugal’s Socialist caretaker government reached agreement with the European Commission, European Central Bank, and International Monetary Fund (IMF)--“the troika”--on a €78 billion (approx. $111 billion), 3-year bailout package that required Portugal to implement comprehensive austerity measures, including privatization of state-owned enterprises and measures to reform its labor market and justice sector. The package was approved by EU and euro zone finance ministers in mid-May. The new PSD-led government of Prime Minister Coelho took office in June 2011. The troika has given the Portuguese Government high marks for its implementation of the agreement, while identifying gaps and areas for improvement. Although workers have organized protests and strikes to oppose austerity measures, demonstrations have been relatively nonviolent. Nevertheless, Portugal’s economic future depends heavily on wider euro zone developments.

Before the economic crisis, Portugal's membership in the EU had contributed to stable economic growth, largely through increased trade fostered by Portugal’s low labor costs and an influx of EU funds for infrastructure improvements. Portugal's subsequent entry into the EMU brought exchange rate stability, lower inflation, and lower interest rates. Falling interest rates, in turn, lowered the cost of public debt and helped the country achieve its fiscal targets. Until 2001, average annual growth rates consistently exceeded those of the EU average. However, a dramatic increase in private sector loans led to a serious external imbalance, with large capital account deficits that year. De-leveraging by Portuguese banks to meet the June 2011 EU requirement to increase core tier-one capital ratios above 9% has caused bank lending to tighten.

The Government of Portugal managed to keep the budget deficit under 3% in accordance with the euro zone's Stability and Growth Pact during 2002-2004. However, in 2005 Portugal’s budget deficit surged to a high of 5.9%. Subsequently, the government undertook efforts to bring the budget situation under control. In 2006, the government reduced the deficit to 4.1%, mainly through revenue-generating measures, including increased collection enforcement and higher taxes. The 2007 budget further reduced the deficit to 3.1% of GDP, through spending cuts and structural reforms. In 2009, however, the budget deficit soared to 10.1% of GDP as a result of a more than 11% drop in tax revenue. Portugal’s public debt reached 93% of GDP in 2010, with a projected increase to 97.3% of GDP in 2011.

Helped in part by a wider EU recovery, the Portuguese economy grew by 2.74% in 2007, up from 1.4% the previous year. But a slowing regional economy saw the Portuguese economy contract by 0.35% in 2008 and by 2.1% in 2009. Although GDP grew 0.91% in 2010, it contracted 1.6% in 2011 and is projected to contract 3.2% in 2012 as a result of higher taxes and public wage cuts introduced under the government’s austerity program.

Unemployment is expected to rise in coming years and reach 12.5% in 2011, 13.8% in 2012, and 14.2% in 2013, up from 7.6% in 2008, 9.5% in 2009, and 10.8% in 2010.

The service sector, which includes public service, wholesale and retail trade, tourism, real estate, and banking and finance, is now Portugal's largest employer, having overtaken the traditionally predominant manufacturing and agriculture sectors since the country joined the EU in 1986. EU expansion into Eastern Europe has negated Portugal's historically competitive advantage of relatively low labor costs, particularly in the manufacturing and agriculture sectors. Since 2009, governments have been working to change Portugal's economic development model from one based on public consumption and public investment to one focused on exports, private investment, and development of the high-tech sector.

Due to weak economic growth, Portugal has lost ground relative to the rest of the EU since 2002. Portugal's 2010 per capita GDP stood at 80 Purchasing Power Standards (PPS) compared to the EU-27 average of 100 PPS, leaving the country in last place among its Western European counterparts after accounting for price differences (but ahead of EU’s newest members). Now among the weaker economies in the EU, and the third euro zone member (after Greece and Ireland) to request a bailout, Portugal aims to reduce its budget deficit to 5.9% (from 9.1% in 2010) of GDP in 2011, 4.5% in 2012, and 3% in 2013. In accordance with the terms of its bailout agreement, Portugal has until 2014 to bring its budget deficit back below the mandated 3% euro zone limit. In 2010, the government implemented a series of austerity measures, including cutting public sector wages, reducing attrition replacement hiring, decreasing pension benefits for early government retirement, and increasing taxes. The government’s 2012 budget, considered the most demanding in 30 years, includes salary cuts for public sector employees, benefit cuts, and tax hikes. The government seeks to impose fiscal discipline and further reduce its deficit over the next 3 years through structural reform measures, as agreed upon with the EU and IMF.

Sources:

CIA World Factbook (January 2012)
U.S. Dept. of State Country Background Notes ( January 2012)

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