Clouds on the horizon

The headline figures suggest that Portugal’s economy is in great shape. GDP grew by at least 3% last year and is set to continue on track through 2001. Unemployment is low by European standards at 4% across the board.

Government borrowing requirements are steadily falling, and the deficit is expected to end up at around 1.5% of GDP. Moreover, the Portuguese economy should be more resilient than most to the US slowdown. More than 80% of exports go to other EU countries and only 5% to the US.

That is the good news. Less auspicious is the fact that Portugal is saddled with structural imbalances. Most serious in the short to medium term is the external deficit, now around 10% of GDP and expected to worsen to about 11% this year and 12% in 2002. Excess demand, clearly reflected in a trade deficit running above 13%, is unlikely to cool down while the euro is appreciating and interest rates are held steady or are heading down.

Moreover, Portugal’s competitiveness vis-à-vis other economies with relatively low labour costs is steadily deteriorating.

“The striking feature of this economy,” says Rui Martin dos Santos, formerly chief economist and now finance director of Banco Português de Investimento, “is that it is growing faster than the European average but we have full employment in certain key sectors”. Although the overall unemployment rate remains at about 4%, in some sectors, such as construction, pressing manpower needs have only been met by bringing in immigrant labour, mainly from the Ukraine and Moldova.

In information technology – which has attracted major international investors such as Alcatel, Microsoft and Siemens – there is estimated to be a shortfall of around 100,000 skilled workers.

Portuguese labour costs are still well below the EMU average but nowadays, labour-intensive industries such as auto-manufacturers are looking to central and eastern Europe rather than the Iberian peninsula. The era of multi-billion dollar inward investments, such as those that funded Volkswagen and Ford assembly plants near Lisbon, would seem to be over.

This is mainly because there is insufficient slack in the labour market, while other fixed costs, such as electricity and property, are high compared with other EMU countries.

“From now on”, says dos Santos, “economic growth has to proceed either through bought-in manpower or through productivity increases.

Corporates are very much aware of this problem.” Many of the larger Portuguese companies are seeking to expand elsewhere, especially in Brazil, where huge market opportunities and cultural and linguistic affinities combine. At the same time, foreign direct investment into Portugal is on a downward trend.

“The second striking factor in Portugal is that people are feeling optimistic about the future,” says dos Santos. The consumer credit boom triggered by lower interest rates after Portugal entered the eurozone in January 1999 continues unabated. Consumer credits rose by 25% last year.

Provided the global economic soft landing holds good, Portuguese consumers have every reason to feel confident. Their currency is expected to firm against the dollar, which combined with lower oil prices implies cheaper energy and fuel bills. Domestic banks are competing fiercely in the consumer credit market, putting further downward pressure on loan rates. Mortgage take-ups were growing at 22% in the first 10 months of last year. With secure nest eggs in real estate and the labour market so tight, the average worker might be forgiven for thinking there was scarcely a cloud on the horizon.

In some respects Portugal, like Ireland, is becoming a victim of its own success. Competitive advantage is steadily being eroded by above-average inflation within a fixed currency grid. The most recent public sector wage settlement of 3.7% is significantly higher than the 2.5% negotiated in the previous round and above the private-sector norm. But unions now engaged in the annual negotiating phase are arguing that, with last January’s consumer price index up 4.4% over the previous year, nominal wage increases have already been eroded.

Either wage constraint or greater productivity will become necessary, since Portugal is already running a current account deficit of between 10% and 11% of GDP – even though exports grew last year by 8.2%. Cheap consumer credit and lack of spare capacity internally to fulfil demand is leading to more imports being sucked in. Average household indebtedness is on a sharply rising trend, though, as dos Santos points out, the ratios of debt to GDP and disposable income remain low compared with many European countries.

However, unless there is a change in direction on three fronts – wages, consumer credit or productivity – the Portuguese barque cannot go on sailing through such calm seas indefinitely.

And there are other clouds on the horizon. “We have a structural problem,” says dos Santos, “which arises from our social security system”. Whereas the immediate debate over the centre-left government’s budget is focused on the rapid – and some say unsustainable – growth in current expenditure, the roots lie in Portugal’s social security system and its apparent inviolability. Few European politicians relish the task of downsizing inherited social security obligations. But in Portugal this is particularly tricky since such citizens’ rights are so closely entwined with the relatively recent emergence of Portugal as a democracy in the 1970s.

In the short term, the government has some leeway. There is scope for being more efficient in collecting income tax and other levies that Portuguese taxpayers have traditionally evaded. But sooner or later, structural reforms will be needed. They may not be quite as pressing as in, say, Germany, since in Portugal the baby-boomer demographic bulge came slightly later and is not so pronounced. Nonetheless, this is an ageing population. Compounding the problem is the relatively low level of individual savings and the rising trend in household indebtedness.

Private healthcare and pension provision are in their infancy – the vast majority of Portuguese continue to rely exclusively on state-funded agencies.

Private-sector financial services firms sense an opportunity here. “There is almost everything to be done in Portugal in terms of private pension plans and health insurance”, says the vice-chairman of Banco Espirito Santo, José Maria Ricciardi. Indeed, he foresees the rapid growth of pensions and insurance sectors as providing a fillip to both domestic securities and bond markets. “It will happen, because the state will not be able to continue paying all the costs. It’s already happening, especially in the development of pension funds. But it’s still early days.”