October 12, 2012 / 12:27 PM / 5 years ago

Portugal in danger of recessive spiral

LISBON (Reuters) - If not quite yet staring into the abyss, bailed out Portugal is close to a vicious recessive cycle where austerity required to cut debt triggers a deeper slump that sparks more economically damaging spending cuts and tax hikes.

Such a process has already dragged Greece through recession for five consecutive years, as it repeatedly failed to meet its budget goals.

It is still early days for Portugal — 2012 is only its second year of recession — but alarm bells have started ringing since Lisbon announced swingeing tax hikes last month that could stop already stretched consumers in their tracks. This year the country entered its deepest recession since the 1970s.

“Portugal is one of the countries that is most advanced in this process of a recessive cycle, after Greece,” said Guillaume Menuet, an economist at Citi. “To a degree, Portugal is already in a recessive cycle, we only see it growing again in 2015.”

If Portugal, the third euro zone country to seek a bailout after Greece and Ireland, were to fail in its adjustment plan it could further undermine Europe’s German-inspired austerity as a solution to heavily-indebted countries’ troubles. Lisbon has so far been praised by Berlin and Brussels for its efforts at reforming under the 78-billion-euro (62.9 billion pounds) bailout it sought in 2011.

Portugal’s troubles have mounted since the centre-right government was forced last month to back down from a rise in social security contributions after mass protests. To compensate for the measure, it subsequently announced sweeping income tax hikes, which could sap economic confidence even further.

The government will unveil its 2013 draft budget on Monday, when the full details of the tax increases will be announced, likely including a hit of up to two months’ salaries for many middle class workers. Property and wealth taxes will rise as well and the country will introduce a financial transaction tax.


The austerity plan came after the government said it would fail to meet 2012 budget deficit goals under the bailout and the ‘troika’ of creditors — the European Commission, ECB and IMF — agreed to ease the country’s deficit goals this year and next.

Portugal now needs to achieve a budget deficit of 5 percent of GDP this year and 4.5 percent in 2013.

“The loss of purchasing power in Portugal already surpassed everything that is normal and the new measures will lead to new declines in disposable income and declining private consumption,” said Tiago Caiado Guerreiro, a tax consultant.

The key problem for public accounts this year has been a drop in tax revenues, of 2.4 percent between January and August, against government expectations that they would rise thanks to sharp increases in value-added tax. The opposite happened due to a deeper recession and worse-than-expected unemployment, which has soared to record highs above 15 percent.

Caiado Guerreiro said it was clear tax revenues would fall in 2012 as the point at which higher taxes stop adding extra revenues to the government was “surpassed more than a year ago”, due to the economy’s decline. Still, next year’s planned austerity package is worth 3 percent of gross domestic product, most of it tax increases.

Economists say the government’s assumptions for the 2013 outlook may be even more stretched as it expects GDP to contract by only 1 percent, widely seen as unrealistic. The government expects a contraction of 3 percent this year.

“There is a very high probability that GDP in 2013 will contract as much as in 2012, it would be no surprise at all,” said Rui Barbara, an economist at Banco Carregosa.

Some economists are more pessimistic, such as Citi’s Menuet, who expects a 5.7 percent contraction in GDP next year after a decline of 3.8 percent in 2013.


The impact on consumer confidence and the economy in coming months could be greater still as the latest austerity measures hit many Portuguese like a bombshell as the government had previously said 2013 would be a year of recovery. The uncertainty could make consumers even more reluctant to spend.

Opposition to austerity has risen markedly in the past few weeks, as unions step up marches and protests. A general strike has been called for November 14.

“A major worry is that in the middle of next year the country is unable to meet (budget goals) and the response is a return to yet more austerity,” said Rui Bernardes Serra, chief economist at Montepio bank. “Our situation is still very different to Greece, but nobody can completely rule out a scenario of a recessive spiral.”

Rating agency Moody’s warned last week that “the scale of the additional measures that would be needed even to meet the easier (budget) targets was much larger than estimated”.

Still, the bond market has all but ignored the concerns, with 10-year yields trading at 8.1 percent, their lowest levels in more than a year after peaking at 17 percent in January, benefiting from the ECB’s bond buying plan.

Portugal is scheduled to return to financing itself in bond markets in the second half of next year. It took a first step towards that last week, by swapping 3.75 billion euros of bonds maturing in 2013 with bonds due in 2015, marking its first bond operation since the bailout.

The operation indicates investors still view Portugal as closer to replicating Ireland’s favourable economic path than Greece’s, but Lisbon’s performance from now on points to considerably more risk.

“The difficulties in formulating politically palatable measures to meet Portugal’s economic adjustment programme targets point to increased risks for programme compliance,” said Moody’s.

Reporting By Axel Bugge, editing by Mike Peacock

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