Por­tu­gal’s cri­sis due to legacy of pol­icy fail­ures: IMF

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IMF says Por­tu­gal’s cri­sis is due to a legacy of pol­icy fail­ures in the face of a rapidly chang­ing en­vi­ron­ment. Eco­nomic in­sti­tu­tions and poli­cies proved ill-adapted to the de­mands and op­por­tu­ni­ties of mon­e­tary union and glob­al­iza­tion. The rapid tran­si­tion from decades of fi­nan­cial re­pres­sion and mon­e­tary in­sta­bil­ity was prov­ing dif­fi­cult. Mon­e­tary union, in­stead of de­liv­er­ing on the prom­ise of sus­tain­able catch-up growth to EU liv­ing stan­dards, fa­cil­i­tated the ac­cu­mu­la­tion of eco­nomic and fi­nan­cial im­bal­ances. The com­pet­i­tive­ness of the trad­able sec­tor eroded. Abet­ted by a bank­ing sys­tem prone to al­lo­cat­ing too much credit to poor risks, lever­age in the non-trad­able sec­tor in­creased marked- ly, not­with­stand­ing weak pro­duc­tiv­ity growth. The pub­lic sec­tor in turn fi­nanced rapidly grow­ing spend­ing, par­tic­u­larly on so­cial pro­tec­tion, through higher taxes and ac­cu­mu­lat­ing debts. And in the face of all this, the pol­icy re­sponse was, at best, muted. Con­se­quently, in the first half of 2011, Por­tu­gal’s government and banks were shut-out from fi­nan­cial mar­kets.

In re­sponse, the Por­tuguese au­thor­i­ties have mounted an im­pres­sive pol­icy ef­fort to grad­u­ally re­verse the ac­cu­mu­lated im­bal­ances and fore­stall cri­sis. A front-loaded fis­cal ad­just­ment pro­gram is aim­ing at restor­ing cred­i­bil­ity in government bond mar­kets, while jump-start­ing ex­ter­nal ad­just­ment. Fi­nan­cial sec­tor mea­sures seek to keep banks well cap­i­tal­ized and liq­uid, while fa­cil­i­tat­ing or­derly delever­ag­ing. And struc­tural re­forms, rang­ing from re­form­ing in­ef­fi­cient courts to phas­ing out rent con­trols, aim to re­vi­tal­ize the econ­omy’s sup­ply side. Con­sid­er­able progress has al­ready been made. In spite of set­backs, un­der­ly­ing fis­cal ad­just­ment has ad­vanced markedly; ex­ter­nal ac­count ad­just­ment has also made sig­nif­i­cant strides.

Yet the near-term out­look is un­cer­tain, and siz­able medium-term eco­nomic chal­lenges re­main. With trad­ing part­ner growth slow­ing, the econ­omy will likely be in re­ces­sion in 2013, while un­em­ploy­ment will rise fur­ther from al­ready record high lev­els. Be­yond the short term, main­tain­ing and an­chor­ing fis­cal dis­ci­pline and delever­ag­ing pri­vate-sec­tor bal­ance sheets will re­main im­per­a­tives, but also gen­er­ate head­winds for growth. In par­tic­u­lar, fis­cal ad­just­ment needs to con­tinue, although un­ex­pect­edly large rev­enue short­falls are de­lay­ing the achieve­ment of the orig­i­nal nom­i­nal deficit path. Fos­ter­ing more com­pet­i­tive trad­able sec­tors while re­duc­ing ex­ces­sive mark-ups in the non-trad­able sec­tors re­quires po­lit­i­cally dif­fi­cult struc­tural re­forms.

Success of the pro­gram will also de­pends on whether Euro­pean pol­i­cy­mak­ers forge ahead with re­forms to over­come euro area fis­sures. While im­ple­men­ta­tion of the ad­just­ment pro­gram re­mains the key for mend­ing Por­tu­gal’s own deep-seated eco­nomic prob­lems, th­ese domestic ef­forts will need to be com­ple­mented by re­forms of euro area ar­range­ments to clear a path not only to­ward a durable re­turn to mar­ket fi­nanc­ing for Por­tu­gal but also to avoid a re­peat of the build-up of un­sus­tain­able im­bal­ances in the fu­ture. The pub­lic com­mit­ment by Euro­pean lead­ers to pro­vide ad­e­quate sup­port to Por­tu­gal un­til mar­ket ac­cess is re­stored, pro­vided the pro­gram is on track, pro­vides a valu­able safety net. To over­come credit mar­ket seg­men­ta­tion and re­store an ap­pro­pri­ate mon­e­tary pol­icy trans­mis­sion, it would also be im­por­tant to fur­ther clar­ify the el­i­gi­bil­ity cri­te­ria for the ECB’s Out­right Mon­e­tary Trans­ac­tions as the coun­try starts re­gain­ing bond mar­ket ac­cess.

Given the still sig­nif­i­cant fis­cal ad­just­ment ahead, pub­lic de­bate is needed on how to share the bur­den of re­main­ing fis­cal ad­just­ment fairly and in a growth­friendly man­ner.

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