Portugal Through Quantitative Easing (QE)1
The ECB initiated asset purchases in October 2014 in order to further ease monetary conditions in the context of below-target inflation in the euro area, where key ECB interest rates were near the lower bound. The asset purchase program aimed to improve access to finance for firms and households, supporting investment and consumption and contributing to a return of inflation toward the ECB’s target range. While it is difficult to build a counterfactual to assess what would have happened in the absence of a policy response, this paper summarizes the scale of ECB support to Portugal through its asset purchase program, and assesses the impact on public finances, the financial sector, and macroeconomic developments.
A. An Overview of the ECB’s Asset Purchase Program
1. In September 2014, the ECB announced an Asset Purchase Program (APP) as part of its toolkit to provide further monetary accommodation in the context of prolonged low inflation. Quantitative easing (QE) through the APP was intended to enhance the monetary policy transmission mechanism and support the provision of credit to the broad economy. Asset purchases were initially limited to private assets in the form of asset-backed securities and covered bonds2, but were expanded to also include public sector securities under the Public Sector Purchase Program (PSPP), which was announced in January 2015 and began operations in March 20153. The APP originally called for combined monthly purchases of €60 billion, to be completed at the end of September 2016; this was subsequently extended to March 2017, with monthly purchases increasing to €80 billion from April 2016. The range of securities covered by the PSPP included (i) nominal and inflation-linked central government bonds, and (ii) bonds issued by recognized agencies, international organizations and multilateral development banks within the euro area. This was subsequently expanded to also include corporate bonds under the Corporate Sector Purchase Program (CSPP), launched in June 2016.
2. The APP was anticipated to have an effect through several channels of transmission. A decline in sovereign bond yields as a result of large-scale purchases of longer-term securities, together with the ECB’s commitment that monetary policy would remain accommodative until price stability achieved, was expected to create an incentive for banks to shift from government bonds to riskier investments and ease lending conditions (the portfolio balance and credit channels). The impact on bank lending was considered to be particularly important in a bank-centered lending environment such as the euro area. Higher prices of financial and real estate assets would also increase financial wealth (wealth channel), inducing households to reduce precautionary savings and to raise consumption spending. In addition, by reassuring households and companies of its determination to use all available tools within its mandate to ensure the integrity of the euro area and address the risks of a prolonged period of low inflation, QE was expected to help reduce uncertainty and in turn encourage spending and investment by households and companies (the confidence channel). Lower interest rates were also expected to result in a weaker euro, helping to support exports and inflation (the exchange rate channel).
3. The support provided to the Portuguese sovereign bond market through the APP buying in the secondary market has been sizable, with PSPP purchases equal to a large share of new issuance since its inception. Average monthly purchases of Portuguese government bonds amounted to €1.2 billion from March 2015–June 2016, with total ECB holdings reaching €19.1 billion at end-June 2016, equal to 17 percent of the total outstanding and with a weighted average remaining maturity of 10 years. This compares with a total of €26.4 billion in IMF funding provided to Portugal under its 3-year adjustment program. In addition, banks have been able to issue €1.8 billion in covered bonds and €0.7 billion in asset-backed securities since the ECB launched those programs in late 2014.
4. In addition to the APP, the ECB also introduced several additional longer-term refinancing operations in September 2014 to support bank lending to the real economy. In addition to the expanded Long-Term Refinancing Operation (LTRO, providing financing with a maturity of 3 years, in place since 2011), the ECB introduced Targeted Long-Term Financing Operations (TLTRO, with a maturity of 4 years) in September 2014. As of June 30, long-term loans to Portuguese banks provided under the ECB’s LTRO and TLTRO facilities amounted to €22 billion.
B. Assessing the Impact on Portugal
The impact of the APP is most clearly visible in the fiscal sector, where it has alleviated financing constraints and facilitated a slower pace of fiscal adjustment than had been envisaged previously. The APP, together with the ECB’s expanded refinancing operations, has similarly helped improve access to financing for banks and put downward pressure on lending rates, but transmission to lending appears constrained by the high level of NPLs. The impact on bank lending appears to have been primarily on household mortgages, where NPLs are relatively modest, with corporate lending continuing to contract. As a result, the macroeconomic effect thus far appears most evident on consumption, rather than investment, with little impact on headline growth.
5. Portugal has enjoyed a significant improvement in access to long-term market financing since ECB sovereign debt purchases began in 2015. After very limited net sovereign bond issuance in 2013 (-€1.1 billion) and 2014 (€0.5 billion), Portugal’s net bond issuance jumped to €12.9 billion last year, almost fully covered by the amount of purchases by the ECB. The increase in bond issuance allowed Portugal to make €10.3 billion in advanced repurchases to the Fund during 2015-16, around a third of its outstanding liability to the Fund at the end of the program, at an annual interest rate savings of around 0.1 percent of GDP through 2019.
6. Sovereign debt purchases under PSPP also appear to have contributed to the stabilization of bond yields at reduced levels. Sovereign yields fell sharply in the year prior to PSPP, as market participants began to anticipate a move toward unconventional monetary policies in the context of rising concerns about euro area deflation with key ECB rates near the lower bound. During 2014, ten-year Portuguese yields fell by 300 basis points, a large part of which likely reflects the pricing in of these expectations, as spreads over German bunds decreased by 200 basis points. Yields have remained broadly stable at close to 3 percent throughout 2015-16, with upward pressure relatively well-contained despite market concerns with regard to fiscal slippages, growth underperformance and election-related uncertainties in late 2015. Recent studies suggest that yields are well below what macroeconomic fundamentals would imply based on pre-crisis relationships, with Juvenal and Wiseman (2015) estimating that Portugal’s 10-year sovereign spread against German Bunds was 270 basis points below the level implied by macro fundamentals at the end of March 2015. In addition, recent work by the Bank of Portugal estimated that 2 and 10-year sovereign yields were about 2.5 percentage points below the level implied by macroeconomic fundamentals in October 20154.
7. Improved access to market financing on more favorable terms has coincided with a slowing of the pace of fiscal adjustment relative to pre-QE plans. Staff’s projections at the time of the 8th/9th review under the adjustment program, as an indication of the fiscal path envisaged before expectations of QE began to be reflected in bond yields, anticipated a structural primary adjustment of 1.3 percent of GDP during 2015-16, reflecting the need for sustained fiscal consolidation in order to ensure access to market financing. The path of fiscal adjustment has diverged considerably from these targets, however, with a structural primary easing of 1 percent of GDP now projected for 2015-16, and a much more modest decline in public debt than originally envisaged.
Figure 1.Fiscal Developments
Sources: IGCP; Bloomberg; Bank of Portugal; and IMF staff calculations
8. The ECB’s APP together with its expanded refinancing operations have helped to further reduce interest rates despite the main policy rate having reached the lower bound. Interest rates on new loans to non-financial corporations of less than €1 million and new mortgage loans declined by 116 and 101 basis points, respectively, from December 2014-May 2016, even as the ECB’s refinancing rate remained unchanged.
9. New lending since the inception of the APP has primarily focused on mortgages, however, with loans to NFCs remaining subdued. Although the total stock of outstanding loans has contracted further as banks continue to deleverage, new loans to households rose 30 percent during the first half of 2016 (y/y) after an increase of 28 percent (y/y) in 2015. The growth in household lending is reflects a sharp pickup in mortgage borrowing (although remaining well below levels prior to the financial crisis), contributing to the recovery in real estate prices since early 2014. This compared with a decrease in new lending to NFC of 5 percent in the first half of 2015 and 18 percent in 2015. The share of bank assets held in government securities has remained steady, meanwhile; while the fall in lending rates likely reflects in part a decline in risk premia, there is little indication thus far of any significant re-balancing in bank portfolios on aggregate.
10. The transmission to lending activity is likely to have been constrained by weak bank balance sheets and high private indebtedness. The problem is particularly acute in the corporate sector, where the high and rising stock of NPLs reflects the unresolved debt overhang. NPLs to the non-financial corporate sector amounted to 19.8 percent at end-2015, with a steady increase from 18.6 percent at end-2014 and 17.2 percent at end-2013. Loan performance on mortgages, which account for the bulk of household lending, has been significantly better, with NPLs to the household sector relatively stable over the past four years at 7-8 percent.
11. The decline in interest rates has so far been accompanied by an offsetting fall in the cost of funding, limiting the impact on bank profitability. The significant decline in the cost of funding, reflecting a fall in the average rate on deposits as well as lower rates on interbank and central bank financing has helped offset the decrease in interest income, contributing to a small increase in banks’ net interest income in 2014-15 after large declines in 2012-2013.
12. However, going forward, limited space to further reduce the cost of deposit rates could begin to diminish bank profitability. Thus far, deposit rates have been able to adjust downwards, preserving bank profitability as lending rates decreased, but there is likely to be a lower bound below which disintermediation occurs. At the same time, Euribor-linked lending rates are likely to continue to decline; this would imply an adverse impact on bank profitability unless lending growth picks up sufficiently to offset diminishing interest margins. A recent simulation by the Bank of Portugal estimated that a 100 basis point fall in Euribor rates would have a negative cumulative impact on domestic banks’ net interest income of approximately €700 million5. Weaker profitability would, in turn, limit scope for capital-constrained banks to be more proactive in NPL resolution.
Figure 2.Financial Sector Developments
Sources: Haver Analytics; Bank of Portugal; and IMF staff calculations.
|Total domestic demand||0.5||4.6||4.1|
|Final consumption expenditure||−0.3||3.2||3.5|
|Gross capital formation||0.8||1.4||0.6|
|Real GDP growth, percent||2.3||2.4||0.1|
13. QE appears to have had the strongest impact on consumption in Portugal. While headline growth has not deviated from staff’s pre-QE projections, its composition became much more skewed towards consumption. The pickup in consumption appears to have mostly resulted in higher imports rather than stronger growth, however, reflecting the openness of Portugal’s economy and the high import content of consumption expenditure. The impact of QE on investment appears to be relatively modest, relative to staff’s pre-QE projections, reflecting both the corporate debt overhang and the continued contraction in bank lending to NFCs.
14. QE appears to have contributed to a significant recovery in consumer confidence, helping to allay concerns about the future of the area. Consumer confidence in Portugal fell dramatically from early 2009 through mid-2012 as fears rose that the country would be forced to exit the Eurozone, coinciding with a sharp fall in the private consumption. The ECB’s indication from mid-2012 that it stood ready to undertake sovereign asset purchases if needed to support monetary transmission, followed by the introduction of the OMT program and then the launching of APP, helped to alleviate fears of an imminent break-up of the euro area, contributing to a sharp recovery in household consumption.
15. The rise in consumption also appears to be linked to the recovery in real estate prices. Despite only a modest increase in disposable income of 1 percent between 2013Q1 and 2015Q3, household consumption grew by 6 percent. This corresponding decline in saving can be explained in part by the wealth effect from the rising house prices, with a one-percent increase in house prices corresponding to a roughly ½-percentage-point decline in the saving rate. The real estate wealth effect appears particularly important in Portugal, given the higher real estate ownership rate. While the recovery in housing prices since mid-2014 is also attributable in part to the recovery in confidence and employment as the economy stabilized after the crisis, record-low interest rates and the subsequent pickup in mortgage lending are also likely to have played an important role. This appears to have offset any decrease in returns on financial assets owned by the households as a result of lower interest rates.6
Figure 3.Macroeconomic Developments: Housing Prices and Consumption
Sources: Haver Analytics; INE; and IMF staff calculations.
Figure 4.Macroeconomic Developments: Consumption, Savings, and Investment
Sources: Haver Analytics; INE; and IMF staff calculations
16. The APP looks to have had a positive impact on consumer confidence and mortgage lending, but the credit channel has been constrained by the corporate debt overhang. The confidence channel appears to have been particularly important in Portugal, with the ECB’s commitment to take action helping to alleviate fears of an imminent break-up of the euro area. The transmission of lower interest rates to lending activity has been primarily limited to household mortgages and consumption loans, however, as high corporate debt and rising NPLs on corporate loans have constrained lending in this segment. Overall, net lending has continued to contract as the increased availability of financing has done little to arrest the process of deleveraging in the banking system.
17. The resulting macroeconomic impact has been mostly on consumption, with limited impact on headline growth. The recovery in household confidence and pick-up in mortgage lending has contributed to a recovery in real estate prices, in turn boosting household consumption. The impact on growth has been modest, however, and is expected to fade as the household savings rate normalizes from historic lows at present. The impact on investment has been limited, meanwhile, reflecting the corporate debt overhang and rising uncertainty as a result of the standstill in efforts to address structural obstacles to growth.7
18. The ECB’s asset purchases may also have had the side effect of diminishing the sense of urgency regarding the need for fiscal adjustment. Sovereign debt purchases through the PSPP will account for a large share of Portugal’s gross bond issuance in 2015-16, providing a backstop that has alleviated financing concerns and reduced the priority attached to fiscal adjustment in order to ensure market access. As a result, the structural primary adjustment in 2015-16 is now projected to be nearly 2½ percent of GDP less than originally envisaged prior to QE.
Banco de Portugal2015 “An Interpretation of the Low Sovereign yields in the Euro Area” Economic Bulletin December 2015 (Lisbon: Banco de Portugal).
Banco de Portugal2016 “Net Interest Income – Recent Developments and Future Prospects” Financial Stability Report May 2016 (Lisbon: Banco de Portugal).
BerkmanP. and A.Jobst2015 “An Early Assessment of Quantitative Easing” Selected Issues Paper (Washington, DC: International Monetary Fund).
BlattnerL.FarinhaL. and G.Nogueira2016 “The Effect of Quantitative Easing on Lending Conditions” Banco de Portugal Working Paper March 2016 (Lisbon: Banco de Portugal).
CoeuréB.2015 “Embarking on Public Sector Asset Purchases” Speech at the Second International Conference on Sovereign Bond Markets March 10 (Frankfurt am Main: European Central Bank).
DraghiM.2015 “Introductory Statement to the Press Conference January 22” (Frankfurt am Main: European Central Bank).
European Central Bank2013 “The Eurosystem Household Finance and Consumption Survey: Results from the First Wave” Statistics Paper Series No. 2April (Frankfurt/M.: European Central Bank).
European Central Bank2015 “The Governing Council’s Expanded Asset Purchase Programme” Economic Bulletin Issue 1 2015 (Frankfurt/M.: European Central Bank).
European Commission2015 “Putting the Spring Forecast into Perspective: The ECB’s Quantitative Easing and the Euro Area Economy” European Economic Forecast Directorate- General for Economic and Financial AffairsApril (Brussels: European Commission) pp. 10–5.
JobstA. and H.Lin2016 “Negative Interest Rate Policy (NIRP): Implications for Monetary Transmission and Bank Profitability in the Euro Area” IMF Working Paper No. 16/172 (Washington, DC: International Monetary Fund).
Juvenal and Wiseman2015 “Portugal’s Regained Market Access: Opportunities and Risks” Selected Issues Paper (Washington, DC: International Monetary Fund).
Prepared by Matthew Gaertner.
This was the ECB’s third covered bond purchase program (CBPP3), following operations in 2009-10 (CBPP) and 2011-12 (CBPP2).
The ECB had previously carried out sovereign debt purchases under the Securities Market Program (SMP), which was in operation from 2010-12. The SMP and its successor, the Outright Monetary Transactions program (OMT) aimed to repair the transmission mechanism of monetary policy by containing sovereign risk premia that were considered excessive.
See “An interpretation of the low sovereign yields in the euro area.” In the Bank of Portugal’s December 2015 Economic Bulletin.
See “Net Interest Income – Recent Developments and Future Prospects,” in the Bank of Portugal’s May 2016 Financial Stability Report.
On the real estate side, Portugal has 5.9 million housing units with an estimated value of €300 billion. House prices rose 9.9 percent between 2013Q1 and 2015Q4. Accordingly, the estimated value of the real estate assets owned by households increased by €25 billion, while household savings declined by €5 billion. On the financial asset side, we estimate a loss of €0.4 billion for a 50-bps decline in interest rates and a loss of €0.6 billion for a 100-bps decline.
ECB President Draghi, at the press conference announcing the decision to launch PSPP in January 2015, noted that: “For investment you need confidence, and for confidence you need structural reforms. The ECB has taken a further, very expansionary measure today, but it’s now up to the governments to implement these structural reforms, and the more they do, the more effective will be our monetary policy.”