Portugal
Recent Economic Developments
Author: International Monetary Fund
Publication Date:
19 Dec 1995
eISBN:
9781451832082
Language:
English
Keywords:
ISCR; CR; U.S. dollar; exchange rate; Portuguese escudo; broad money; first quarter; terms of trade; economic recovery; current account; private sector; long-term debt; monetary policy
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This paper reviews economic developments in Portugal during 1990–95. Economic activity rebounded weakly in 1994, growing by 1 percent after a fall of 1.2 percent in 1993. The recession in 1993 was deeper, and the recovery in 1994 weaker than that experienced by the European Union as a whole. Thus, real convergence with Europe was interrupted: although Portuguese GDP per capita increased from 51.4 percent of the European Union average in 1985 to 64.8 percent in 1992, it fell back to 64.4 percent by 1994.

Abstract

This paper reviews economic developments in Portugal during 1990–95. Economic activity rebounded weakly in 1994, growing by 1 percent after a fall of 1.2 percent in 1993. The recession in 1993 was deeper, and the recovery in 1994 weaker than that experienced by the European Union as a whole. Thus, real convergence with Europe was interrupted: although Portuguese GDP per capita increased from 51.4 percent of the European Union average in 1985 to 64.8 percent in 1992, it fell back to 64.4 percent by 1994.

I. The Real Economy

1. Overview

Portugal has achieved significant progress toward convergence with the EU since its accession in 1986. Its GDP per capita increased from 51.4 percent of the EU average in 1985 to 64.4 percent in 1994, while its inflation differential with the EU has fallen to 2.2 percent. The 1993 recession, with a downturn that was deeper and a recovery that was weaker in Portugal than elsewhere, interrupted real convergence with the EU. This did not signify a pause in the structural transformation of the Portuguese economy, however, as evidenced by gains in market share for its merchandise exports and continuing privatization.

In hindsight, the remarkable thing about the Portuguese disinflation is how quick and relatively painless it was. Compared with the Spanish disinflation experience, which was accompanied by unemployment rates exceeding 20 percent, Portugal achieved lower rates of inflation with unemployment rates not exceeding 8 percent. The timing was one factor: Spain and Italy, for instance, disinflated during the early 1980s, when the effects of the earlier adverse oil price shocks were still being felt. In contrast Portugal’s disinflation, by contrast, coincided with the “reverse oil shock” of the mid-1980s, and thus benefitted from the lagged effects of lower oil prices. The flexibility of the Portuguese labor market during this period was another important factor, especially the sensitivity of wages to labor market conditions. This kept Portuguese exports competitive, despite a rise in the real effective exchange rate for the escudo, which began shortly after Portugal’s accession into the EU. A final factor that has been important in this context is that the real effective appreciation of the escudo coincided with an increase in the equilibrium exchange rate, engendered by EU accession and the structural changes in the economy that this implied.

2. Output

Economic activity in Portugal rebounded weakly in 1994, growing by 1 percent after a fall of 1.2 percent in 1993 (Table 1). The recession in 1993 was deeper, and the recovery in 1994 weaker, than that experienced by the EU as a whole. 1/ Thus, real convergence with Europe was interrupted: whereas Portuguese GDP per capita increased from 51.4 percent of the EU average in 1985 to 64.8 percent in 1992, it fell back to 64.4 percent by 1994. The main reason for the relative under-performance of the Portuguese economy can be found in domestic demand, which grew by 1.4 percent in 1994 (compared to 2.5 percent in the EU), after falling by 2.5 percent in 1993 (compared to a fall of 1.9 percent in the EU). Since investment growth, viewed cumulatively over 1993-94, was substantially the same in Portugal as in the EU, the main reason for the relative under-performance of domestic demand can be attributed to consumption--more specifically private consumption, which was flat in 1994 (compared to 1.7 percent growth in the EU). 1/

Table 1.

Portugal: Aggregate Demand

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Source: Banco de Portugal estimates.

Examining the contributions of the components of demand, it is seen that investment and exports were the main engines of growth in 1994 (Table 2). This pattern, also observed in a number of other EU economies (e.g., Italy and Greece), was different from that observed in the 1984 and 1975 Portuguese recessions:

Table 2.

Portugal: Contributions of Demand Components to Real GDP Growth 1/

(In percentage)

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Source: Banco de Portugal estimates.

Based on the structure of the previous year (at current prices).

  • Both GDP and investment fell less quickly during the downswing and rebounded less quickly during the upswing than during the earlier recessions.

  • Public consumption rose relative to GDP, but not by as much as during the earlier recessions.

  • Private consumption was flat during the upswing so far, whereas following the 1984 recession it grew strongly during the upswing.

  • Labor productivity was some 10 percent above the level reached at a comparable point in previous recessions, reflecting significant labor shedding by firms.

A number of factors help explain these developments, and they are examined in turn.

The continuing fiscal consolidation under the convergence program has kept growth in public consumption relatively low: in past upswings, public consumption instead grew much faster (in relation to GDP). Monetary policy was also constrained by the need to support the escudo, and thus could not play a countercyclical role. In addition, turbulence in the international bond markets kept interest rate differentials and real interest rates higher than they would otherwise be, which dampened investment somewhat, while the atypical weakness in consumption has restrained income growth and hence muted the usual accelerator effects on investment. 2/ On the other hand, investment benefitted from some factors not usually present during a recovery. As in Italy, Portuguese firms took the opportunity to shed labor and boost productivity, and this, together with moderate rates of wage increase, led to a decline in the share of wage income in GDP; this in turn improved investment profitability (Table 5). Finally, rising and positive net project transfers from the EU to Portugal have helped investment rebound, although the end of the first Community Support Framework (CSF) and the beginning of the second CSF resulted in some delays in disbursements, which lowered investment in 1994 and correspondingly increased it in 1995.

Table 3.

Portugal: Consumption and investment indicators

(Year-on-year real percentage change)

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Based on sales by main supermarkets.

Passenger vehicles, excluding 4×4

Imports of capital goods, excluding transport equipment

Light commercial vehicles, excluding 4×4

Heavy commercial vehicles, excluding 4×4

Sold to construction industry

From 1988 to 1992 includes steel imports

Table 4.

Portugal: Composition and Structure of Gross Fixed Investment 1/

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Sources: Figures for 1989:INE; since 1990: Bank of Portugal, Ministry of Finance-GAFEEP.

Figures for public enterprises are based on estimates provided by the GAFEEP. Investment by the private sector (including nationalized banks) were calculated as a residual.

Nonfinancial public enterprises.

Table 5.

Portugal: Distribution of National Income

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Source: Figures for 1989: INE; since 1990: estimates of Bank of Portugal.

The behavior of private consumption, which comprises approximately 60 percent of aggregate demand, is intimately linked to developments in disposable income and in the labor market. Real disposable income has not only not rebounded after falling 1.3 percent in 1993, but has even declined further, by 1.5 percent in 1994 (Table 6). 1/ The weakness in wages (which fell 1.3 percent in real terms in 1994), and the rise in direct and social security taxes (which rose 1.4 percent in real terms) contributed to this, as did accelerating reductions in receipts of private external transfers. However, many ostensible private external transfers appear actually to reflect inflows by expatriates, and their decline has been attributed to the increasing availability of alternative investment vehicles abroad. To the extent that these transfers do not truly represent income for residents, their decline may have little influence on domestic consumption.

Table 6.

Portugal: Disposable Income

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Source: Bank of Portugal.

These figures are not comparable with those published in the previous year due to the change in the basis year of National Accounts statistics.

Deflated by the CPI.

The decline of the private savings rate bears out the shifting relationship between private consumption and disposable income (Table 7 and Chart 2). As a percent of disposable income and as a percent of GDP, the savings rate fell, also reflecting consumption smoothing behavior in the face of cyclical weakness in income. By contrast, savings by firms remained relatively constant. Since government dissaving has also remained relatively constant over 1993-94, the decline in household saving had as its counterpart an increase in foreign saving, which in turn reflected the increase in EU transfers.

Table 7.

Portugal: Savings and Investment

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Source: Bank of Portugal, Annual Report.
CHART 1
CHART 1

PORTUGAL Aggregate Demand

(In Percent)

Citation: IMF Staff Country Reports 1995, 124; 10.5089/9781451832082.002.A001

Sources: Data provided by the authorities; and staff estimates.1/ Staff estimates for series at constant 1987 prices, using growth rates for the demand components provided by the Bank of Portugal.2/ Assessment of activity by construction entrepreneurs, according to INE’s construction survey.
CHART 2
CHART 2

PORTUGAL Savings

(In Percent)

Citation: IMF Staff Country Reports 1995, 124; 10.5089/9781451832082.002.A001

Sources: Bank of Portugal, and IMF.1/ Private and nonfinancial public enterprises.2/ General Government: Current balance and offical unrequitted transfers.

The contribution of net exports to GDP growth was positive in 1993 (due primarily to the drop in imports of goods and nonfactor services), and negative (-0.5 percent) in 1994. Exports of goods and nonfactor services grew by 9.4 percent in volume terms in 1994, because of a 14.3 percent growth in merchandise exports. 2/ The drop in exports of services was accounted for by non-tourist services (especially air transport), as tourist services grew by 1.1 percent. The 8.9 percent growth in the volume of imports of goods and non-factor services in 1994 was due to an 11.2 percent growth in merchandise imports, with imports of services dropping due to lower spending by Portuguese tourists abroad. The growth in merchandise imports reflects high--but not surprising by historical standards-elasticities, and the high investment component of imports. 1/

Further indications of the behavior of GDP and its components can be gleaned from higher frequency and more disaggregated data. Economic activity bottomed out around the third quarter of 1993, when GDP fell by 1.9 percent year-on-year (Chart 1). 2/ GDP growth became positive in the first quarter of 1994, led by exports, whose growth was positive already in the fourth quarter of 1993, and which surged strongly--with growth rates exceeding 10 percent--in the first three quarters of 1994. Investment growth became positive in the third quarter of 1994, while import growth surged in the third and fourth quarters, dampening GDP growth. 3/ Investment in equipment grew much faster than investment in construction, reversing a recent trend (Table 4). Also, the share of private sector investment in total investment continued to fall, reflecting the increasing importance of public investment financed by EU funds. The breakdown of GDP growth by sector of origin is consistent with the investment and export led pattern of growth described earlier. Manufacturing and energy grew faster than GDP, whereas services grew more slowly than GDP.

Since quarterly GDP estimates only extend to end-1994, more timely information has to be sought in other indicators, which are not as reliable and do not always agree on the direction of change. Nevertheless, the statistical integration of such indicators through the construction of coincident indicators is one useful way to synthesize these data (Chart 1 and Table 3). 4/ The picture is clearest for investment, whose strong growth is reflected in most available indicators, such as sales of steel, cement, heavy commercial vehicles, and machinery imports (as of the first quarter of 1995), as well as the coincident indicator. 1/ When comparing the period January-July 1995 with the same period in the previous year, sales of cement increased by 9.7 percent, while sales of steel increased by 17.5 percent.

The available indicators of private consumption provide mixed signals, suggesting a weak and uneven pattern of recovery. In the first quarter of 1995, retail sales were weak, as were passenger vehicle sales. 2/ Gasoline sales were growing, but at a rate lower than that achieved in the first three quarters of 1994. Some observers also suggested that durable goods purchases may have been delayed because of initial uncertainty regarding the date of general elections. Later data seem to suggest that private consumption may be beginning to pick up. Retail sales grew 1.5 percent year-on-year in the period January-June, while imports of consumption goods grew 5.1 percent year-on-year in nominal terms in the period January-May. Consumer credit grew rapidly, although from a low base. 3/ Finally, the consumer confidence indicator has continued to improve until June 1995, reaching levels last seen in April 1993. In terms of overall output, the coincident indicator constructed by INE reached year-on-year growth of 2.8 percent by the first quarter of 1995, having turned positive in the third quarter of 1994.

3. Prices

CPI inflation continued to decline toward the EU average despite brief interruptions in the process of disinflation caused by special factors (Charts 3 and 4, and Table 9). 4/ From a peak of 13.4 percent in 1990, CPI declined to 5.2 percent in 1994. In the same period, the inflation differential between Portugal and the EU fell from 7.8 percent to 2.2 percent, while the differential between Portugal and its trading partners (a broader basket than the EU) fell from 8.3 percent to 1.2 percent (measured on a year-on-year basis at mid-year). In addition, in 1994 Portuguese inflation fell below the Spanish inflation rate for the first time in many years. By August 1995, CPI inflation had fallen to 4 percent. A number of factors help account for the reduction in inflation, and they are discussed in turn.

CHART 3
CHART 3

PORTUGAL Inflation Rates 1/

(In Percent; Year-on-Year)

Citation: IMF Staff Country Reports 1995, 124; 10.5089/9781451832082.002.A001

Source: IMF, International Financial Statistics.1/ Consumer Price Index.
CHART 4
CHART 4

PORTUGAL Price Developments

(In percent)

Citation: IMF Staff Country Reports 1995, 124; 10.5089/9781451832082.002.A001

Source: Bank of Portugal, Monthly Bulletin, various issues.1/ Excludes food and energy.
Table 8.

Portugal: Origins of Gross Domestic Product

(Real percentage change, except when otherwise indicated)

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Source: Bank of Portugal.

In billions of escudos.

Table 9.

Portugal: Consumer Prices 1/

(Annual average percent change)

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Source: Bank of Portugal.

Annual averages.

New CPI series starting January 1988.

New CPI series starting January 1991.

Excluding rents.

Excluding health, transport and communications, education, entertainment, and tobacco.

Excluding food and beverages, and energy.

Rate of change of nominal effective exchange rate of the escudo.

EU excluding Portugal.

The first factor aiding disinflation is the exchange rate policy followed by the Portuguese authorities. After the abandonment of the crawling peg in October 1990, the escudo shadowed a basket of five currencies, formally joining the ERM in April 1992. Despite four downward realignments of the central rate, the real effective exchange rate has appreciated significantly--12.4 percent between October 1990 and June 1995. As a result, tradeable price inflation fell from 9 percent in 1990 to 4.4 percent in 1994, and growth in import prices slowed appreciably. 1/ Because of the relative openness of the Portuguese economy--the estimated weight of tradeable goods in the CPI is 58 percent--tradeable prices have exerted a considerable downward pressure on inflation.

The second factor is the wage flexibility evident in the labor market (Chart 5 and Table 12). 2/ In 1994, ex post real wages implicit in collective agreements were flat, whereas productivity increased by 1.1 percent, and unit labor costs increased by only 3.6 percent. The importance of wage flexibility was evident in the evolution of non-tradeables prices, which fell even more rapidly than tradeables prices--down to 6.4 percent in 1994 from 19.1 percent in 1990. The rapid rise in unemployment in 1994 was a particularly significant factor in this regard. The reduction in inflation was also aided by continuing structural improvements arising out of increasing competition resulting from the opening up of the economy to Europe and the modernization of retail channels.

CHART 5
CHART 5

PORTUGAL Labor Market 1/

Citation: IMF Staff Country Reports 1995, 124; 10.5089/9781451832082.002.A001

Source: Data provided by the authorities; WEO; and Staff estimates.1/ In percent, unless otherwise indicated.2/ Series redefined after 1991.3/ Share of long-term unemployed (one-year or more) in total.
Table 10.

Portugal: Population, Labor Force, Employment, Unemployment, and Labor Market

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Sources: National Institute of Statistics, Inquerito ao Emprego: Bank of Portugal, Monthly Bulletin: and WEO.

As a result of methodological changes in the construction of the series, data for 1992 is not strictly comparable to previous years.

In percent of dependent employment.

Table 11.

Portugal: Employment by Sector 1/

(In thousands)

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Source: National Institute of Statistics, Inquerito ao Emprego.

Period average.

As a result of methodological changes in the construction of the series, data for 1992 is not strictly comparable to previous years.

Including education and health services, public and private.

Nonfinancial public enterprises covered by GAFEEP.

Table 12.

Portugal: Wage Developments

(Annual nominal percentage change, except where otherwise indicated)

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Source: Bank of Portugal, Monthly Bulletin.

Including employers’ social security contributions.

The final contributing factor was the cyclical weakness of output in 1993 and the continuing weakness of private consumption despite the recovery in 1994 and early 1995. The weakness of private consumption was also instrumental in moderating the effect of a 1 percentage point increase in the VAT rate in January 1995, which directly resulted in a 0.6 percent increase in the CPI (according to estimates provided by the Portuguese authorities). The increase in the VAT rate together with a transitory increase in potato prices caused by factors external to the Portuguese economy, temporarily arrested the downward path of inflation, which had fallen to 4 percent on a year-on-year basis by end-1994, only to rise to 4.8 percent by March 1995. 1/ But by June 1995, these transitory factors appeared to have run their course.

Among the components of CPI, growth in clothing and footwear--a volatile subgroup which is excluded from the underlying CPI index--increased to 4.8 percent in 1994 from 2.8 percent in 1993, whereas all other components exhibited declines. Administered prices, which in previous years had grown at a rate similar to that of non-administered prices, grew by only 3.9 percent in 1994 (compared to 5.4 percent for non-administered prices). Underlying inflation, which in recent years had been growing significantly faster than total CPI (excluding rents), fell to 5.7 percent in 1994, reflecting the more “average” behavior of the food and beverages subgroup.

4. The Labor market

Following the recession, unemployment continued increasing, reaching 6.8 percent in 1994 (Chart 5 and Table 10). In the first quarter of 1995 unemployment increased further, to 7.4 percent, although by the third quarter of 1995 it fell back somewhat, to 6.9 percent. Despite the rapid rise in unemployment, Portugal still enjoys one of the lowest rates of unemployment in the EU, well below the EU average (11.6 percent in 1994).

The rise in unemployment does not, in the first instance, appear to be out of line with Portuguese historical experience. After the 1984 recession, for example, unemployment was higher, peaking at 8.5 percent. 2/ Other indicators that are often thought of as signifying labor market rigidity also worsened considerably, however: youth unemployment rose from about 10 percent at the beginning of 1992 to more than 16 percent in the first quarter of 1995, while long-term unemployment rose from about 22 percent to 37 percent over the same period. Expenditures on unemployment benefits increased faster than unemployment primarily because of an increase in the coverage ratio (the percentage of unemployed receiving unemployment benefits). In 1985, the previous peak of unemployment, 21 percent of registered unemployed were receiving benefits; In 1993, this ratio had risen to 48 percent. 3/ This occurred because of an easing of unemployment benefit eligibility requirements in 1989, raising the question of whether the flexibility that had characterized the Portuguese labor market had been adversely affected. This question is addressed in more detail in Appendix I.

The rise in unemployment is accounted for primarily by a drop in employment of 2 percent between 1992-93 and an increase in the labor force of 1.3 percent between 1993-94. Although dependent employment declined by 2 percent between 1993-94, self-employment increased, so that total employment declined by only 0.1 percent in the same period. To the extent that self-employment is not a perfect substitute for dependent employment (70 percent of total employment in agriculture, for example, is represented by self-employment), under-employment may have increased. The 1993 fall in the labor force was primarily cyclical, as was the 1994 increase in the labor force; the increase in the number of first employment seekers was relatively small. The participation rate, especially for females, mostly recovered its pre-1993 levels.

The sectoral distribution of employment mainly reflected output developments, with increases in agriculture, and declines in manufacturing and construction in the period 1993-94 (Table 11). However, there was a noteworthy decline in services in the period 1992-94. As is shown by the experience of some other EU countries (e.g., Italy), employment in services has in the past been relatively immune to recessions. This state of affairs was overturned in the 1993 recession, probably as a result of technological and structural changes in the service industries.

Economy-wide wages grew by only 4.7 percent in 1994, while wages specified in wage agreements increased by 5.2 percent--exactly equal to CPI inflation (implying a fall of 0.2 percent in real terms if deflated by the private consumption deflator). 1/ Wages in Portugal have tended to react quickly and flexibly to labor market conditions, and the 1993 recession was no exception (Chart 5 and Table 12). Another factor explaining the weakness of wages is the continuing decline in the number of workers covered by collective agreements. A social pact also failed to be concluded during 1993-94. Economy-wide productivity increased by 1.1 percent in 1994 (or 1.4 percent if changes in working hours are included in the calculation).

II. Fiscal Policy

1. Overview

Portugal has made substantial progress with fiscal consolidation since the mid-1980s. There was a serious setback in 1993 when the general government deficit doubled to 7 percent of GDP and the primary balance--which had been in surplus for a decade--turned into deficit. The debt-to-GDP ratio had been declining, reaching around 60 percent in 1992, but in 1993 it reversed its trend. The setback of 1993 was partly due to the recession, which reduced revenues and increased unemployment benefits. However, there were also structural factors that contributed importantly to the fiscal deterioration. Specifically, revenues fell due to the weakening of tax collection after the abolition of customs within the EU, and social security and capital expenditures increased. The next two budgets reduced the deficit modestly, by about 1½ percent of GDP in 1994-95, while the public debt-to-GDP ratio has continued rising.

The 1995 budget seeks to maintain the deficit-to-GDP ratio at 5.8 percent, implying some deterioration in the primary balance. At the time the 1995 budget was being formulated, a worse fiscal outcome was expected for 1994, and thus, the 1995 budget envisaged some adjustment in relation to projections for 1994; since the 1994 outcome was better than expected, the 1995 budget targets are unambitious in comparison. However, the execution of the budget in the first half of 1995 was also better than projected in the budget.

Since the mid-1980s several major structural reforms have shaped the public finances. The VAT was introduced in 1986 and has gradually been harmonized with the EU; the income tax was introduced in 1989. Most recently, in 1994 the government initiated a program to improve tax administration. The government began a large scale privatization program in 1989, and devoted a substantial part of the receipts to reducing debt. Finally, changes in debt management policy have resulted in a shift from central bank borrowing to market-based domestic borrowing and the introduction of long-term fixed-rate instruments.

2. Fiscal Policy in 1994

The 1994 budget targeted a general government deficit of 6.6 percent of GDP, 0.4 percent better than in 1993, and a deterioration of the primary balance of 0.3 percent of GDP to -0.7 percent. The projected improvement in the fiscal balance was entirely due to lower projected interest payments, as a result of lower interest rates and a once-and-for-all effect of a change in interest payments on government bonds from twice to once a year. The main policy measures of the 1994 budget were an increase in contributions of public sector employees by 2 percent, several measures aimed at improving the finances of social security (see Appendix II) and a wage increase of 2.5 percent, below the range of projected inflation of 4 to 5½ percent. The budget also included efforts to strengthen tax administration. Revenue projections were made cautiously, however.

General Government Revenues and Expenditures

(In percent of GDP)

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The fiscal outturn in 1994 was dominated by a stronger-than-projected revenue performance that more than compensated for some expenditure overrun. The general government deficit fell by 1.2 percent of GDP to 5.8 percent and the primary deficit was eliminated (Tables 14 and 15, and Chart 6). Looking at the different levels of the general government, the central administration improved its balance significantly, while the balance of the social security system worsened (Tables 16-18). The borrowing requirement of the general government also fell, by ½ percent of GDP to 6.7 percent.

Table 13.

Portugal: Labor Costs in Manufacturing

(1999 = 100)

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Source: Bank of Portugal based on the following data:

INE, Industrial Production Index (manufacturing); adjusted for working days.

INE

(1)/(2)

Ministry of Employment and Social Security. Wages in manufacturing.

ULC = (4)/(3)

ULC of main partner countries weighted by manufacturing trade.

(5)/(6)

Provisional

Table 14.

Portugal: General Government Expenditures and Revenues

(In billions of escudos: national accounts basis)

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Sources: Ministry of Finance.