March 25, 2019
Thank you for joining us today. It is an honor to take part in this event recognizing Portugal’s economic achievements. I would like to express my appreciation to Governor Costa da Silva for hosting us today.
When IMF Managing Director Christine Lagarde was here in Lisbon three weeks ago to speak before the State Council, she made a point that is well worth restating: in the depths of crisis, successive Portuguese governments and the Portuguese people themselves took ownership of the reforms needed to bring about recovery. There were difficulties along the way—as in any complex adjustment. But the positive results highlight the importance of political cohesion in responding to economic difficulties.
We have already had a chance this morning to hear about Portugal’s achievements, the tasks that remain, and the challenges that Portugal and Europe still face in a time of global uncertainty. I would like to examine each of these themes before circling back to the matter of political cohesion.
Global growth has slowed, including in Europe. Trade tensions continue to undermine confidence. Financial markets have been quick to react— and sometimes over-react—to perceptions of vulnerability. Political divisions have been heightened by rising inequality, economic divergence within the EU, migrant and refugee flows, and Brexit. And the post-World War II consensus on the importance of multilateral solutions to international problems appears to be fragmenting.
Growing Risks and Uncertainties
I am not saying that the sky is falling. It is not. In fact, most forecasts out there, including ours, see some recovery in Europe over the next several quarters. But we are facing growing risks and uncertainties. And that means that all countries need to renew their commitment to the reforms that will support growth now—and strengthen potential growth in the long term.
At our opening panel this morning, Wolfgang Munchau raised the topic of the next downturn. Whether we are talking about a garden variety recession or a worst-case scenario, we should anticipate that a downturn awaits us somewhere over the horizon. So, the question we should address is whether Europe and Portugal are properly prepared to sustain growth, to prevent another systemic shock, and to react to whatever comes.
I recognize that this is a well-trodden path for the EU, and that it is all about risk rather than the baseline. But it is important. If Europe is going to strengthen its defenses against crisis and make further progress toward integration, then it must overcome the policy shortcomings that could exacerbate the next downturn—whenever it eventually comes.
The bottom line is this: the tools used to confront the Global Financial Crisis may not be available or may not be as potent next time. The space for additional monetary policy accommodation will surely be more constrained; fiscal resources may not be as available in many countries; and political resistance to bailouts may be greater because many people feel that those who brought about the last crisis did not shoulder their share of the burden.
Strengthened EU Architecture
Despite the narrowing policy space, there has been good progress. The EU has strengthened its institutional architecture. The ESM provides firepower to support countries in need of financing. The Single Supervisory Mechanism has bolstered bank surveillance. The Single Resolution Mechanism has enhanced the credibility of bank resolution and made it less likely that taxpayer-funded bailouts will be needed. And, after long deliberations, there is agreement on establishing a common backstop for the Single Resolution Fund.
But there is still more to be done—especially in the realm of risk sharing across the EU. Bank supervision remains too fragmented; banking union is missing the pillar of a common deposit insurance scheme. Capital markets are still fragmented along national lines, which limits the potential for cross-border risk sharing.
While some fiscal reforms have been put in place, a fiscal-stabilization capacity at the center is needed to respond to macroeconomic shocks and improve the fiscal-monetary policy mix. In its absence, the euro area will remain over-reliant on monetary policy for stabilization and too much of the burden of crisis response will fall on individual countries, with their ability to respond depending on each country’s fiscal space.
Within bounds, this is as it should be. Each country has the responsibility to reduce risks and to sustain—or raise—growth. But in a severe downturn, those bounds may be tested.
Of course, greater risk sharing must go hand-in-hand with risk reduction that is ensured through strong regulation and supervision. All countries have an obligation to put—and keep—their own house in order. That will strengthen the case for more risk sharing without creating moral hazard.
Obviously, this is not a matter for Europe alone. The U.S. needs to get its fiscal house in order as well. U.S.-China trade tensions pose the largest risk to global stability. Beijing needs to continue its shift toward high-quality growth and should support a sustainable globalization. All emerging markets should face up to external shocks and volatile capital flows.
While most baseline forecasts show some recovery ahead for Europe, many have been surprised by the size and pace of the recent deceleration. So, it is important to acknowledge the continuing uncertainty about the coming year, including with the crucial issue of Brexit still unresolved.
Each country should act now to strengthen their defenses ahead of a potential downturn. That includes those who have not addressed glaring vulnerabilities, most notably Italy. A serious recession could be very damaging for these countries, because they will be shown to be ill prepared. Their weaknesses could present a serious setback for Europe’s goal of convergence—of standards of living, productivity, of national well-being.
On the other hand, there are countries that are in a strong position to face a downturn—most notably Germany, which continues to have space to increase spending. I will return to this point in a moment.
So where does Portugal fit into this picture? Portugal has made remarkable progress since the time of its adjustment program.
Consider these three sets of numbers:
- Unemployment peaked at 16 percent in 2013, with the young particularly hard hit. Now joblessness is at 7 percent, its lowest level since 2004. There has been a sharp decline in the long-term unemployed and an impressive reduction in youth unemployment, which is not far above the EU average.
- Yields on Portugal’s bonds were in double-digit territory during 2011-2012. By contrast, the yield on the 10-year bond is currently around 1.3 percent, showing a remarkable improvement.
- The overall fiscal deficit in 2010 was about 11 percent of GDP. The government is targeting a small deficit this year, and the primary balance is expected to hit its highest level since 1992. This will contribute to the reduction of public debt as a ratio to GDP, continuing the downward path that began in 2017.
In addition, exports and tourism have boomed, and the current account has been nearly balanced for the last several years. That followed a long period of very large external deficits. All of these achievements have reduced Portugal’s risk profile and strengthened its resilience to shocks.
But there is still room for more improvement. Public debt remains very high—about 120 percent of GDP last year, the third highest in the euro area, and unlikely to fall below 100 percent until 2025. Continuing on the path of debt reduction will help restore fiscal space that can be useful in a downturn.
The private sector remains highly leveraged: non-financial corporate debt is about 140 percent of GDP, and households some 75 percent. And the banking system remains vulnerable despite significant progress repairing balance sheets. NPLs declined to about 11 percent in the third quarter of 2018 from above 17 percent in 2015. But that is still high, and bank profitability continues to be low.
Portugal’s future is not just a matter of addressing vulnerabilities. Growth has been above its estimated potential for some time, reflecting the momentum of the recovery and the positive external environment. But the real challenge is to improve the longer-term growth prospects while continuing the job of repairing balance sheets. That means lifting productivity and enabling Portugal to participate in the global competition for future prosperity.
An important challenge is to inject new vitality into the country’s labor markets. Yes, joblessness has been reduced markedly, and a high proportion of new jobs are permanent. But too many of the new jobs have been minimum wage.
There is reason to think this can change. The economy is increasingly focusing on export markets, and that is forcing companies not only to compete with goods from other European countries, but with the whole world. That places a premium on a flexible work force equipped with advanced skills. And the level of education among young Portuguese is much higher than in earlier generations.
Meanwhile, the decline of non-performing loans in the banking sector is freeing capital that can be allocated to meet the needs of the 21st century economy. But here, too, there is a long way to go because the NPL ratios remain high, as we will hear this afternoon.
Portugal’s product market needs reforms, and the business sector needs to reshape itself to deal with the coming wave of artificial intelligence, robotics, and e-commerce. The government can play a key role in facilitating this change if it remains focused on the reform effort and makes sure that the regulations it controls do not discourage dynamic and innovative activities.
Providing a Supportive Environment
The rest of Europe is essential to this effort. Portugal’s top five export markets are in the EU, led by Spain, France and Germany. Their ability to sustain higher growth can provide countries like Portugal a supporting environment as they continue transforming themselves. In a sense, this is addressing risk without hammering out agreements in Brussels.
All of which brings us back to the point I made at the beginning about Portugal’s economic success being built on a foundation of political consensus in a time of crisis. This is no small achievement. As we face a period of heightened uncertainty and risk, this country has shown that there is a way forward by rising above differences in the face of common challenges.
It is also a lesson for the rest of Europe—indeed, the world. In the realm of economic policy, conflict and unilateral action only heighten vulnerabilities. Countries that follow this path ultimately will be hard pressed to produce higher levels of high-quality growth.
The issues in front of the EU are tough, but not intractable. Nevertheless, the way toward future accords will lie with a combination of cooperation and reforms. Portugal achieved this amid a crisis. There is no reason that Europe can’t do it without one!