The IMF Mission Chief to Portugal, Laura Papi, spoke to ECO to mark ten years since the bailout, which was marked by austerity policies and a subsequent "mea culpa."
The International Monetary Fund (IMF) came to the rescue of Portugal for the third time in 2011 when the then prime minister, José Sócrates, asked for a bailout in the face of the unsustainability of the country’s situation. However, unlike previous interventions in the 1970s and 1980s, this time the Portuguese economy had a common currency with other European countries, which could not devalue, and the prevailing recipe in both Washington and Brussels was the dreaded austerity. Later, the IMF did the “mea culpa” and changed the message, faster than some European governments, currently aligning itself with the message that it is necessary to invest to overcome the pandemic crisis.
This Tuesday, April 6, marks the ten-year anniversary of Portugal’s bailout. ECO spoke to Laura Papi – the successor of Poult Thomsen and Abebe Selassie, the IMF Mission Chief to Portugal – about this painful process, full of polemics, setbacks, excesses and mistakes. It was eventually recognised that the fiscal multipliers on the economy used by the IMF underestimated the effect of spending cuts and tax increases.
A decade later, the new head of mission for Portugal recognises the difficulties of adjusting an economy inserted in a monetary union in which it is not possible to devalue the currency, making the process more difficult and time-consuming. Laura Papi talks about what she considers to be good examples of changes made in the Portuguese economy, such as the rental law, and criticises the lack of action in other areas, such as the labour market. Even so, the economist is optimistic about the future of the country, arguing that the situation was “much stronger” when the pandemic arrived than when the financial system collapsed in 2007/2008.
10 years have passed since Portugal asked for a bailout, including from the IMF. What’s the IMF’s assessment of this process?
Portugal’s implementation of its program and the continuation of the core policies in the post-program period succeeded in improving public finances and stabilizing the financial sector, providing the basis for a sustainable and job-rich growth. The performance of the Portuguese economy has improved notably in the post-program years. A significant depreciation of the real exchange rate and a tourism boom have led to a significant rebalancing towards the tradable sector. The fiscal consolidation has led to a decline in debt. The health of the banking system has also improved and private debt has declined. In 2019, GDP surpassed its 2008 level and unemployment declined to historically low levels. Nevertheless, the income per capita convergence with the Euro Area has been slow, reflecting remaining structural bottlenecks.
Is Portugal’s economy better, despite Covid-19’s huge impact?
Portugal’s economy entered the pandemic in a much stronger situation compared with the outset of the global financial crisis. In particular, the financial system was more resilient, firms were more profitable and were less indebted, and so were households. The GDP contraction in 2020 of -7.6 percent, while representing the largest annual shock on record, is comparable with the cumulative output decline from 2008 to 2013 of -7.9 percent. Unlike in the previous crisis, unemployment increased only marginally supported by job retention schemes, such as the simplified layoff. Although the full duration of the current crisis is uncertain, we project a robust recovery in the second half of the year on the expectation that vaccinations will accelerate and that the economy can reopen.
What lessons did the IMF take from this?
The adjustment in the context of currency union membership is difficult and takes time. Further work is needed to flesh out the measures required to support internal devaluation and private sector deleveraging.
Country ownership is key to the success of a program. Key too is a legal system that can facilitate the required adjustment, without which successful reform may be impossible.
What could have been different?
Improvements in competitiveness were a main objective of the program. In absence of monetary policy at a national level, labour and product markets reforms were viewed as a key to restoring competitiveness in the crisis countries. The change in the rental law is a good example of a product market reform with a positive effect on the supply side. Important labour reforms were also carried out. Nevertheless, labour regulations still exhibit some rigidities that may affect adaptability and competitiveness of businesses. Resulting in labour market segmentation. Enhancing the flexibility of the labour market by making permanent contracts more flexible would help Portugal adjust to adverse shocks supporting resource reallocation and, in turn, productivity growth.