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Cablegate: Portugal - Economy On Upward Trajectory

VZCZCXRO0829
RR RUEHAG RUEHDF RUEHIK RUEHLZ
DE RUEHLI #1341/01 1871518
ZNR UUUUU ZZH
R 061518Z JUL 06
FM AMEMBASSY LISBON
TO RUEHC/SECSTATE WASHDC 4952
INFO RUCNMEM/EU MEMBER STATES
RUEHPD/AMCONSUL PONTA DELGADA 0230
RUEATRS/DEPT OF TREASURY WASHDC
RUEHBS/USEU BRUSSELS

UNCLAS SECTION 01 OF 03 LISBON 001341

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD PO
SUBJECT: PORTUGAL - ECONOMY ON UPWARD TRAJECTORY

REF: 2005 STATE 1446

LISBON 00001341 001.2 OF 003


Summary
1. (U) Despite muted warnings over the last few months, the
European Commission (EC) for Economic and Monetary Affairs
Joaquin Almunia recently gave Portugal passing marks for its
efforts to reduce its huge budget deficit and undertake
structural reforms, in accordance with Growth and Stability
Pact commitments. Bank of Portugal Governor Vitor
Constancio, who has been critical of the government in the
past, also expressed support for the government's efforts but
cautioned against end of the year spending which threatened
to undercut gains made earlier in the year. On the other
hand, the OECD expressed concern in its April report by
lowering key economic indicators for Portugal and recommended
that the government take additional measures in order to
reach its target of reducing the budget deficit to 4.6% of
GDP in 2006. End Summary

Overview
2. (U) In 2005, the newly elected Socialist government of
Jose Socrates undertook a series of measures (reftel) to rein
in Portugal's soaring deficit which was well on its way
towards reaching 6.8% of GDP and to counter the loss of
purchase power parity vis-a-vis the EU-25 average. Its
revised 2005 budget did not resort to extraordinary measures.
Instead it raised value-added tax rates, thereby greatly
increasing revenue and preventing the deficit from growing
beyond 6%. It also introduced a multi-year Technology Plan
that targets education, human capital, research and
development, and public-private in an effort to make Portugal
more competitive and attractive to foreign investment. The
economy stagnated, however, as GDP grew by a mere 0.3%.

3. (U) The 2006 consolidated national budget aims to reduce
the government deficit by 1.4% to 4.6% of GDP. It has raised
taxes on gasoline and tobacco, undertaken social security
reforms by increasing contributions, raising the civil
service retirement age, and reducing pension outlays to
retirees. It has also begun to restructure its civil service
by downsizing several ministries and reducing their budgets,
cutting health expenditures and creating an interagency
oversight system to monitor investments over 250 million
euros. Perhaps most importantly, it has made major
improvements in its public finance statistical reporting and
created a technically independent commission to monitor the
deficit, a move which helped to remove the EC's lingering
doubts about the government's willingness and ability to
implement the needed reforms.

4. (U) In 2007, Portugal hopes to reduce its budget deficit
by 0.9% to 3.7% of GDP by further increasing taxes on
gasoline and tobacco, consolidating expenditure cutbacks
resulting from 2006 reforms in health, pensions and public
administration, and implementing a new civil service
structure, to include civil service mobility and sliding
salaries. The 2008 Growth and Stability target brings
Portugal in line with the "no greater than 3% budget deficit"
Eurozone policy by decreasing it 1.1% to 2.6% of GDP.

Growth Predictions
5. (U) Given all the measures outlined above, the government
maintains that it is on track to reach its Growth and
Stability Pact goals - predicting a 1.1% increase in GDP in
2006, a 1.8% increase in 2007, and a convergence with the
EU-25 median of 2.1% by 2010. The European Commission's
prediction is slightly less optimistic, at 0.9% in 2006 and
1.1% in 2007, due to lingering concerns with the government's
efforts to control spending - namely social transfers,
regional/autonomous zone transfers to the central government,
and late payments collection. On the positive side, the EC
has removed its reservations regarding the nation's
statistical methodology and collection. The Bank of Portugal
has indicated it will raise its 2006 estimate of 0.8% GDP
growth and 2007 estimate 1.0% due to increases in private
investment and exports, but has not yet done so.

6. (U) However, the OECD has downgraded GDP growth to 0.7% in
2006 because it believes Portugal must undertake additional
measures to reach its targets and doubts the government's
optimism with regard to efficacy of its budget consolidation
measures. In response to the OECD's April report, Finance
Minister Fernando Teixeira dos Santos commented that Portugal
would undertake additional measures if necessary. Though the
public has, by and large, been very supportive of the
government's belt tightening measures, there was rumbling at
the mention of further measures.

Projected GDP (% change from previous year)

LISBON 00001341 002.2 OF 003


2006 2007
Government 1.1 1.8
European Commission 0.9 1.1
OECD 0.7 1.5
Bank of Portugal 0.8 1.0

Deficit Reduction
7. (U) With specific regard to the budget goals outlined
under the Growth and Stability Pact, the government remains
committed to reducing its deficit to 4.6% in 2006 and 3.7% in
2007, noting improvement in revenue collection. Both the
OECD and the European Commission predict that the budget
deficit will reach 5.0% in 2006, with the former underscoring
the need to strengthen consolidation efforts, increase taxes,
control expenses, intensify reforms in social security and
public administration, strengthen manufacturing
specialization, and enhance education and personnel
resources, and the latter expressing concern with the
increase in social transfers and huge debt payments.

8. (U) The EC predicts a budget deficit of 4.9% in 2007 in
contrast to the government's estimate of 3.7% because the
government has not yet introduced legislation to control
public expenditures although it announced its attention to do
so over a year ago and because it predicts GDP growth of only
1.1% instead of Portugal's more optimistic estimate of 1.8%.

Budget Deficit Projections (% of GDP)
2006 2007 2008
Government 4.6 3.7 2.6
European Commission 5.0 4.9 n/a
OECD 5.0 n/a n/a
Bank of Portugal n/a n/a n/a

Unemployment Trends
9. (U) With regard to unemployment, though the rate increased
to 8.0% this year for the first time since the 1980s, the
government predicts unemployment will stabilize around 7.7%
in 2006 and drop to 7.5 % in 2007 due to salary adjustments.
The OECD also predicts that unemployment will decrease in
2007 to 7.7% due to relatively better economic conditions,
but that real salaries will grow faster than productivity.
EC predictions contrast with those of the government and the
OECD, estimating that unemployment will reach 8.1% in 2006
and 8.3% in 2007, with job creation being sluggish.

Unemployment (% of eligible workforce)
2006 2007
Government 7.7 7.5
European Commission 8.1 8.3
OECD 7.7 7.6
Bank of Portugal n/a n/a

Current Account Balance
10. (U) As for the current account balance, the price of oil
has further exacerbated the current account deficit, with the
government predicting a deficit increase of 8.8% in 2006 and
8.4% in 2007 due to a slight recovery in the balance of goods
and services. The Bank of Portugal predicts a current
account deficit of 8.5% in 2006 and 8.8% in 2007. Painting
an even more pessimistic picture, the OECD predicts external
debt will reach 9.6% of GDP in 2006, and the EC predicts it
will reach 9.8% in 2006 and 9.6% in 2007 as oil costs
continue to rise.

Current Account Deficit (% increase over previous year)
2006 2007
Government 8.8 8.4
European Commission 9.8 9.6
OECD 9.6 n/a
Bank of Portugal 8.5 8.8

Export Growth
11. (U) And finally, with regard to export growth, Portugal's
government predicts exports will increase by 5.7% in 2006 and
6.1% in 2007, but notes that the country will continue to
lose its competitive edge if the government does not take
corrective action. The Bank of Portugal and the OECD
estimate that exports will grow by only 4% in 2006, again
emphasizing the loss of competitiveness to Asia and the new
EU members. The EC predicts that exports will grow by 3.9%
and 4.5% in 2007, underscoring that the position of
industrial goods will continue to deteriorate vis-a-vis
emerging markets.

Export Growth (% change over previous year)
2006 2007
Government 5.7 6.1
European Commission 3.9 4.5

LISBON 00001341 003.2 OF 003


OECD 4.0 n/a
Bank of Portugal 4.0 n/a

Comment
12. (SBU) The OECD's skeptical review provided a much needed
reality check to an overly optimistic government. Though
Finance Minister Teixeira dos Santos continues to paint a
best case scenario for Portugal's economic recovery, it is
likely that Portugal will have to undertake additional
measures to meet its targets as outlined under the Growth and
Stability Pact. Some have suggested that the government
might reluctantly resort to one-off measures such as selling
vacant government property. Other suggest that the
government decrease rather than increase taxes to stimulate
the economy, something Teixeira dos Santos has said he would
not consider until the economy is much stronger. Still, post
believes that the economy has turned the corner and that the
government is on the right track, using its unprecedented
four year term to ensure that reforms take root. Despite the
economy's upward trajectory, there is much concern that
Portugal will continue to lose ground to Eastern Europe,
given that it will take decades for the Technological Plan -
with its focus on educational and personnel reforms - to take
effect. Some have even theorized that the lack of confidence
most Portuguese currently have in their economy is linked to
the country's early 2002 World Cup defeat and the resulting
pessimism. Perhaps Portugal's achievements in the 2006 World
Cup will put the country back on the map literally - earning
it new found respect both inside and out - and giving it the
missing "can-do" optimism so sorely lacking in the nation's
psyche.
Hoffman

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