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Ernst & Young Eurozone Forecast June 2013Eurozone

Outlook for Portugal

Ernst & Young Eurozone Forecast — June 2013

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Portugal

1Ernst & Young Eurozone Forecast June 2013 | Portugal

HighlightsAnother sharp GDP decline forecast for 2013, followed by a slow recovery

• With the restructuring of the economy still in progress, we forecast another sharp contraction in economic activity in 2013, followed by stabilization in 2014. If efforts to restore competitiveness and enhance the flexibility and attractiveness of the economy continue, Portugal can expect to start growing from Q4 2013 onwards, albeit still at a slow pace.

• Our growth forecast is lower than the Government’s for two main reasons. First, developments in 2011 and 2012 throughout the Eurozone have shown that fiscal consolidation measures have a significant negative impact on growth, larger than the Government currently estimates. This is mainly due to the inability of monetary policy to offset the negative effect of the fiscal squeeze. Second, the global environment is relatively muted, especially in the short term, limiting opportunities to take advantage of improved competitiveness via rising exports.

• Consumption is expected to decline sharply in 2013, as household incomes are hit by rising taxes, and high and rising unemployment undermines consumers’ ability and willingness to spend. We expect the unemployment rate to peak at around 18.5% in mid-2014.

• Beside a bleak outlook for domestic sales and profits, investment will be constrained by the need for businesses to reduce currently high debt levels. With banks also under massive pressure to reduce leverage, credit conditions for firms in the non-financial sector will remain tight. The prospects of a Eurozone banking union look remote, so the restructuring of the banking sector will need to happen without external financial help. As a result, credit conditions will remain tight throughout the forecast horizon, hampering investment growth.

• Exports are forecast to be the only source of growth in the short term. They are expected to pick up in 2014, when demand from Portugal’s trade partners starts to improve. Strengthening foreign demand will help exporters take advantage of the improvement in competitiveness achieved so far.

• In order to enhance medium-term growth prospects, Portugal needs to tackle some of its structural deficiencies. Education levels below the European Union (EU) average will make it difficult for Portugal to compete as a production location.

2 Ernst & Young Eurozone Forecast June 2013 | Portugal

Outlook remains unsupportive …The Government’s austerity measures, aimed at improving Portugal’s competitiveness, will have a negative impact on the economy, particularly domestic demand. We expect the ongoing contraction of the economy to end only by Q4 2013, supported by a pickup in the demand for exports and a less negative domestic environment.

We forecast GDP to fall by 2.8% in 2013. This is lower than the Government’s projection for two main reasons. First, developments in 2011 and 2012 throughout the Eurozone have shown that austerity measures have a larger negative impact on GDP growth than was envisaged earlier. This is mainly due to the inability of monetary policy to offset the negative effect of the fiscal squeeze, as it is aimed at all Eurozone countries and not tailored to Portugal’s specific economic situation. Second, export demand is expected to remain weak this year. A large share of Portuguese exports goes to countries within the Eurozone, of which 25%

are absorbed by recession-hit Spain. And the upturn in global demand is likely to be less robust than expected, especially in the short term, thus limiting opportunities to take advantage of improved competitiveness via rising exports.

... amid weak domestic demandDomestic demand in Portugal is very weak and is expected to be the main drag on growth in the short term. Austerity measures, such as severe tax hikes at the beginning of the year, will damage individuals’ disposable incomes. Meanwhile, unemployment, which climbed to 17.5% in Q1 2013, will limit households’ willingness and ability to spend. Although the International Labour Organization unemployment rate stabilized at 17.5% in the three months to March, this is likely to be temporary, and we expect unemployment to start rising again. With Portugal’s relative unit labor costs in Portugal — the key measure for competitiveness — being the highest among all the peripheral Eurozone countries, the Government still

needs to continue with the adjustment process. This is likely to entail a further reduction in employment through public sector job cuts. As such, we expect unemployment to pick up to around 18.5% in mid-2014 and to decline very gradually thereafter.

Some support for consumption will come from the increase in remittances from abroad, especially from Germany and Portuguese-speaking countries, where people migrate for work. However this is unlikely to be enough to prevent consumption from falling. We forecast consumer spending to decline by 3.8% in 2013 and a further 0.3% in 2014.

The outlook for investment is also bleak. Portugal has one of the most indebted corporate sectors in Europe and it is currently undergoing a deleveraging process. Therefore companies’ willingness to borrow money to invest remains limited. At the same time, credit conditions in Portugal are still tight. According to the Central Bank of

Another sharp GDP decline forecast for 2013, followed by a slow recovery

Table 1 Portugal (annual percentage changes unless specified)

2012 2013 2014 2015 2016 2017

GDP -3.3 -2.8 0.3 1.1 1.1 1.1

Private consumption -5.6 -3.8 -0.3 0.5 0.5 0.6

Fixed investment -14.5 -8.4 -1.6 2.1 2.4 2.3

Stockbuilding (% of GDP) 0.1 -0.6 -0.5 -0.5 -0.7 -0.9

Government consumption -4.4 -2.4 -0.9 1.3 1.6 1.5

Exports of goods and services 3.3 1.6 4.3 3.9 3.8 3.6

Imports of goods and services -6.9 -3.7 2.0 3.7 3.4 3.0

Consumer prices 2.8 0.2 0.8 0.8 0.8 0.9

Unemployment rate (level) 15.9 17.9 18.2 17.5 16.5 15.5

Current account balance (% of GDP) -1.5 -0.9 0.2 0.2 0.2 0.2

Government budget (% of GDP) -6.4 -6.0 -4.2 -2.9 -1.7 -0.8

Government debt (% of GDP) 123.6 132.5 134.5 134.2 132.8 130.5

ECB main refinancing rate (%) 0.9 0.6 0.5 0.5 0.5 0.7

Euro effective exchange rate (1995 = 100) 115.5 118.5 115.6 112.0 111.1 110.9

Exchange rate ($ per €) 1.28 1.29 1.21 1.17 1.17 1.17

Source: Oxford Economics.

3Ernst & Young Eurozone Forecast June 2013 | Portugal

Figure 1Contributions to GDP growth

Figure 2Government balance and debt

Source: Oxford Economics. Source: Oxford Economics.

Portugal’s latest bank lending survey, a number of factors, such as less favorable expectations regarding general economic activity and the deteriorating outlook for specific sectors and enterprises, caused credit conditions to tighten slightly in Q1 2013. As such, even those companies that are willing to invest are likely to find it difficult to access funds for investment. We expect investment to fall by 8.4% in 2013 and by 1.6% in 2014.

But exports forecast to continue growing …We forecast that exports will be the only growing component of GDP in 2013. But even export growth is going to be relatively weak this year, due to weak demand in Eurozone countries, especially recession-hit Spain, which absorbs 25% of all Portuguese exports. Exports are expected to pick up fully in 2014, when domestic demand in key trading partners returns to growth.

But on a more positive note, the main refinancing rate was cut by 25 basis points to a record low of 0.5% by the European Central Bank (ECB) in May. This will help to weaken the euro, making it easier for firms to compete in foreign markets, particularly Angola and Brazil, where Portugal is actively trying to win market share.

… helping to improve the current account balanceThe modest rise in exports and weak imports will help to improve the current account deficit, which we expect to narrow to 0.9% of GDP in 2013 from 1.5% in 2012. In addition, we expect more people to emigrate to other European and Portuguese-speaking countries, which should drive up the inflow of remittances and support the current account. The current account balance is expected to move into surplus in 2014 when a gradual recovery in the Eurozone should lead to faster demand growth for Portuguese exports. In 2015–17, the current account is expected to remain in surplus, at around 0.2% of GDP. We believe that further growth in the current account surplus will be restricted by capacity constraints, as well as the inability of Portugal to compete in higher value-added sectors.

Financial markets are relatively calm …Portugal recently announced harsh austerity measures in its latest budget for 2013, but four of these measures were ruled to be unconstitutional by the constitutional court. Although the Government was able to present additional spending cuts to bring the budget deficit down to the planned 5.5% of GDP this year, we do not expect Portugal to meet its 2013 deficit target. At best, we expect the deficit to come down to 6% of GDP in 2013, due to a sharper fall in GDP than the Government expects.

2014-8

-6

-4

-2

0

2

4

6

8

10

1990 1993 1996 1999 2002 2005 2008 2011

GDP

Net exports

Domestic demand

Forecast

% year

Forecast

Government debt (right-hand side)

% of GDP

40

50

60

70

80

90

100

110

120

130

140

1990 1994 1998 2002 2006 2010 2014-12

-10

-8

-6

-4

-2

0

2Government balance(left-hand side)

% of GDP

4 Ernst & Young Eurozone Forecast June 2013 | Portugal

Figure 3Current account balance

Source: Oxford Economics.

US$b % of GDP

% of GDP(right-hand side)

Forecast

-21

-18

-15

-12

-9

-6

-3

0

3

6

9

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

1992 1995 1998 2001 2004 2007 2010 2013 2016

US$b (left-hand side)

Nevertheless, latest reports by the EU and International Monetary Fund indicate that the recent bailout review has been positive and Portugal will receive the next tranche of funding, worth €2b. At the same time, markets remained relatively calm with respect to the constitutional court’s decision, which potentially poses a risk to the adjustment program. As a result, Portugal was able to issue its first 10-year government bond since the bailout was requested in 2011. This is a very positive development, because it makes Portugal fully eligible for the outright monetary transactions program, under which the ECB has pledged to buy sovereign bonds of peripheral Eurozone countries to keep governments’ borrowing costs low.

… but downside risks continue to dominate the outlook … The main risk to our forecast comes from the possibility of growth that is weaker than expected in the Eurozone, which will dampen exports — the only growing component of GDP in the near term. Indeed, the recent Q1 GDP estimate in Spain surprised on the downside, indicating that the worst for Portugal’s main trading partner is far from over. Furthermore, there is uncertainty around the economic situation in Germany — which also absorbs a large share of Portuguese exports — where the recent Purchasing Managers’ Index data showed a noticeable weakening in April.

… and medium term prospects are weakCrucially, Portuguese growth in 2015–17 depends on enhancing education levels. They are currently below the EU-average, which makes it difficult for Portuguese firms to compete in international and domestic markets.

Another medium-term problem for Portugal is long-term and youth unemployment. The long-term jobless rate (those unemployed for over a year) climbed from 4% in Q1 2009 to 8.8% in Q4 2012. And given the poor outlook for the economy, we expect it to remain elevated in the years ahead. This, coupled with very high youth unemployment (at 38.3% in March 2013), is likely to result in an erosion of workers’ technical and social skills, as well as migration of part of the labor force. This could exert a drag on productivity and therefore medium-term GDP growth. Although we expect the economy to emerge from recession toward the end of 2013, growth over 2015–17 is forecast to average just 1.1% per annum.

Another sharp GDP decline forecast for 2013, followed by a slow recovery

Figure 4Unemployment

Source: Oxford Economics.

0

2

4

6

8

10

12

14

16

18

20

1990 1993 1996 1999 2002 2005 2008 2011 2014 2017

Forecast

%

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