Carlos da Silva Costa: Crisis management, resolution and recovery
in small European countries on an IMF programme. Comparative
presentation - the experience of Portugal
Address by Mr Carlos da Silva Costa, Governor of the Bank of Portugal, at the Conference held
by the Central Bank of Iceland "Looking back and looking forward&#58; How do we preserve
monetary and financial stability?", Reykjavik, 12 July 2019.
* * *
1. Introductory remarks
Good morning. I would like to thank Governor Már Gudmundsson for his kind invitation to
participate in today's Conference and to share with you the Portuguese experience in regard
to adjustment programmes, including those of the International Monetary Fund (IMF).
Ten years after the start of the great financial crisis, the Portuguese economy is in a growth
phase, economic agents continue to benefit from favourable financing conditions, the public
accounts have improved and the banking sector is stronger. Unemployment is now below
precrisis levels and private and public leverage ratios have improved. In the coming years,
economic activity in Portugal is expected to continue to benefit from a relatively
favourable economic and financial environment. This is good news, because growth is a key
ally in the process of rebalancing the economy.
However, not only in Portugal but in any economy, we cannot ignore the fact that growth periods
also tend to lead to a greater propensity to take on excessive risk. And,
in the absence of a
sense of emergency stemming from bad economic performance or imminent financial
market pressure, policymakers' continued commitment to economic reform and social
consensus becomes much harder.
This is why it is crucial in the current environment to bear in mind the lessons learned from the
crisis and, above all, to prevent the resurgence of the factors that led up to it. The Conference
today will certainly help enhance the level of awareness of all the participants.
2. Portugal had to resort to assistance programmes on three occasions - with similar
problems, but different monetary policy regimes and prescriptions
As you know, under an
in the first half of 2011, Portugal had to resort to official financing
assistance programme negotiated with the European Union (EU) and the IMF. Public and private
indebtedness had accumulated as a result of a credit boom dating from the mid-1990s, and large
current account deficits emerged. After twelve very difficult months, recourse to official financing
under an assistance programme became unavoidable.
Before speaking about the 2011 assistance programme and the factors that led to it, let me say
that this was not the first time Portugal had to resort to official financial assistance. We had
already negotiated adjustment programmes with the IMF in 1977-1978 and in 1983. The
root cause of the accumulated imbalances was then essentially the same: excessive domestic
demand growth in relation to the productive capacity of the economy, leading to external debt
accumulation.
However, given that in the 1970s and 1980s Portugal was not part of a monetary union and
the symptoms of the crisis and the policy prescriptions at the time
had full monetary autonomy,
had some important differences when compared to the 2011 crisis.
In a context of monetary sovereignty, the imbalances translated into currency depreciation,
international reserves depletion and high and rising inflation rates. With monetary policy
fully available at national level, financial repression prevailed. The policy prescription consisted of
interest rate increases, credit growth targets, capital controls and the devaluation of the escudo,
to contain domestic demand and restore export competitiveness.
As a result of the adjustment strategy, the real value of wages, pensions and savings declined
sharply and wealth was transferred from creditors to debtors. Money illusion blurred the
perception of the adjustment costs and of the fundamentally unbalanced burden-sharing.
Also, as nominal variables were targeted and competitiveness was restored in the short term,
structural supply-side imbalances and long-term competitiveness failed to be properly
addressed. As a consequence, the country's competitiveness remained fragile and anchored in
low wages.
The 2011 programme was agreed in a completely different environment. Without the
monetary instrument, money illusion was no longer there and the policy prescription had to be
different. As a result, the need for deleveraging and structural supply-side reforms became
inescapable.
To better understand the crisis that hit the Portuguese economy in 2011 and to draw lessons for
the future, it is important to analyse the factors and policies that led to it.
3. The 1995-2007 period - the accumulation of macroeconomic imbalances
To find the deepest roots of the problem, we have to go back in time to the mid-1990s.
The Portuguese economy presented no significant macroeconomic imbalances at that time.
Meanwhile, financial liberalisation and the prospect of joining the single currency translated into
cheaper and more accessible financing, leading to strong credit growth, and a fall in
households' savings rates. From 1995 to 2007, the stock of credit to the private sector increased
by more than 3⁄4 of GDP, whereas households' savings rates almost halved during the same
period.
Furthermore, the increase in indebtedness was mainly used to finance consumption and
lowreturn investments, mostly in the non-tradable sector. As a result, imports expanded and large
without a corresponding increase in the economy's
current account deficits materialised,
growth potential.
A macroprudential policy and a countercyclical fiscal policy would have helped contain the risks
associated with the expansion of domestic demand. However, macroprudential policy was
simply not part of the standard toolbox and the mostly pro-cyclical fiscal policy that was followed
aggravated the macroeconomic imbalances. In fact,
in the 1995-2007 period, the budget
deficit was, on average, 4.3% of GDP and, according to the most recent (revised) data, it was
never below the 3% limit. The large interest savings and windfall tax revenue coming from the
plummeting interest rates and booming private spending of the second half of the 1990s were
used to finance higher current public spending. Following the introduction of the euro, interest
rates stabilised as they had broadly converged to the best performers and tax revenue fell as a
result of decelerating activity in the early 2000s, causing a
sharp deterioration in the public
accounts.
Large and persistent current account deficits translated into a severe deterioration of the
which went from being close to
Portuguese economy's international investment position,
balance in the mid-1990s to almost -90% of GDP in 2007. Developments in gross external
external debt grew from approximately
debt over the same period were even more striking:
60% to 195% of GDP.
This rising external indebtedness was largely intermediated by the Portuguese banking
system. Banks raised (mostly short-term) funds in the international financial markets and
converted these into (long-term) loans to the private sector. The banking sector's loan-to-deposit
ratio increased from nearly 89% in 1998 to around 156% in 2007. The public sector also resorted
to foreign finance extensively.
In hindsight, it is clear that the pro-cyclical fiscal policy and less demanding regulatory context,
coupled with the complacency of international financial markets, contributed decisively to the
from the mid-1990s.
accumulation of important macroeconomic imbalances
4. The 2008-2010 period - the global crisis, fiscal expansion and increasing difficulty
to access external financing
The imbalances that I referred to made the Portuguese economy extremely vulnerable to the
international financial crisis that started in 2008 and to its contagion effects. When the crisis hit,
followed by a global recession, an expansionary fiscal policy was once again adopted, and this
time it was particularly intense, despite the imbalances hitherto accumulated and the absence of
fiscal space. In 2010, the budget deficit was above 11% of GDP and gross public debt was
around 96% of GDP - of which, more than half was external debt.
The high and rising level of external indebtedness, coupled with weak growth of potential output,
fuelled investors' concerns about the country's ability to pay back its debt. Domestic
banks and the government found it increasingly difficult to obtain external financing: banks had to
turn to the Eurosystem, whereas public debt was increasingly placed in domestic banks.
This situation ultimately resulted in the
country's inability to fund itself in the international
financial markets in the first half of 2011, after the 10-year yields had nearly doubled those of
the previous year, reaching over 9%.
Recourse to external official financing under a
financial assistance programme became unavoidable.
5. 2011 onwards - the adjustment programme
The Economic and Financial Assistance Programme was agreed in May 2011 between the
Portuguese authorities, the EU and the IMF.
On the basis of a strategy aimed at restoring international financial market confidence in the
Portuguese economy and fostering competitiveness and sustainable economic growth, the
Programme rested on three major pillars:
Fiscal consolidation;
Safeguarding the stability of the financial system; and
Structural transformation of the Portuguese economy.
Banco de Portugal participated in the definition and implementation of the Programme's financial
stability pillar, which aimed to:
Reinforce solvency, promote gradual and orderly deleveraging and ensure the stable
financing of the banking system;
Reinforce banking system supervision;
Improve the regulatory framework.
Banco de Portugal's responsibilities in the Programme's implementation were mostly
related to its mandate to safeguard the stability of the Portuguese financial system. The
Bank also participated directly and indirectly in other ways - for example by providing
economic and financial advice to the Government and reporting statistical data - and took part in
different initiatives led by the Portuguese authorities. The Bank also shared responsibilities in
processing the financial assistance disbursements and interest payments, acting as an
intermediary between the financing bodies and the Portuguese Treasury and Government Debt
Agency.
of
The total amount of financial assistance for the 2011-14 period was set at €78 billion,
which €52 billion corresponded to funding through the European mechanisms (the European
Financial Stabilisation Mechanism and the European Financial Stability Facility) and €26 billion to
assistance from the IMF, under an Extended Fund Facility. Of this total amount, €12 billion was
allocated to a Bank Solvency Support Facility. Overall, eleven disbursements were made, which
corresponded to approximately 97% of the agreed package. The Programme expired on 30
During the programme years, 12 review missions took place.
June 2014.
with the implementation of the financial assistance
Remarkable progress was achieved
programme:
The budget deficit significantly declined and public debt was put on a downward trend;
Private sector deleveraging is ongoing; and
The banking sector is more robust, with a stronger liquidity position, higher solvency ratios
and improved asset quality.
The Portuguese adjustment programme has widely been regarded as a success story. In
my view, this success was due to
three factors:
Portugal was committed to the implementation of the programme,
Programme ownership.
its urgency was understood and accepted by the general public and there was a
constructive dialogue with social partners. This ensured the success of the quarterly
reviews.
The speed and intensity of the response from the tradable sector, in particular
exports, was key to the rapid rebalancing of the external accounts and mitigation of the
impact of lower domestic demand on the non-tradable sector.
The preservation of confidence in the banking sector, as evidenced by the behaviour of
deposits. This was crucial to preventing the economy from collapsing with a credit crunch
and avoiding the imposition of capital controls.
The macroeconomic adjustment has continued after the programme ended in 2014, with
encouraging results. After the end of the programme, Portugal was subject to post-programme
monitoring/surveillance by the IMF and the European institutions. The post-programme
monitoring by the IMF ended upon the conclusion of the early repayment of the IMF loan in
December 2018. An early repayment strategy was possible thanks to a marked improvement in
Portugal's market access conditions. This strategy sent a positive signal to the markets,
improved the maturity profile of public debt and generated important interest savings.
6. What lessons has Portugal learned from the 2011 crisis and the adjustment
programme?
The Portuguese experience shows that when investors' concerns about the sovereign's
intensify and a country is unable to fund itself on the international
capacity to pay back debts
markets, an adjustment programme must be negotiated.
The country's authorities need to ensure ownership of the programme and a fair distribution
of costs across the society, so as to create a collective sense of purpose.
The reaction of the tradable sector, in particular exports, is crucial for rebalancing the external
accounts and mitigating the impact of lower domestic demand on the non-tradable sector.
Safeguarding confidence in the banking sector and the regular financing of the economy, i.e.
preserving financial stability, is also a key factor in avoiding a credit crunch and a deeper
economic recession.
It is also important to keep in mind that
adjustment programme goals are always short-term
by nature. Therefore, the adjustment will only be sustainable if there are structural and
institutional changes that prevent the recurrence of the conditions that led to the need for
adjustment.
This means that, despite the undisputed progress made during and after the 2011-2014
programme, there is no room for complacency. The experience of the past 40 years teaches
us that the initial impact from an assistance programme will only be sustainable if there are
structural changes that foster higher potential growth.
7. Major challenges ahead
Portugal has made remarkable progress since the time of its adjustment programme but
several vulnerabilities and important challenges still remain.
The crisis had a significant impact on the accumulation of capital, with negative
repercussions on potential output. Reducing the high levels of indebtedness, in parallel with
creating conditions that allow investment to increase (both in quantity and in quality) is essential
for improving the Portuguese economy's current situation.
In my opinion, the real challenge Portugal is confronted with is that of generating and
maintaining high levels of employment and productivity to ensure a lasting trajectory of
growth and convergence with its European partners. This is a necessary condition to (i) bring
Portuguese workers' wage levels closer to European standards; and (ii) finance the welfare state
in a context of unfavourable demographic developments.
This means that we need to activate the four most critical 'levers' of employment and
productivity:
Investment (it is vital to increase both the stock of capital and investment in intangibles,
learning from past mistakes, particularly by scrutinising investment projects in a far more
demanding way);
(employees' skills have improved considerably in recent years but significant gaps
Skills
remain in relation to European averages);
(management frameworks must encourage openness to risk and favour
Management
decentralised decision-making);
(innovation-friendly public policies are also critical to stimulating
Innovation policies
productivity and employment).
A long-lasting improvement in the economic welfare of the Portuguese people depends crucially
on the maintenance of a sustainable macroeconomic framework that provides suitable
incentives for economic agents and on following a reform agenda that supports long-term
sustainable growth.
8. Concluding remarks
Although my intervention focused on the Portuguese situation, we should bear in mind that
there
are also important challenges ahead at European level.
While we should not underestimate how much has been achieved in recent years, in the
aftermath of the financial crisis, we cannot ignore the fact that the foundations of Europe's
financial architecture are still not sufficiently robust and need to be reinforced further to
withstand the impact of a future crisis, to preserve financial stability and safeguard social
cohesion. Their strengthening should be a priority for policy-makers and relevant institutions.
In the case of both Portugal and the EU, we are talking about the deep institutional and
structural foundations of the economy. The task is hard, and it will take time to complete and
bear fruit. This means we have to start right away and be determined and tenacious, focusing on
what really matters from a long-run perspective.
At EU level, decisive political will to move forward with the completion of the banking
union is required. In the absence of this will, Europe must revisit its existing rules to safeguard
financial stability. This is in the best interests of its citizens. Not many things can be more
destructive to public trust in European institutions than threats to financial stability.
As I have already said, one of the key elements of Portugal's economic success through its
adjustment programme was the political consensus in a time of crisis.
Given that today, at this
Conference, we are talking about lessons from the crisis, I believe that the importance of
collective ownership and consensus should be highlighted both for Portugal and for
Europe as a whole.
Thank you.