We should watch the hundreds of millions that we lent to Portugal
Dátum: 18.07.2013
The article was published on INEKO SME blog website on 25th of June 2013
Portugal keeps making cuts and increases taxes. Despite this public debt rose from 108% of GDP in 2011 to probably unsustainable 124% of GDP in 2012.
Frozen and taxed pensions, temporary withdrawal of early retirement, reduction of salaries in the public sector by 10% or an extension of the working week in the public sector from 35 to 40 hours. These are also the results of the Troika´s presence in Portugal that has been drawing international financial assistance in the period 2011-2014 amounting to 78 billion euros.
The reality is, however, leaving 13th and 14th pensions and salaries in public administration untouched, higher income taxes for businesses and individuals (the highest rate of up to 56.5%), 12-month cap on the amount of severance pay or increases in public debt from 108% of GDP in 2011 to probably unsustainable 124% GDP in 2012.
Why should we be interested in all this? Because Slovakia also participates in the program to help Portugal, and from the point of view of the return on our “investment” it is key to know whether and to what extent the states benefiting from the help manage to restructure their economies. The package in question is not a small one. Taking into account our share in the EFSF (0.99%), the share of the EU budget (0.37%) and Slovakia’s quota in the International Monetary Fund (0.18%), our “loan” to Portugal can grow up to 400 mil euros. All we could get for that amount you can see for yourselves here.
Portugal came to the brink of bankruptcy in 2011 when it was saved by assistance from the Troika that has been drawing international financial assistance in the period 2011-2014 amounting to EUR 78 billion. Until recently Troika marked Portugal as an example of model implementation of reform objectives. That changed in April 2013 when the Constitutional Court indicated its plans to cancel the thirteenth (in the summer) and fourteenth (during Christmas) salary and pension in the public sector, as well as a plan to reduce sickness and unemployment benefits as unconstitutional.
Year 2012 also showed the negative impact of dramatic savings and tax increases on the economy. The problem is particularly the continued growth of unemployment (increased to 15.9% in 2012) and the decline in GDP (by 2.7% in 2012). The public debt rose from 108% of GDP in 2011 to probably unsustainable 124% of GDP in 2012. It is primarily for these reasons that the EU has extended the term of the loan rescue mechanisms by seven years for both, Portugal and Ireland. Extension of maturity should help the two countries reach the financial markets after the complete execution of the rescue loan package (this should occur in May 2014 for Portugal).
Positive impact of reforms is mainly a decrease of the structural primary government deficit from 6.9% of GDP in 2010 to a small surplus in 2012 and increase in the competitiveness of the workforce which can be seen in the sharp drop in unit labor costs and labor productivity growth.
Here is an overview of the most important changes that have been implemented in Portugal:
Raising taxes: The standard VAT rate increased from 21% to 23% in January 2011. Portugal increases the income tax even though this tax measure is amongst the ones slowing down economic growth the most, which is also criticized by the OECD. Tax on profits of companies increased from 26.5% in 2010 to 31.5% in 2013, while the tax on dividends increased at the same time from 20% to 28%. The combined rate has increased from 41.2% in 2010 to 50.7% in 2013, thus Portugal became one of the states with the highest business taxes in the developed world. From 1st of January 2013 personal income taxes have increased. Instead of seven tax brackets with rates from 11.5% to 46.5%, five tax brackets with the rates from 14.5% to 48% were established. The tax rate for the band with the largest number of employees increased from 24.5% to 28.5%. In addition to the base rate, high incomes are subject to high income surtax, which was 2.5% in 2012 for incomes over € 153.300. In 2013, operating margin of 2.5% for incomes above 80 thousand euros is applied and 5% for incomes over 250 thousand euros. Special surtax of 3.5% also applies to income above the minimum wage. Altogether, people with the highest incomes are subject to a rate of 56.5% (48% +5% +3.5%).
Labor market reform: Reduction of the long-term protection of employees against dismissal where the amount of compensation fell from 30-day salary to the 20-day salary for each year of service; it is expected to further decline to 12-day salary in 2013. The change applies only to employees who started work after November 2011; in addition these employees receive allowances as a compensation for dismissal that are dependent on their age. The reform also introduced a 12-month cap on the amount of severance pay, before the reform the upper limit did not exist. The maximum unemployment benefit fell from € 1,257.66 to € 1,048.05, the maximum duration of receiving benefits fell from 38 to 18 months (minimum duration remains 9 months), while the unemployment benefits paid after six months decreased by 10%.
Public administration reform: Since 2011, it was not possible to accept new government employees; salaries in the civil service were limited through their progressive cuts since 2011: about 3.5% of the basic monthly incomes up to 1500 euros, salaries above 1500 euros were shortened by up to 10%. Working week in the public service was extended from 35 to 40 hours a week.
Pension system reform: Pensions over 250 per month have been frozen since 2011. Pensions above 660 euros per month were reduced by 10%. Pensions from 1350 euros to 1800 euros are subject to a “solidarity tax” of 3.5%, which gradually increases up to 40% for higher pensions. Tax-free part of pension income has decreased from 6,000 euros to 4.104 euros per year. The penalties for early retirement have been introduced as well as increased reward payments for late retirement; the possibility for early retirement has been completely abolished until 2014. Retirement age is increasing in 2013, from 65 to 66 years.
PPP projects: Portugal financed its large public investments, particularly highway construction, through the so-called PPP projects. With a share of over 10% of GDP Portugal has become a world leader in their use. Interestingly, the use of PPP projects above European average applies to all countries benefiting from the EFSF and ESM assistance (see Figure below). The main motivation to implement PPP projects in Portugal was to circumvent the public finances, which led to hidden indebtedness of the country. After the outbreak of the crisis, the government began to have problems with repayments; arrears amounted to 1.9% at the end of 2012. Under the pressure of the Troika, Portugal has included several projects in public deficit and gradually restructures them as well as severely decreases repayments.
Source: OECD
Note: Interestingly, the use of PPP projects above average applies to all countries benefiting from the EFSF assistance.
Privatization: The planned privatization includes rail (freight in 2013), energy, banking, aviation (already took place in February 2013), state post office (in the second half of 2013), state water company and public transport in Lisbon and Porto.
Despite reforms the weaknesses among the Portuguese economy include insufficient flexibility in the labor legislation and a high tax burden on labor and corporate income. It is clear from this overview that the scope for further reforms is significant. Reducing severance pay should not be applicable to new employees only; there are reserves also in shortening the maximum amount of severance pay or the maximum period of receiving unemployment benefits, in repealing 13th and 14th pensions and salaries in the public sector and reductions in direct taxes.
The great weakness is the monitoring of economic and social change in Portugal, as published documents, including evaluation reports of the European Commission are not sufficiently detailed. Thus, given monitoring had to be compiled from many different sources. It is however key for the public, from which indebted countries ultimately require money to rescue them, to have an overview of the ongoing changes and to get to know and form an opinion on the effectiveness of the use of rescue resources. Otherwise, thanks to uninformed public the risk of rejecting assistance to indebted countries increases despite the fact that the assistance could be beneficial for countries of Eurozone, including Slovakia.
Peter Goliaš, INEKO