Portugal’s old order loses its grip in painful times of change / Financial Times .

December 4, 2014 9:14 pm

Portugal’s old order loses its grip in painful times of change

Peter Wise

http://www.ft.com/intl/cms/s/0/b4f9e6be-52e6-11e4-9221-00144feab7de.html?siteedition=intl#axzz3L6Y3OudS

Three months after the Lisbon government celebrated Portugal’s successful exit from a punishing three-year bailout programme, the country watched appalled this summer as the family business empire controlling Banco Espírito Santo unravelled and collapsed. It was one of Europe’s largest financial failures.

If a rigorous programme of reform and fiscal tightening overseen by the EU and the International Monetary Fund had failed to detect the imminent downfall of one of the country’s largest banks, what confidence could Portugal have that its deep-rooted structural problems were being adequately addressed?

This question, and other pressing uncertainties about the future of the Portuguese economy, will be at the heart of the campaign for next October’s general election, in which the anti-austerity opposition Socialists are leading in the polls over the fiscally conservative parties of Portugal’s centre-right government coalition.

António Costa, the mayor of Lisbon and recently elected Socialist leader who hopes to become the next prime minister, describes the bailout as an abject failure, saying “all it has produced is poverty.”

Pedro Passos Coelho, the prime minister, says framing the debate as a simple choice between austerity and growth is “childish” and warns that Portugal will need several more years of tight fiscal control to secure a prosperous future. “It was not through lack of finance that the country failed to grow in the past,” he told parliament recently.

Last month an unexpected element was introduced into the political calculations being made ahead of the 2015 election when José Sócrates, Portugal’s Socialist prime minister from 2005 to 2011, was detained at Lisbon airport and held as a suspect in a tax fraud, money laundering and corruption investigation.

His detention came in a year of unprecedented judicial action against top establishment figures. In separate cases, courts found two former ministers guilty of corruption or misconduct. Another case saw Ricardo Espírito Santo Salgado, head of the 145-year-old banking dynasty, released on bail of €3m after being made an official suspect in an investigation into tax evasion.

Suspected of corruption linked to the granting of “golden visa” residence permits, the head of Portugal’s border agency and other top civil servants were also detained in November.

The fallout from the investigation into Mr Sócrates could prove damaging for the Socialists and increase the likelihood of next year’s vote producing a hung parliament. At the same, Portugal’s often slow-moving justice system will be put to the test by a series of high-profile cases.

Beyond the party political arguments and whatever the outcome of these judicial investigations, however, the perception is growing that the bitter economic hardship caused by the adjustment programme and the traumatic collapse of the Espírito Santo group are part of the same painful process — an attempt to allow the more successful areas of the economy to flourish in place of the outworn and the unproductive.

“The demise of the Espírito Santo group is positive news in that it symbolised every thing that was, and partly still is, wrong with the Portuguese economy,” says Pedro Santa-Clara, a professor of finance at Lisbon’s Nova School of Business and Economics. “Its collapse will free up resources to be better deployed elsewhere.”

The Espírito Santos, until recently Portugal’s most powerful bankers, have come to represent the backward-looking face of an economy that has achieved only meagre growth over the past two decades and is slowly recovering from its worst recession in 40 years.

The economic wrongs that the Espírito Santos are seen to embody include excessively cosy relations between the private and government spheres, borrowing heavily to expand despite having limited capital, investing poorly and contriving to influence big companies from minority positions.

“For too long, our smartest kids have been employed by groups like Espírito Santo, essentially to appropriate resources generated elsewhere in the economy, rather than to create real value,” says Prof Santa-Clara. “When that happens, it’s a big loss to society.”

Some economists see the episode as one of “creative destruction”. The Espírito Santos’ fall, they say, has unlocked assets — unproductive in the hands of a highly leveraged banking group — that can be better managed by new, better capitalised investors.

The shift matches the economic transition the EU–IMF rescue sought to engineer through a painstaking programme of reforms and cutbacks, agreed to by Lisbon as the condition for a €78bn bailout. In three years of austerity measures, the programme helped transform a current account deficit equivalent to 12 per cent of gross domestic product in 2012 to a surplus in 2013.

The trade balance moved from a deficit of almost 10 per cent of GDP to a surplus of 2.1 per cent over the same period. This was the first time in more than half a century that Portugal has exported more than it imports.

Since 2011, the government has succeeded in cutting the budget deficit by a total of 6.4 percentage points to an expected 4.8 per cent of GDP this year. Government borrowing costs, in keeping with trends in the rest of Europe, have fallen to historical lows.

The social cost of these gains has been brutal. Unemployment soared to record highs amid a wave of bankruptcies. Living standards plummeted as wages were frozen, taxes increased and social transfers cut. Emigration is at levels unknown since the 1960s and now includes highly qualified young graduates.

Nor is the overall success of the adjustment programme guaranteed. In November, Portugal’s international borrowers sternly criticised the government for allowing the pace of reform to flag and putting at risk the progress that had been made.

The constitutional court has reversed several government measures aimed at cutting public spending. But since the end of the programme, the government itself had been delaying necessary fiscal cuts, the IMF says. It urges Mr Passos Coelho to tackle bottlenecks to growth with “more energy and purpose”.

What is at stake in the Portuguese economy is a struggle to shift resources from non-export sectors such as energy, construction and telecommunications to export-led companies competing in global markets.

Serving the domestic market, sheltered from competition and often dependent on state contracts, such non-export companies have absorbed excessive investment and talent at the same time as they have diminished Portugal’s international competitiveness by driving up costs for exporters.

Inputs such as energy and telecoms account for about 16 per cent of costs for Portuguese exporters, almost as much as labour (19 per cent). They have risen faster than export prices for almost 15 years. The OECD warned in October that expanding exports would depend on further reforms to strengthen competition in the non-export sector.

The other faultline dividing the economy between old and new is debt. Many undercapitalised, poorly managed companies that thrived in Portugal’s debt-fuelled domestic market before the global financial crisis were hit hard when the credit dried up.

Rather than being wound up or sold off, many are being kept artificially alive by banks that would rather roll over loans than take the hit to their equity and bottom lines that enforcing liquidations would incur. These “zombie” companies do not invest, grow or create jobs.

“There are two economies in Portugal,” says Joaquim Souza, chief executive of investment bank Caixa–Banco de Investimento. “One is expanding, restructuring, finding new export markets and has no trouble in accessing credit. The other is too heavily indebted to nurture any growth.”