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2009 Financial and Economic Annual Report from Portugal's Central Bank


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2009 Financial and Economic Annual Report from Portugal Central Bank - 6 pages overview from May 17 2010.

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2009 Financial and Economic Annual Report from Portugal's Central Bank

  1. 1. Overview OVERVIEW The Portuguese economy recorded a strong recession in 2009, in a context marked by the deepest and most synchronized international recession of the post-war period. In fact, the growing and suc- cessive interaction between several economic and financial negative shocks at a global level culmi- nated in an abrupt increase in risk aversion and in uncertainty at the end of 2008, which implied subs- tantial falls in trade flows and in activity in the advanced, emerging and developing economies. In this context, the central banks and the governments of several countries adopted unprecedented policy measures that limited the potential systemic risks associated with that interaction, and which contri- buted to stimulate economic activity. Thus, from the second quarter of 2009 onwards, the conditions in international financial markets improved significantly and there was an acceleration in worldwide economic activity, even though at different speeds across regions. The evolution of the Portuguese economy reflected directly these developments, given its strong economic and financial integration. The generalized economic recovery contributed to decrease the risks regarding global financial sta- bility throughout 2009. However, the uncertainty on the international economic outlook remains high. In fact, the need for an adjustment in financial systems, in public accounts and in the economic agents’ balance sheets will tend to condition the economic dynamism in the short and medium term. Additionally, at the end of 2009 and beginning of 2010, there was an increase in sovereign risk in several economies - with prominence to some euro area countries, including Portugal - motivated by significant and non-anticipated increases in public deficits and in public debt levels, combined with the maintenance of several additional structural fragilities. These developments will tend to condition the evolution of the Portuguese economy, contributing to accelerate the inevitable economic adjust- ment towards a smaller disparity between domestic investment and saving. The global recession in 2009 had exceptional characteristics and the recovery throughout the year was supported by policy measures of unprecedented magnitude and nature The global economic recession in 2009 was particularly deep, prolonged and synchronized (see “Box 1.1 The global economic recession: comparison with previous episodes”, in this Report). The exceptional reduction in activity had its origin in a US financial crisis that quickly spread to almost all the advanced and emerging economies. The generalized increase in the uncertainty levels and in risk aversion in the last quarter of 2008, following the bankruptcy of the investment bank Lehman Brothers, generated an abrupt fall in the agents’ confidence and expectations and a strong increase in the restrictiveness of financing conditions at a global level. In this context, there was a substantial fall in aggregate demand and in world trade flows at the end of 2008 and in the beginning of 2009. The high degree of vertical specialization in production chains at a global level also contributed to the exceptional trade reduction observed in 2009 (see “Box 1.2 What may have led to the strong fall in world trade?”, in this Report). This context of global demand declines and of low levels of capac- ity utilization was reflected in a reduction of internationally traded goods prices, with prominence for commodity prices. In this context, there was a significant decrease of inflation that reached negative values in some economies, including Portugal. The strong worldwide economic deterioration – with the potential of becoming a second Great De- pression through a spiral of systemic effects stemming from the interaction between the economic Annual Report 2009 | Banco de Portugal 1
  2. 2. Overview and financial crises – caused an unprecedented response from the monetary authorities and the gov- ernments. In the case of governments, the fiscal stimulus measures differed from country to country, due to the respective fiscal situation before the crisis, the depth of the recession and the functioning of the automatic stabilizers. Additionally, there were interventions with the goal of stabilizing financial systems, namely the concession of guarantees and, in some cases, the injection of capital in banks and the creation of schemes of removal of impaired assets in the banks’ balance sheets. This way, most countries recorded a significant increase in fiscal deficits and in public debt levels in 2009. In the case of monetary authorities, besides the generalized maintenance of official interest rates at levels close to zero in 2009, several central banks continued to adopt non-conventional monetary policy measures, in particular the acquisition of public and private debt securities and the increase in the maturity of liquidity providing operations. Overall, these measures contributed to stimulate de- mand, decrease the economic agents’ uncertainty and reduce systemic risk in financial markets. In particular, the reduction of tensions in money markets and the significant decline in the private debt risk premium should be highlighted. In this context, global production and global trade flows expanded again from the second quarter of 2009 and the global economic activity outlook became gradually less negative throughout the year. However, the economic recovery was different among regions - being led in magnitude by the emerg- ing economies - and moderate given the severity of the recession. Several factors contributed to this outcome, in particular the maintenance of fragilities in the financial systems of some countries, the need to gradually remove the monetary and fiscal stimulus measures, the undergoing process of restructuring of household balances - with prominence for the countries that recorded corrections of bubbles in real estate markets - as well as the continued deterioration of labour market conditions in some developed economies. However, given the improvement in financial markets and in economic activity, the authorities in several countries started a gradual removal of the extraordinary policy mea- sures at the end of 2009 and in the beginning of 2010. The global economic developments were transmitted to the Portuguese economy, which evidenced elements of robustness in the context of the economic and financial crisis, but continued to be characterized by a set of structural fragilities The set of global shocks during 2009, of both a positive and negative nature, were transmitted to the Portuguese economy through several interlinked channels, influencing the level of uncertainty, the evolution of external demand, the financing conditions in international markets, the degree of restrictiveness in credit conditions for households and firms, the inherent expectations regarding the intertemporal consumption and investment decisions of economic agents, as well as the evolution of their solvency conditions. This external environment, together with the institutional framework in force and the authorities’ reaction, determined the main traits of the evolution of the Portuguese economy in 2009. The recession of the Portuguese economy in 2009 was the deepest of the last three decades, with a strong fall in employment and an increase of the unemployment rate to historical maximums. As regards demand, the economic contraction was associated with the behaviour of the macroeconomic variables with greater cyclical sensitivity, in particular the consumption of durables, investment and exports. In turn, the current consumption of goods and services decelerated less markedly, in a context where real disposable income maintained momentum. In intra-annual terms, and in line with international developments, the Portuguese economy recorded a gradual attenuation of the fall in activity from the second quarter of the year onwards. The net external financing needs diminished in 2 Banco de Portugal | Annual Report 2009
  3. 3. Overview 2009, reflecting the confluence of lower net financing needs of the private sector and a significant de- terioration in the public deficit. Both households and firms recorded increases in savings and reduc- tions in investment as a percentage of GDP. In the case of households, the evolution of the savings rate was in part related with the significant increase in uncertainty since the end of 2008 (see “Box 5.1 Determinants of the households’ savings rate in Portugal”, in this Report). In the context of the economic and financial crisis, the Portuguese economy revealed some robust- ness factors that contributed inter alia for the fact that the fall in activity in Portugal was lower than the one observed in the majority of developed economies. Among these factors, two deserve special mention. Firstly, there was no overvaluation in the real estate market in Portugal. In fact, in the pres- ent decade, real estate prices evolved in line with inflation and the construction activity remained anaemic. Secondly, the banking system stood in a relatively favourable position in the European context in terms of profitability, liquidity and solvency. Note that, despite the international crisis hav- ing significantly conditioned the activity of domestic banks, there was not a fall in the aggregate bal- ance sheet of the domestic banking system in 2009, in contrast with the evolution in the euro area. In what regards loans to the private sector, there was a strong deceleration during 2009, but in the case of loans to non-financial corporations, the deceleration was interrupted at still positive growth levels, which contrasts with the evolution in the euro area. The loan dynamics essentially reflected the cyclical evolution of demand. In fact, loans to non-financial corporations tend to lag the business cycle while loans to households tend to lead the cycle (see “Box 2.2 Cyclical evolution of loans to non-financial corporations and households”, in this Report). Additionally, the tightening of credit stan- dards to the private sector also played a role, after a prolonged period where banks accommodated the financing needs of non-financial corporations and provided contracts to households which were adapted to their ability to service the debt. In what regards the evolution of deposits, there was a gradual slowdown during 2009 after a strong growth in 2008. This evolution should be interpreted in light of the significant adjustments in the households’ portfolios observed in 2008, following a generalized increase in the investors’ degree of risk aversion (see “Box 2.1 Effects of the crisis in the international financial markets on the house- holds’ financial assets portfolio in Portugal”, in this Report). Additionally, it also reflects the improve- ment in the remuneration of deposits - in particular until the first quarter of 2009 - associated with disturbances in the wholesale financing markets. Note also that from the second quarter onwards the issuance of securities - without State guarantee - reassumed a central role in the financing of the banking system activity. However, the Portuguese economy continues to be characterized by a set of well-identified structural fragilities. Firstly, the qualifications of the working population - in terms of quantity and quality - are relatively low in the context of the European Union. This factor conditions the increase in productivity and restricts the adoption of technologies that incorporate new ideas and new ways of production. Secondly, the institutional framework in force conditions the efficient functioning of the product and labour markets, and does not promote the necessary reallocation of productive factors, which arises as particularly important in a context of global competition and of rapidly evolving comparative advan- tages of the Portuguese economy. The reforms recently introduced in the labour market are favour- able contributions in this context (see “Box 4.1 Employment protection: indicators and perception”, in this Report). However, there is still a growing segmentation in the labour market in Portugal – which also contributes to distort the incentives to invest in human capital – as well as a high duration of unemployment (see “Box 4.2 Wages after unemployment” and “Box 4.3 Flows in the labour market”, in this Report). Thirdly, the high formalism in terms of procedures and the long duration of the judicial Annual Report 2009 | Banco de Portugal 3
  4. 4. Overview processes imply a lower ability to ensure the fulfilment of contracts, which constitutes a basic founda- tion for long term investment decisions. In the fourth place, the economy is characterized by a high degree of energy dependence and a sectoral energy intensity which is relatively high in the context of the euro area (see “Box 4.4 Production structure and energy consumption in Portugal”, in this Re- port). Finally, the dynamics of the primary current expenditure in Portugal in the last decades, in some cases without the desirable degree of efficiency, has demanded recurrent plans of fiscal adjustment, contributing to increase the investors’ degree of uncertainty. The confluence of these fragilities has been manifested throughout the present decade in the persis- tence of a low productivity growth trend, in an increase in the natural rate of unemployment, as well as in the accentuated deterioration of the international investment position, in a context of globally favourable international financing conditions. These dynamics are particularly relevant given that they affect the level of well-being of economic agents, as well as the evolution of their intertemporal solvency conditions. The strong fiscal deterioration in 2009 resulted essentially from a fall in the structural tax burden and from an acceleration in the structural primary current expenditure The evolution of public finances in Portugal in 2009 was marked by the substantial increase in the budget deficit and in the public debt ratio. The deterioration of the fiscal situation was conditioned by the global economic and financial crisis and was observed, albeit in different magnitudes, in most countries of the European Union. The worsening of the deficit in Portugal had essentially a structural nature. In fact, there was a strong acceleration in the structural primary current expenditure and a fall in the structural tax burden. It should be noted that the degree of persistence of this fall remains sur- rounded by high uncertainty, given the difficulty in identifying the structural evolution of tax revenues in the context of an economic crisis without recent historical precedents. At the end of 2009 and in the beginning of 2010, concerns by international investors re-emerged re- garding the sustainability of the public finances in several economies, characterized not only by high fiscal deficits and/or high levels of public debt, but evidencing in addition some structural fragilities, for example regarding the level of domestic savings, the robustness of the financial system or the potential rate of growth of the economy. The contagion effects associated with the concerns regard- ing the sustainability of the fiscal situation in Greece contributed to heighten this movement, and were reflected in a significant revaluation and differentiation of sovereign risk, with prominence for some euro area countries, including Portugal. This context made the presentation by the national authorities of a credible medium-term fiscal con- solidation plan urgent. Within this context the update of the Stability and Growth Programme of March 2010 gained particular importance. This update foresees the correction of the excessive deficit situa- tion until 2013, through a concrete set of measures, both on the revenue and the expenditure sides. Despite the high uncertainty involved, the measures of fiscal consolidation announced in detail might not be sufficient for the fulfilment of the objectives established in the Programme, as highlighted in the evaluation of the European Commission (see “Box 3.1 Medium term fiscal outlook”, in this Report). In this context the government announced in May the adoption of additional fiscal measures aiming to accelerate the budgetary consolidation process in Portugal. These measures, as well as others that may be deemed necessary, should remain in place until the excessive deficit is corrected on a sustainable basis. The government bond yield spreads of Portugal vis-à-vis Germany increased significantly since mid- 4 Banco de Portugal | Annual Report 2009
  5. 5. Overview April, being magnified by contagion effects resulting from the relative uncertainty regarding the imple- mentation and the adequacy of the financial support programme to Greece by the euro area Member- states. These developments were reflected in the banking system financing costs, which should tend to spread to the financing conditions of the remaining economic agents. In the beginning of May, and in the context of a severe resumption of tensions in international finan- cial markets, the European Union Council and the Member-states decided on a comprehensive pack- age of measures aimed at preserving financial stability in Europe, including a financial stabilization mechanism. In turn, the Governing Council of the ECB decided to conduct interventions in the euro area public and private debt securities markets to ensure depth and liquidity in dysfunctional market segments, with the objective of restoring an appropriate monetary policy transmission mechanism. This decision follows the announcement of changes in the collateral eligibility requirements of debt instruments issued or guaranteed by the Greek government. In the aftermath of these measures the turbulence in international financial markets abated markedly, which was in particular reflected in the sharp fall in the government bond yield spreads of Portugal vis-à-vis Germany. Financial integration in the context of the euro area allows sustaining, in a prolonged but not indefinite manner, significant gaps between the domestic demand and supply Within the framework of a monetary union, the macroeconomic adjustments can be particularly pro- longed. In fact, in case financial markets are functioning regularly, the macroeconomic adjustment between countries is undertaken through competitiveness gains and losses resulting from changes in costs and inflation differentials. The negative inflation differential between Portugal and the euro area, observed since mid-2007, can be interpreted as the beginning of a typical process of compe- titive disinflation within a monetary union (see “Box 6.1 Trend indicators for the inflation differential between Portugal and the euro area”, in this Report). This process requires a transmission to the unit labour costs and to the profit margins, being desirably supported by reforms in the labour and product markets. By their nature, these adjustments in the context of a monetary union are slow and gradual. Additionally, the financial integration between economies allows the sharing of risk in face of idiosyncratic and temporary shocks to the economic agents’ income and wealth. This fact may contribute to postpone the correction of unsustainable financial positions, both at the level of indivi- dual agents and at a more aggregate level. Note, however, that this sharing of risk does not allow an indefinite support of gaps between domestic demand and supply. In contrast, the current context of relatively high sovereign risk differentiation across euro area econo- mies illustrates a situation of potential market segmentation, which may contribute to accelerate the inevitable economic adjustment towards a smaller gap between domestic savings and investment. Note that in situations of marked increase in uncertainty at a global level, that risk differentiation tends to be enhanced. In this context, the evolution of the Portuguese economy in the near future will be decisively conditioned by the international investors’ evaluation regarding the intertemporal solvency conditions of the domestic economic agents, with prominence for general government. The Overview and Box 3.1 of this Annual Report were written with information until mid-May 2010. The remaining chapters of the Report were essentially written with the information available in mid- April. Annual Report 2009 | Banco de Portugal 5
  6. 6. Overview Table 1 PORTUGAL – MAIN ECONOMIC INDICATORS, 2006-2009 Units 2006 2007 2008 2009 I. Prices, wages and unit labour costs Inflation (HICP) arc % 3.0 2.4 2.7 -0.9 Goods arc % 3.2 2.2 2.4 -2.4 Services arc % 2.7 2.8 3.1 1.3 Inflation (CPI) arc % 3.1 2.5 2.6 -0.8 GDP Deflator arc % 2.8 3.0 2.0 1.2 Private consumption deflator arc % 3.1 2.7 2.6 -1.8 Goods and services export deflator arc % 4.2 2.8 3.2 -4.7 Goods and services import deflator arc % 3.9 1.5 5.0 -8.7 Nominal compensation per employee, total economy (a) arc % 2.7 3.4 3.1 3.4 Nominal compensation per employee, private sector (b) arc % 3.1 3.9 3.3 3.3 Unit labour costs, total economy (a) arc % 1.4 1.5 3.5 3.5 Unit labour costs, private sector (b) arc % 1.7 1.7 3.8 3.6 II. Expenditure, income and savings Gross domestic product (GDP) rrc % 1.4 1.9 0.0 -2.7 Total domestic demand rrc % 0.8 1.7 1.2 -2.5 Private consumption rrc % 1.9 1.7 1.7 -0.8 Public consumption rrc % -1.4 0.0 1.1 3.5 Gross fixed capital formation rrc % -0.7 3.1 -0.7 -11.1 Exports of goods and services rrc % 8.7 7.8 -0.5 -11.6 Imports of goods and services rrc % 5.2 6.1 2.7 -9.2 Household disposable income (DI) rrc % 3.8 2.7 4.8 0.0 Household disposable income, excluding external transfers rrc % 3.5 2.4 4.9 0.6 Domestic savings rate % of GDP 11.7 12.4 10.2 8.6 Private sector (c) % of GDP 13.4 12.5 11.2 15.0 Households % of DI 8.1 6.1 6.4 8.8 Households, excluding external transfers % of DI 5.9 3.7 4.0 7.0 Corporations % of GDP 7.7 8.2 6.7 8.6 General government % of GDP -1.7 -0.1 -1.0 -6.4 III. Employment and unemployment Total employment (d) arc % 0.1 0.0 0.4 -2.5 Employees (d) arc % 0.8 -0.3 0.9 -1.7 Unemployment rate annual average; % 7.7 8.0 7.6 9.5 IV. Balance of payments Current account + Capital account % of GDP -9.1 -8.1 -10.4 -9.4 Current account % of GDP -9.9 -9.4 -12.0 -10.3 Goods account % of GDP -10.8 -10.8 -12.8 -10.5 Capital account % of GDP 0.8 1.3 1.6 0.8 V. Exchange rates Nominal effective exchange rate index (e) arc % 0.2 0.8 1.2 0.5 Real effective exchange rate index Adjusted for the relative unit labour costs (f) arc % 0.2 0.1 1.4 1.3 Adjusted for the relative consumer price index arc % 0.8 1.0 0.5 -0.7 VI. Interest rates 3-month Euribor %, Dec. 3.7 4.8 3.3 0.7 10-year fixed rate Treasury bond yields %, Dec. 4.0 4.5 4.0 3.9 Interest rates on outstanding amounts of credit granted by MFIs (g) Loans to households for house purchase %, Dec. 4.8 5.5 5.9 2.0 Loans to non-financial corporations %, Dec. 5.4 6.2 6.1 3.3 Deposits and deposit-like instruments up to 2 years %, Dec. 2.7 3.6 4.0 1.7 VII. Stock price index (PSI-Geral) y-o-yrc 31-Dec. 33.3 18.3 -49.7 40.0 VIII. Bank deposits and loans to the resident sector (h) Deposits of non-financial private sector y-o-yrc Dec. 4.2 5.7 10.6 2.1 Loans (i) Non-monetary sector, excluding general government y-o-yrc Dec. 8.6 10.7 7.7 2.2 Non-monetary financial institutions y-o-yrc Dec. 6.3 27.0 17.4 4.3 Non-financial corporations y-o-yrc Dec. 7.1 11.2 10.5 1.9 Households y-o-yrc Dec. 9.9 9.0 4.6 2.3 IX. Public finances General government overall balance (j) % of GDP -3.9 -2.6 -2.8 -9.4 General government primary balance % of GDP -1.2 0.2 0.1 -6.6 Consolidated gross public debt Dec., % of GDP 64.7 63.6 66.3 76.8 Notes: (a) Compensation per employee including: wage scale values, additional benefits and employers’ social contributions; excluding: general government social contributions.(b) Private sector – economy as a whole excluding general government and corporate hospitals.(c) Aggregate savings for all economic agents excluding the general government. (d) Data from INE National Accounts. (e) A positive change denotes an appreciation in effective terms; a negative change denotes a depreciation. (f) Relative unit labour costs in the total economy. A positive change denotes an increase in the relative costs of Portuguese producers.(g) Calculated as the average of interest rates on outstanding amounts of credit granted and deposits taken by MFIs, denominated in euro, to/from euro area residents, broken down by sector and/or purpose, in every maturity, weighted by the respective end-of-month amounts outstanding. (h) End-of- month balances.(i) Annual rates of change are calculated on the basis of the ratio of end-of-month outstanding amounts of bank loans adjusted for securitisa- tion operations to monthly transactions derived from outstanding amounts adjusted for reclassifications, write-offs and exchange rate and price revaluations. (j) According to the excessive deficit procedure rules. arc: Average rate of change. rrc: Real rate of change. y-o-yrc: Year-on-year rate of change. Annual Report 2009 | Banco de Portugal 9