Portugal should take a leaf from Ireland’s book says Lloyds bank CEO
Portugal can and should do better by following Ireland’s example as a success story in economic recovery argues Portuguese banker and CEO of Lloyds Bank António Horta Osório who addressed the 1st AICEP Congress on Exports and Investment on 17 May at Nova SBE.
Portugal has come a long way in recovering from the 2008-2014 economic recession which saw the country bankrupt and effectively managed by the IMF/EC/ECB ‘troika’.
It has one of the best growth rates in Europe (2.8%) and has succeeded in reducing its annual budget deficit to near 0%. Its property market has recovered and tourism is booming, while unemployment is at its lowest rate for over a decade (December 2018: 6.7%).
“In terms of recovery over the past 10 years and Portugal’s GDP, the country’s economy has enjoyed a fairly good performance out of the peripheral countries (Spain, Greece and Italy) since 2008 with an average GDP growth of 2.8%” said the CEO of Lloyds Bank Horta Osório, one of the UK’s major high street banks.
When looking at the current account balance (exports and imports with trading countries), between 2007-2010 Portugal ran a current account deficit equal to 10% of GDP which meant Portugal imported 10% more than it exported which was “an obviously unsustainable situation”.
This led to a huge contraction in internal demand for Portuguese companies, but from 2013 the economy “achieved a point of balance” and the deficit, which represented around €20Bn of GDP, was “covered by an increase in exports” but also imports.
“Half of Portugal’s balance of payments deficit was covered by the boom in tourism in 2017 and 2018” said the banker.
At the same time, the unemployment rate fell (under 3%) with Portugal now performing better than France since 2017.
As for the public accounts deficit, Horta Osório said that in 2010-2012 Portugal had a 10% budget deficit (i.e., what it was receiving in receipts was 10% less than outgoings) which was “completely unsustainable” and caused Portugal’s public debt to double from the amount that it had been before the crisis (In 2017: 105% of GDP) and rise to 130% of GDP.
“Thanks to the enormous efforts of companies in containing demand expenditure, the budget deficit has not grown on an annual basis with accounts close to zero in 2019” he said.
This means that Portugal’s GDP has grown and its debt in terms of percentage of GDP has fallen from “very worrying levels” (130% of GDP) to 120% in 2019 and “going in the right direction” but with “no room for complacency” he said.
The construction and property sectors, critical pillars for the economy in terms of employment, saw the number of building projects triple to what they had been in 2013 with a “remarkable recovery” in the Portuguese property sector.
However, on an external level, overseas construction and property development from Portuguese developers are “just a third of what they had been in 2007.”
Portugal’s three big problems
1) The banking sector
Although Portugal’s banking sector is “clearly going in the right direction,” capital ratios are adequate but still vulnerable in both Portugal and Italy, with Core 1 Capital (the best quality) at around 13% in Portuguese banks which is “positive in international terms” when taking into account the contribution of the capitalisation that the Portuguese made in state-owned bank Caixa Geral de Depósitos (25% thanks to capital injections).
In terms of loan defaults on the books of Portuguese banks as a percentage of all loans, there is “still a lot to do.”
In terms of percentage of loans, both Italy and Portugal attained levels of loans default at 15% of all loans made. This means that the capital that banks hold is not enough if these defaults were not recovered which is “worrying”.
This value has since fallen to around 10% of GDP (in both Portugal and Italy) while Spain’s loans default stands at around 5% of GDP.
“There are, however, two very relevant points: Portugal’s 10% loan default in terms of GDP is still very high and represents a required cover of 50-55% which has to be compared with the actual 13.5% capital ratio the banks now hold” said António Horta Osório.
The European Central Bank made a generic recommendation to Portuguese banks to create cover for default loans of 80%, and if cover was increased now to around 80% the average capital ratio of the banks would go down to 9% — an amount that would not be “comfortable”.
2) The level of debt in the Portuguese economy
This is, for Horta Osório, a problem not just at a public sector level but for the economy as a whole. The percentage of total accumulated debt in terms of GDP and its evolution over the past 11 years went from 265% of GDP to 293% of GDP.
“Despite all the efforts that the Portuguese and Portuguese companies have made, the total debt in Portugal has got worse and is now around 10% higher than it was 10 years ago, with public debt going from 118% of GDP to 125% of GDP in 10 years,” said Horta Osório.
“Portugal’s companies’ debt has gone down from 110% of GDP to 100%, but all told Portugal has a debt 10% higher than it had 10 years ago” the banker pointed out.
“This is high in absolute terms, is high in terms of most EU partners, with a total debt 20% higher than that of Italy and Spain. Germany, on the other hand, had a total debt per GDP of 169% 10 years ago but has reduced it to less than it was before the crisis. Germany’s public debt in 2018 stood at 60.9% of GDP with Germany and India being the only G20 countries to have reduced their total debt per GDP over the past 10 years” he explained.
Why is this amount of debt so important? With Portugal’s debt at 293% of GDP (almost 300%), the interest rates in the Euro Zone are close to 0 and the goal of the European Central Bank for inflation is around 2% and there is nothing to indicate that interest rates are likely to rise in the short-term.
However, over the timeframe of the next 5-6 years, it does not seem prudent to go against the targets set by the European Central Bank. If the ECB has an inflation target of 2% and if the inflation goes over this or interest rates rise, the Portuguese economy would have an added burden in terms of interest payments to service the debt equivalent of 6% of GDP.
3) Demographic problems
Even more worrying and according to estimations for the growth of the Portuguese population from the United Nations, is Portugal’s shrinking population. Portugal had a population of 8.4 million people in 1950 and now has around 10 million. However, in 2050 “we will go back to the population we had in 1950”.
Combined with this, the ratio of children and the elderly (currently at 1.5 persons of working age for each dependent person) will, by 2050, stand at 1 working person for each dependent with the population shrinking 25% in Portugal compared with an average of 5% in the rest of the Euro Zone countries.
“This is critical for lots of reasons. It means that Portuguese society will have to spend a lot more on medical and social care expenses for our elderly population, we will have a lot less workers to sustain the public sector in terms of social security and taxes, not to mention paying the pensions of those who will be retiring” warned Horta Osório.
It will be critical too for Portugal’s companies because the internal market will be significantly reduced, with less demand for houses and consumption. A problem that no single government in recent years has paid due attention to.
“I think this is an intergenerational problem that is fundamental for the country to solve in an issue that cuts across all political parties and governments,” he said.
“This has to be solved by a government policy of social support to encourage families to have more children and to provide incentives for Portuguese emigres to return (some are returning with experience from overseas which is positive) and, like Ireland and Singapore have, pursue a policy of intelligent immigration which is not just based on tax incentives, or buying a property or bonds in Portuguese debt, but attract to Portugal people with the qualifications and skills that our companies and society needs” the Lloyds CEO added.
In fact, since the crisis, Portugal has lost more young talent than those who have since returned (around 150,000 people between 2011-2016). Since 2017, 5,000 have returned.
Following the Ireland example
For the next few years the Portuguese economy is expected to grow 2% which is “reasonable” but “clearly not enough” and Horta Osório thinks Portugal should have “more ambition” in terms of economic growth.
Portugal has grown just 1% per annum over the past 20 years, which is “clearly insufficient given how far behind we are to the advanced economies of Europe.”
“It is, in fact, one-fifth of the GDP growth Ireland has enjoyed over the same period. Ireland had suffered the same level of crisis as Portugal (it too had an IMF/EU bailout), with a collapse of the property market, but has grown 5% per annum in 20 years” said Horta Osório.
This means that Ireland has created double the wealth on average of Portugal with average real salaries twice those of Portugal.
“This shows two things: our lack of ambition; we should have the ambition to do more and better, and show — looking to Ireland – that it is obviously possible to do better,” the CEO of Lloyds Bank PLC concluded.
Text: Chris Graeme