Portugal cannot afford to take its eye off public finances

 In AmCham, Economy, News

The Portuguese government has to tread carefully over the coming months as inflation starts to bite.

It cannot afford to put public finances at risk in a bid to help ease the plight of families warned economist Vítor Bento who is the president of Portugal’s bank association.
The former director of Novobanco said at a luncheon organised by the American Chamber of Commerce in Portugal (AmCham) that the European Central Bank was caught between the “Devil and the deep blue sea” because either it had to deal with controlling inflation, which meant raising interest rates, or it had to allow some divergence away from the stability and growth pact by allowing more public spending in countries like Portugal through overstepping limits on budget deficits.
The ex-director of SIBS – an innovative payments solution company — advised that the government should use the surpluses on VAT being made on fuel and other commodities to offset the losses suffered by families most affected by inflation, and the consequent loss of purchasing power caused by rising prices — inflation in Portugal current stands at around 8.1%, the highest in 28 years.
“The European Central Bank is faced with an unusual dilemma; either it tackles inflation (through hiking interest rates) which could run the risk of causing a financial crisis in the Euro Zone; or it can give assistance to public finances (relaxing controls) and risk losing the instruments that control rising prices,” he said.
Vítor Bento said that most people under the age 40 had no experience of inflation which hit European economies in the 1970s (OPEC crises), and Portugal in the 1990s.
The economist said that in the past governments like Portugal had been able to counter imbalances by devaluating their currencies to make their goods more competitive in international markets. Now that Portugal was in the Euro Zone it no longer had control over exchange rates and devaluations through monetary controls which is now the remit of the European Central Bank (ECB).
Earlier in thee year, the US Federal Reserve took the decision to raise key interest rates but so far the ECB had chosen not to do so substantially.
This is partly because inflation is lower in Europe and its economies are more diverse and heterogeneous. In the US it currently stands at 11%.
Weaker economic development means that the growth of aggregate demand is smaller. Thus inflationary pressure is lower in Southern Europe, at least in Portugal and Italy.
Government debt in the four southern European countries is significantly higher than in the three western states of Austria, Germany and the Netherlands. However, the war in Ukraine, spiralling energy and fuel costs, the impeding good crisis and continued fallout from the pandemic which severely disrupted supply chains could change all that.
Vítor Bent thinks that the ECB led by Christine Lagarde “will try and manage the current situation of high inflation in the same way that hedgehogs mate … extremely carefully!”
If it does introduce inflation controls through interest rates, that could stifle an already weak economy recovering from the Covid-19 pandemic and throw Europe and, as a consequence, Portugal into recession.
Faced with the current situation, Vítor Bento likened the situation of the banks as being “caught between the Devil and the deep blue sea” because of the many challenges it has to face at the same time: price stability, financial stability, and public finance stability. Having to deal with all three simultaneously is a bit like a juggler having to keep three grandes in the air at the same time.

Windfall taxes?

Some companies, particularly energy and fuel, have done well out of the current situation and Vítor Bento argues that the government should use the extraordinary VAT surpluses generated by the current energy crisis to compensate families most affected by loss of purchasing power from inflation.

This is exactly what the UK chancellor Rishi Sunak has done, providing households with further support in an effort to offset rising energy costs.
In the UK case, this will be funded partly by a proposed £5Bn windfall tax on oil and gas companies who profited during the pandemic. A further £10Bn will raised through borrowing.
“The price changes we have seen in the gas market are genuinely a once-in-a-generation event not seen since the oil crisis of the 1970s,” said the British chancellor defending the measure.
Portugal will use incomes and budgetary policy, regulation and “moral persuasion” to try and ensure that salaries and prices “do not stray from Euro Zone behaviour” whatever that is meant to mean given Portugal is currently run by a socialist government (traditionally big-spending) while unions are likely to press hard for salary increases to offset inflation which he said would be disastrous for Portugal in the long run.
“Budgetary policy should help those who mist need it, the most vulnerable in society who are affected by this inflationary shock”, he said.
But given that the average take-home salary in Portugal after taxes is around €1,000 and the minimum wage is €705, that means around 1.3 million people could soon be in dire straits.
The economist also said that the unions and other labour groups and left-wing parties also had a role to play in ensuring that salaries do not spiral out of control as they did in the UK during similar inflationary years in the 1970s.
This would be of particular importance in the area of transactional goods (i.e., exports) which need to be competitive and could be a “potentially destabilising force” in terms of inflationary pressures.