Special report: IMF’s Sixth Review of the Adjustment Programme

On Friday, the IMF released its 6th review of the Portuguese adjustment programme which was concluded in December. Overall, the IMF concludes that the program is broadly on track but downside risks remain significant. A more tense social climate, reform fatigue and a worse-than-expected record of high frequency economic indicators, namely on the labour market, may undermine the efforts made so far.

IMF review is broadly positive but there are significant risks ahead
The IMF commends the speed of external adjustment the speed at which the current account balance has improved, despite the dockers’ strikes, which led to a an upward revision to its forecast. In a related report published at the same time as the 6th review, the IMF points out that unit labour costs have improved markedly, though mostly in the non-tradable sector, thanks to the civil servants’ wage cuts.

The IMF is also satisfied that financial stability is safeguarded due to the recapitalization of the major Portuguese banks, either through state funds or through private investors. The IMF also notes that deposits remain broadly stable and that two banks have recently accessed international financial markets which reflects improved financing conditions in the euro area and also a growing appetite for Portuguese assets.

On the labour market and product reform, the IMF commends the Government’s efforts to support labour market policies for young and disadvantaged people. It also recognises the progress made in the judicial system. By 2014, after Parliament approval, the Government is due to introduce far-reaching reforms of Civil Procedures (for instance to reduce number of appeals and concentrate on substance rather than form) and the Judicial Organization Law that focuses on increasing flexibility, specialization and concentration of resources.

On the downside, the IMF notes that output remains very weak and that the rise in unemployment has been very rapid which represents a risk to the programme. State revenue has fallen more than expected, partly due to the rapid adjustment of firms that have turned to the lighter-taxed export sector. The IMF is also concerned that credit conditions remain very tight, in particular due to very high interest rates to compensate for the legacy of portfolios with very low rates. Finally, reform fatigue and a more tense social climate may undermine the Government’s efforts so far.

The IMF concludes that the authorities’ strategy to gradually return to the financial markets is feasible, especially if market conditions in Europe continue to improve.

Macrometria’s assessment
Recent developments suggest that the gradual return to the markets may happen sooner than expected as the Government has announced its intention of issuing 5-year bonds over the next few weeks through a syndicate of banks. Should this operation be successful, it would send a strong signal to the markets that the situation is normalising and also relieve some of the pressure refinancing debt later in the year.

This operation may also become an important signal to investors interested in the private sector as the country risk attributed to Portugal is on a downward trend. This would improve conditions for Portuguese firms, which we believe is a milestone in the path to recovery in late 2013.