MINISTRIO DAS FINANAS

Portugal: restoring credibility and confidence

London School of Economics and Political Science Vitor Gaspar
MINISTRIO DAS FINANAS

February 1, 2012

Outline 1. On the way to become the difficult Portuguese case

2. The Economic and Financial Assistance Program

3. Fiscal consolidation

4. Financial stability
5. Structural transformation 6. Conclusion: how will it work?

MINISTRIO DAS FINANAS

ON THE WAY TO BECOME THE DIFFICULT PORTUGUESE CASE

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Portugals imbalances exposed in the context of the economic and financial crisis
10-year Government bond yields Spread against Germany in basis points
3500

Macroeconomic imbalances and structural weaknesses that have been accumulated over more than a decade

1. Unsustainable public finances

3000

France Italy

Netherlands Spain Finland Greece Portugal

2500

Austria Belgium Ireland

2. Over-indebtedness

2000

1500

3. Anemic economic growth and low productivity

1000

500

0 Jan-08 Jul-08

Jan-09 Jul-09

Jan-10 Jul-10

Jan-11 Jul-11 Dec-11

Source: Bloomberg

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1. UNSUSTAINABLE PUBLIC FINANCES

Persistent imprudence in fiscal policy

Persistent government deficits and increasing public debt

Deficit and public debt As a percentage of GDP
15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 100
Net borrowing of Gen. Govern. Public debt - right axis

Fragile public finances

Structural Current Primary Balance As a percentage of GDP
6
5 4 3 2 1 0

90 80

70
60

50
40

30
-1

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

20
-2

10
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Portugal -3 -4

Euro Area

Source: INE, Bank of Portugal and Ministry of Finance MINISTRIO DAS FINANAS

Source: AMECO and Ministry of Finance 5

2. OVER-INDEBTEDNESS

Debt accumulation by households and firms

Increasing indebtedness of the private sector

Debt of the Households and Non-financial Corporations As a percentage of GDP
160 Households (*) 140 Non-financial Corporations

Increasing external debt

Portuguese gross external debt As a percentage of GDP
250

200

120 150 100 100 80 50

60

40 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

(*) Financial Debt Source: Bank of Portugal MINISTRIO DAS FINANAS

Source: Bank of Portugal 6

3. ANEMIC ECONOMIC GROWTH AND LOW PRODUCTIVITY

Insufficient conditions to foster economic growth

Obstacles
Restrictions on the market for corporate control Protection of several sectors of the economy Weak conditions to entrepreneurial activity Poor functioning of the justice system Rigidity of the labor market

Consequences Insufficient attraction of direct foreign investment Capital accumulation in non-tradable goods and services sectors Lack of competition in several sectors Low levels of innovation and productivity growth High levels of youth and long-term unemployment

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3. ANEMIC ECONOMIC GROWTH AND LOW PRODUCTIVITY

Disappointing performance of the Portuguese economy

GDP Portugal and some of its European partners 2000 = 100
150 Germany Greece France EA -17 Ireland Spain Italy Portugal

140

130

120

110

100

In the period 1999-2010, the GDP of Portugal grew at an annual average rate of 1%, compared with 1.4% in the euro area
2006
2005 2007 2008 2009 2010

90

1999

2000

2001

2002

2003

Source: Eurostat MINISTRIO DAS FINANAS 8

2004

THE ECONOMIC AND FINANCIAL ASSISTANCE PROGRAM

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Adjustment Program agreed with the IMF, EC and ECB in April 2011
Key facts The Economic and Financial Adjustment Program covers the financing needs of General Government for the period 2011 to mid-2014. It comprises a financial package amounting to EUR 78 billion in loans, including EUR 12 billion for banking sector re-capitalization. Each disbursement depends on the technical missions quarterly assessment about Portugals performance on the implementation of the Adjustment Program. Financial package EUR Billions
Already disbursed(1)

To be disbursed

IMF 13,1

39,5

38,5

EFSF 9,8 EFSM 15,6

1 Net issuances Source: IGCP, January 2012

After the 2nd Review, the program implementation was considered on track

More information is available at: IMF: http://www.imf.org/external/pubs/ft/scr/2011/cr11363.pdf European Commission: http://ec.europa.eu/economy_finance/publications/occasional_paper/2011/pdf/ocp89_en.pdf MINISTRIO DAS FINANAS 10

A balanced Program to cope with the major challenges of the Portuguese economy

Fiscal consolidation Putting fiscal policy on a sustainable path Financial stability

Addressing banking sector vulnerabilities

The Economic and Financial Adjustment Program

Structural transformation Implementing structural reforms to contribute to potential growth

The Economic Adjustment Program protects Government financing from market pressures, allowing an orderly adjustment of imbalances and time to build up confidence and credibility.

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Reducing uncertainty: Portugal is delivering in all fronts

Main risks
1 2 At the start of the Program, Portugal faced a very uncertain outlook Weakening of political support for the Program Unfavorable macroeconomic developments

Major outcomes
Broad political consensus Social support to the Program Milder recession than expected in 2011 Strong performance of exports Major reduction in overall and structural deficits Progress in institutional reforms Compliance with the Core Tier 1 ratios Reduction of loan-to-deposit ratio Successful debt auction in January, 18 Bond issuance of 11 months T-bills (last issuance in April 2011) High demand in all maturities Significant participation from non resident investors

Missing the fiscal targets

Uncertainty regarding the stability of the financial sector

Insufficient pace of structural reforms

Success of privatizations process Labor market tripartite agreement Broad range of implemented measures

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FISCAL CONSOLIDATION

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Major reduction of structural deficit in 2011 and 2012

Overall deficit As a percentage of GDP Structural deficit (*) As a percentage of GDP

10,1

9,8

11,4
9,6 6,9
4,0 4,5

2,6
2009 2010 2011 2012
(**)

2009

2010

2011

2012

(**)

Limit of 5,9% prescribed in the Program

(*) Deficit adjusted for the effect of the cycle; excludes transfer of pensions funds in 2010 and 2011 and concessions in 2011 (**) Excludes temporary effects in 2012 Source: Ministry of Finance, January 2012 MINISTRIO DAS FINANAS 14

Portugals structural adjustment stands out

Structural adjustment 2010-2011(1) Percentage points of potential GDP
4,0

3,0
2,3 2,0

1,5

1,5

1,3

1,2
0,8

Portugal Greece Germany Ireland

Italy

United Euro area Kingdom

Spain

France

(1) Change in General Government Cyclically Adjusted Balance Source: IMF, Fiscal Monitor Update, January 2012 MINISTRIO DAS FINANAS 15

Q3 budget deficit below 4%

Accumulated deficit

Quarterly general government deficit - national accounts As a percentage of GDP

9,0
8,3 6,8

7,7
Accumulated deficit fell from 8,3% in the first semester to 6.8% for the first three quarters.

3,8

?
Q1
Source: INE, December 2011 MINISTRIO DAS FINANAS 16

Q2

Q3

Q4

Significant fiscal consolidation in 2011

Percent change in total values

Total revenues In percentage of GDP

Other revenue Tax Revenue

Total expenditure In percentage of GDP

Interest Primary expenditure

51,3

-5,3%

44,9
41,5 7,4%

2,9
-7,3% 42,4

48,9

-5,9%

46,9
4,9

4,1

19,3

21,5

17,8
-8,1%
44,9

48,4

-7,9%

42,0

22,2

4,5%

23,4

3,0%

24,6

2010

2011

2012(*)

2010

2011

2012 (*)

(*) Excludes temporary effects in 2012 Source: Ministry of Finance, January 2012 MINISTRIO DAS FINANAS

Coercive tax collection of 1.230M: 12% above target

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Important progress in the institutional reform front

NON-EXHAUSTIVE

Major actions

Next challenges

Effective operation of the Portuguese Public Finance Council Presentation of the Commitments Control Law Creation of the new Tax and Customs Authority Implementation of the PREMAC (Plan for the Reduction and Modernization of the Central Administration of the Government)

Improve budgetary control across all levels of Public Administration Control and possibly renegotiate Public Private Partnerships agreements

Restructure State Owned Enterprises

Continue to streamline Public Administration

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FINANCIAL STABILITY

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Reinforcement of banks capital and deleveraging process are ongoing

Key achievements Reinforce ment of banks capital Core Tier 1 target of 9% to be reached by end-June 2012, following a prudent evaluation of sovereign debt exposures Special on-site inspections confirmed the robustness of capital adequacy Regulatory framework was improved: legislation on early intervention, resolution and deposit insurance Core Tier 1 ratio, percentage
9 8,6 7,8 7,9 7,8 8,1

8,5

8
7

6,8

6
5
Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Sep-11

Credit-to-deposits ratio, percentage Deleveraging process Adjustment is progressing as planned Important contribution of higher deposits and sizeable asset sales Stabilization of financing from the Eurosystem
170 165 160 155 150 145

140

Source: Bank of Portugal MINISTRIO DAS FINANAS 20

Depositors trust in the Portuguese banking system

Total deposits (excluding deposits from financial institutions) Million Euros
270.000 Greece Ireland Portugal 250.000

230.000

210.000

190.000

170.000

150.000

Source: EBC MINISTRIO DAS FINANAS 21

STRUCTURAL TRANSFORMATION
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Milder recession than expected in 2011

Strong performance of Portuguese exports As a percentage of GDP
2 0

Export of goods increased 16% up to November

0,3

GDP decline of 1.6% in 2011, against 2.2% initially projected in the Program (May 2011)

2010 -2 -4 -6 -6,5 -8 -8,9 -10

2011

2012 -1,6

-3,7

-6,8

Current and capital account Trade balance

Source: Bank of Portugal, Boletim Econmico Inverno 2011, January 2012 MINISTRIO DAS FINANAS 23

Economic growth: importance of the Structural Transformation Agenda

Broad range of structural reforms
Fiscal consolidation and financial stability are necessary conditions for sustained growth but they are not sufficient. Privatizations Liberalization of the Market for Corporate Control Competition: e.g. reduction of rents in sectors shielded from foreign competition Labor market Education and training Energy Telecommunications and postal services Transports Other services Housing Market Judicial system Public procurement Business environment Structural transformation of the Portuguese economy Opening to foreign investment and to the challenges of international competition Competitive location for physical and human capital

Fully integration in the Single European Market

Development of a stability culture

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Clear strategy and strong implementation effort

Structural Transformation Agenda

Confidence, credibility and justice

Openness, competition and competitiveness

Entrepreneurship, innovation and labor market flexibility

Limited State and economic democracy

Structural MoU measures implementation Second Review Observed / Ongoing Partially observed Not observed 22 4 0

Source: European Commission, The Economic Adjustment Programme for Portugal Second Review, December 2011 MINISTRIO DAS FINANAS 25

Privatization program as a flagship in the agenda

Energy retail and production

Energy retail and production

Air infrastructure

Insurance

Water distribution

Seguros
(1) (2)

Seguros

(3)

2011

2012 Q1 Q2 Q3 Q4

2013

Electricity distribution

Air transport

Railway logistics

Mail distribution

Television broadcasting

(1) Sale of Caixa Geral de Depsitos participation of 1% (2) Concession (3) Expected completion date by Caixa Geral de Depsitos MINISTRIO DAS FINANAS 26

Success of EDP privatization: a global operation

Opportunities Key facts identified EBITDA, 9M2011 Privatization process 4 international bidders

20% Internatio nalization vehicle 40%

1 Europe
2 Latin America 1 Asia

Sale of 21.35% of equity to China Three Gorges 19% Total revenue of EUR 2,693M with a premium of 53.6% per share1 Investment of 2,000M until 2015 in wind farms Guaranteed funding of EUR 2,000M through Chinese banking entities

20%

#1 hydro developer in Europe Access to specialized know-how #3 wind player worldwide Ranked as Best Electric Utility Worldwide in 2010 and 2011

1 Considering the closing price of the day before the Council of Ministers decision Source: EDP Investor Presentation, November 2011; Ministry of Finance MINISTRIO DAS FINANAS 27

Labor market reform

Agreement on Growth, Competitiveness and Employment
NON-EXHAUSTIVE

Objectives

Key measures Working time Implementation of individual and group bank of hours (working time accumulation) Decrease in 50% of compensation for overtime work The agreement between the Government, Unions and Enterprises Associations: an important step to implement reforms in an environment of social dialogue

Increase in competitiveness through Labor market flexibilization Labor cost reduction Holidays/ vacations Dismissal and compensa tion

Reduction of 4 national holidays Elimination of 3 extra days of vacation

Reduction of restrictions to individual dismissal Reduction of severance payments to align with EU average Implementation of labor arbitration mechanisms

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Improving business environment

NON-EXHAUSTIVE

Objective

Key measures

Judicial system Portugal as a competitive location for physical and human capital

Conclusion of an audit with targeted measures to accelerate the resolution of the backlog
Adoption of a law on arbitration to facilitate out-of-court settlement Proposal to amend the insolvency code and corporate recovery, focusing on speed, simplification and creation of an extra-judicial phase of corporate recovery Approval of a new Competition Law harmonized with the EU legal competition framework Strengthen the power of the Competition Authority

Competition

Operationalization of specialized court on Competition, Regulation and Supervision

Liberalization of regulated professions access and exercise Reduction of companies administrative burden

Other services

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CONCLUSION: HOW WILL IT WORK?

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Public finances on a sustainable path

General government balance approaching equilibrium

General Government balance As a percentage of GDP
2010 0,0 -2,0 2011 2012 (2) 2013 2014 2015

Decreasing of public debt

General government gross debt As a percentage of GDP
120 110 100

-4,0 90 -6,0 80 -8,0 70 -10,0 Overall balance -12,0

(1) Deficit adjusted for the effect of the cycle; excludes transfer of pensions funds in 2010 and 2011 and concessions in 2011 (2) Excludes temporary effects in 2012 Source: Ministry of Finance, 2010-2012 : Jan. 2012, 2013-2015: Nov. 2011

Structural balance (1)

60 2010 2011 2012 2013 2014 2015

Source: Ministry of Finance, November 2011

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Elimination of the trade deficit

As percentage of GDP

4,0 2,0 0,0 2008 -2,0 -4,0 -6,0 -8,0 -10,0 -12,0 -14,0
Capital account balance Current account balance

2009

2010

2011

2012

2013

2014

2015

Balance of trade (goods only)

Source: Ministry of Finance, November 2011 MINISTRIO DAS FINANAS 32

Return to growth

Sustained economic growth

GDP Growth Year-on-year percent change
3

Job creation
Unemployment rate Percentage
15

14
2 13 12 11

0
2010 -1 2011 2012 2013 2014 2015

10 9 8

-2

7 6 2010 2011 2012 2013 2014 2015

-3

Source: Ministry of Finance, November 2011 MINISTRIO DAS FINANAS

Source: Ministry of Finance, November 2011 33

Portugal has entered a transformation process

Crisis as an opportunity for positive change that fosters further progress

Portugal was a success case in the second half of the 20th century History proves that we attain great achievements when facing national challenges

Building up credibility and confidence at home and abroad

Broad internal consensus, both political and social, about the need of adjustment Support from our international partners providing financing up to 2014

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MINISTRIO DAS FINANAS

Portugal: restoring credibility and confidence

London School of Economics and Political Science Vitor Gaspar
MINISTRIO DAS FINANAS

February 1, 2012

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