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IMF Urges Portuguese Government To Consolidate Finances

by Ulrika Lomas, Tax-News.com, Brussels

04 December 2009


The International Monetary Fund, concluding its Article IV Consultation with Portugal on November 29, has warned that government indebtedness could pose significant risks to the country’s long-term prosperity if it is not reined in through tax hikes and retrenchment starting 2010.

The IMF report estimates that the Portuguese economy will contract by 3% in 2009, driven by sharp falls in exports and investments – as elsewhere in the euro area.

The Fund however has lauded the government’s policy responses as rapid and supportive. On the financial side, the government raised the coverage limit for deposit insurance and instituted facilities to recapitalize banks and guarantee their borrowing.

On the fiscal side, support amounted to some 1.25% of GDP over 2008-09, with measures including tax reductions, broadening social protection and increasing public investment put in place.

The IMF has urged the Portuguese government to consolidate the budget to prevent further deterioration in state debt.

The Fund argued that: “Merely relying on the recovery and the impact of previous reforms is not enough. Despite impressive consolidation in 2005-07, the fiscal deficit will likely come in around 8% of GDP in 2009, with debt close to 80% of GDP."

"Although projections are fraught with particularly high uncertainty, our estimates indicate that without new measures the deficit will likely increase in 2010 before declining to around 5-6% of GDP by 2013, with the debt ratio approaching 100% of GDP."

"While achieving even this adjustment requires considerable spending restraint, it would still leave public finances: poorly positioned to respond to any growth shocks or financial crises; vulnerable to further ratings downgrades, higher spreads and financing problems; contributing to external imbalances; and, far from Portugal’s Medium-Term Objective of a broadly balanced budget.”

It continued: “Achieving the government’s deficit target of 3% of GDP in 2013 is thus critical, and requires structural consolidation of somewhat more than 1% of GDP a year on average.”

“If well-designed, this would help put public finances back onto a sustainable path, reduce the economy's vulnerabilities, improve confidence, and help boost long-term growth potential. Given the economy’s continued weakness in 2010, the introduction of such measures should be protracted, but a start should still be made.”

The IMF has suggested that the deficit should at least not widen in 2010. In order to achieve this, the Fund recommends that the government focus on reducing the public sector wage bill in 2010, particularly after the large real increase in 2009.

The report further advocated that:

“The consolidation should focus on reducing primary current spending, especially the public wage bill (building on recent public administration reforms) and social transfers. In particular, eligibility criteria for social benefits should be carefully assessed for effectiveness and health costs will need rigorous management."

"However the consolidation need is large enough that revenue enhancement should also be considered. Here, the focus should be on broadening the base of taxes by reducing tax expenditures and simplifying their administration. Raising the VAT rate, while generally undesirable, should be an option if other measures fall short.”

According to the IMF, Portugal will grow at a fragile rate of around 0.5% in 2010, with a brighter outlook for the longer term.


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