Portugal Says Economy to Shrink Twice as Much as Forecast Under Added Cuts

Portugal’s economy will shrink twice as much as forecast this year as the government implements additional austerity measures to qualify for an international aid package of as much as 78 billion euros ($116 billion).

Gross domestic product will decline 2 percent both in 2011 and 2012, Portuguese Finance Minister Fernando Teixeira dos Santos forecast today at a press conference in Lisbon to announce the bailout agreement with the European Union and the International Monetary Fund. That compares with the government’s March projection that GDP would shrink 0.9 percent this year and expand 0.3 percent in 2012.

Portugal resorted to the EU-led bailout after parliament rejected the government’s latest round of spending cuts and tax increases to tackle the budget deficit, prompting early elections. The budget measures, which include freezing public- sector wages and cuts in pensions and jobless benefits, have sparked protests, with public workers planning another one-day strike tomorrow.

“It’s a big hit,” said Gustavo Bagattini, a European economist at RBC Capital Markets in London. “ These measures will have a very large impact on the domestic economy.”

Portugal is the third euro-area country to seek rescue aid from the EU and the International Monetary Fund, after bailouts last year of 110 billion euros for Greece and 67.5 billion euros for Ireland. Under Portugal’s program, 52 billion euros of loans will come from the EU and 26 billion euros from the IMF.

Three Years

The IMF loans will have an interest rate of 3.25 percent for the first three years, and 4.25 percent after that, based on current rates, Poul Thomsen, head of the IMF mission in Portugal, said at a separate press conference in Lisbon. The EU portion will carry higher rates that have not been set yet. The aid will allow Portugal to avoid having to raise funds in bond markets for two years, Thomsen said.

The rates Portugal had to pay at debt auctions surged in the past year on concern the country would need a bailout. The two-year period “will give the government the breathing space it needs,” Thomsen said.

Portuguese 10-year bonds fell today, snapping four days of advances as the aid negotiations neared completion. The 10-year yield rose 16 basis points to 9.68 percent as of 3:37 p.m. in London.

Austerity Measures

The package calls for Portugal to implement the austerity measures that the government proposed and parliament rejected in March. Spending reductions for 2012 and 2013, including cuts to pensions, will amount to 3.4 percent of GDP, while revenue increases will represent 1.7 percent of economic output, Teixeira dos Santos said. The plan also earmarks 12 billion euros for Portugal’s banks.

The government will freeze public workers’ salaries and pensions through 2013 and cut pensions or more than 1,500 euros a month. Tax deductions will be limited and the government aims to sell its stakes in companies including EDP-Energias de Portugal SA, the country’s biggest electricity company, and REN- Redes Energeticas Nacionais SA, operator of the national power grid, by the end of this year.

“It’s a very strong and very front-loaded fiscal program,” the IMF’s Thomsen said. “That is by any standard ambitious and a strong pace of adjustment.”

The program will allow the economy to start recovering in 2013, Teixeira dos Santos said. The economy expanded less than 1 percent a year on average in the past decade, one of Europe’s slowest growth rates. The unemployment rate, which stood at 11.1 percent in the fourth quarter of 2010, will peak at 13 percent in 2013, the finance minister said.

Aid Plan

Portugal’s aid plan is set to be shorter than the 7 1/2- year maturities on the EU-IMF packages for Greece and Ireland. Greece pays an average 3.5 percent for the first three years of its plan and 4.5 percent thereafter. Ireland, which is trying to negotiate better terms, currently pays an average of 5.8 percent.

Portugal is heading for elections on June 5, after Prime Minister Jose Socrates resigned following the opposition’s rejection of his deficit-cutting measures. He is governing with limited powers until the vote.

Socrates’s depiction of the bailout agreement “as a big success” while he is seeking re-election constitutes “a slap in the face” to other countries, Frank Schaeffler, a member of German Chancellor Angela Merkel’s governing coalition, said today.

The Social Democrats and the People’s Party, Portugal’s biggest and second-biggest opposition parties, have said they support the program, while blaming Socrates, a Socialist, for requesting it.

The 78-billion euro package “is the bill, or the price of indebtedness of the last six years in Portugal,” Social Democratic leader Pedro Passos Coelho said last night in a television interview. Socrates took office in 2005.

To contact the reporters on this story: Joao Lima in Lisbon at jlima1@bloomberg.net Anabela Reis in Lisbon at areis1@bloomberg.net.

To contact the editors responsible for this story: Tim Quinson at tquinson@bloomberg.net Angela Cullen at acullen8@bloomberg.net

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