IMF Says Euro-Area Reforms Needed for Portugal to Succeed

Reforms are needed in the euro area to ensure that Portugal succeeds with its financial aid program and regains access to bond markets, the International Monetary Fund said.

“While implementation of the adjustment program remains the key for mending Portugal’s own deep-seated economic problems, these domestic efforts will need to be complemented by reforms of euro-area arrangements to clear a path not only toward a durable return to market financing for Portugal but also to avoid a repeat of the build-up of unsustainable imbalances in the future,” the IMF said in a statement after concluding a regular mission to the country.

Portugal is battling rising joblessness and a deepening recession as it raises taxes to meet the terms of a 78 billion-euro ($100 billion) bailout from the European Union and the IMF. Prime Minister Passos Coelho has said that if the country can’t tap bond markets by September 2013 due to “external reasons,” it would be able to count on continued international support.

European Central Bank President Mario Draghi on Sept. 6 said bond purchases may be considered for euro-area countries currently under bailout programs, such as Greece, Portugal and Ireland, when they regain bond-market access.

OMT Possibility

Outright Monetary Transactions “would not apply to countries that are under a full adjustment program until full-market access will be obtained,” Draghi said Oct. 4. “The OMT is not a replacement” for a lack of primary-market access, he said.

“The public commitment by European leaders to provide adequate support to Portugal until market access is restored, provided the program is on track, provides a valuable safety net,” the Washington-based lender said today. “To overcome credit market segmentation and restore an appropriate monetary policy transmission, it would also be important to further clarify the eligibility criteria for the ECB’s Outright Monetary Transactions as the country starts regaining bond-market access.”

Coelho said Nov. 12 it “shouldn’t be acceptable” that when the ECB lowers interest rates, yields often rise in so-called peripheral countries.

Yields Fall

Portugal’s 10-year bond yield is now 8.2 percent, while two-year debt yields 5.1 percent. The difference in yield that investors demand to hold Portugal’s 10-year bonds instead of German bunds has narrowed to 6.8 percentage points from 16 percentage points on Jan. 31. The cost of the loans Portugal is receiving as part of its financial aid program is 3.6 percent, Finance Minister Vitor Gaspar said Nov. 6.

The government plans to implement an “enormous” increase in taxes on wages and other income to meet budget deficit targets in 2013, when the economy is set to shrink for a third year, Gaspar said Oct. 3. Portugal needs to push deeper reforms to cut state spending, Coelho said later that month.

“The main focus will have to be on further rationalizing public sector pay and employment as well as reforming pensions and other social transfers, aiming at more efficient public services and more equitable re-distribution,” the IMF said in the statement. “At the same time, while it will be difficult to reduce the overall tax burden in the coming years, there is scope to reduce tax distortions and simplify the tax system.”

The government yesterday said it forecasts debt will rise to 120 percent of gross domestic product this year before peaking at 122.3 percent in 2014. It aims to reach a deficit of 5 percent of GDP in 2012 and narrow it to 4.5 percent in 2013.

Portugal yesterday completed the sixth quarterly review of its bailout program. The next review is scheduled for February.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE