Portuguese bond yields reached historical lows this week – unimaginable only a few short months ago. Surely this must be a vindication of the prevailing orthodox policies of reducing government expenditures and raising taxes as part of the government’s austerity program in order to secure external funding. Right?
As proponents of a comprehensive and, as much as possible, orderly debt restructuring program for the weakest Eurozone economies, we beg to differ. The following graph seldom makes the news, but in our view is critical to understand what has been happening in the Portuguese economy in recent years and gauge the sustainability of the current situation.
Indebtedness Ratios as % of GDP: Dec-09 to Present
Source: Bank of Portugal, INE.
Let’s see what is going on here. The level of indebtedness as % of GDP has steadily increased since the end of the great financial crisis in 2009. If debt was ever a cause for the bust, we now have much more of it. But the driver of that increase is what concerns us, as a euro spent by the government typically has a very different economic outcome of a euro invested by a company.
Small and medium enterprises (SMEs) are the engine of economic growth in a modern developed economy. If these are doing well, the economy is doing well. But in Portugal SMEs have been caught between the country’s need to delever and securing funds to remain in business. As a result, their indebtedness as % of GDP has flatlined since 2009, meaning a reduction in absolute terms given the decline in nominal GDP. In other words, society’s wealth generators have steadily shrunk in recent years.
What accounts for this? A combination of credit becoming more selective – which more or less continued to flow to large corporations during this period – bankruptcies, restructurings and fixing balance sheets as a result of the most severe recession in years. Managers of Portuguese SMEs are nothing short of heroes, having to make payroll in circumstances like these. Many have even managed to gain market share abroad.
But as deleveraging goes, it’s private individuals who took one for the team, with their indebtedness shrinking from 106% of GDP in 2009 to 95% now. Rising unemployment, a reduction in wages and government transfers, tax increases as well as an uncertain economic environment, all took their toll on the Portuguese consumer. The steep rise in emigration recently should also be noted, meaning that the local demand curve, tax and demographics bases, productivity and entrepreneurial spirit may all suffer as a consequence for many years to come.
This curtailment of liquidity growth in the private sector would have undoubtedly pushed the economy into a deep depression. But the Portuguese government intervened and put its balance sheet on the line, with the support of the now departed (in agreement, not in practice) “Troyka” – the IMF, the ECB and the EU.
Whatever the private sector delevered the government soaked up and borrowed some more. The indebtedness of the non-financial public sector jumped from 108% in 2009 to 166% now. This is a staggering increase in just over four years, and clearly challenges the belief that the already painful austerity measures substantially shrunk government largesse – perhaps in absolute terms, but certainly not in relative terms. However, under the prevailing economic thinking there was no other choice to preserve the status quo.
Therefore, the graph shows that the true wealth generators of the economy continue to struggle, and now face the prospect of having to pay for the snowballing government debts in the not so distant future. With limited access to funds and rising taxes and costs (with the notable exception of labor, which has its own circular implications), how can they generate enough growth to restore the country’s finances? Bond yields better stay at historical lows indeed.
Looking back at history, low bond yields and burgeoning external financing is not what follows after a relatively small, little diversified and highly indebted country goes bust without any significant debt restructuring.
Is the current situation in Portugal the result of a successful economic policy, or are we merely setting the stage for bigger financial problems in the future? Sacrifice is hard, and it must have a reason.