Portugal’s slow-motion economic crisis

A question hitherto "confined to university seminars" has gone mainstream, says Patricia Kowsmann in The Wall Street Journal. Should Portugal leave the euro? The economy is in its worst recession in 40 years. Portugal didn't even enjoy a bubble before the bust. Instead, it has been in a slow-motion crisis. The economy has stagnated for over a decade amid a decline in competitiveness in its low-tech export industries, such as textiles, and weak productivity growth.

Both the private and public sectors went into debt to make up for it, with governments focusing on infrastructure and construction and households splurging on plastic. By 2008, corporate and household debt had reached 200% of GDP. Government debt has reached 123%. By 2011, the markets were no longer prepared to lend to Portugal at sustainable interest rates, so it negotiated a e78bn bail-out package.

Portugal has implemented the conditions of the rescue plan to the letter. But to no avail. Had official forecasts made in 2011 proved accurate, the economy would now be growing. Yet "every projection has proved over-optimistic, including forecasts of the fiscal consolidation austerity was meant to deliver", says Peter Wise in the Financial Times. The budget deficit, 6.4% of GDP last year, is now not expected to be back to 3% before 2015. And the latest forecasts expect a 2.3% fall in GDP this year after last year's 3.2% drop.

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That's partly because Europe's recession has proved worse than expected. But exports are only worth 35% of GDP. Domestic demand, always likely to be subdued after a debt binge, has been further undermined by austerity, leading to a "downward deflationary spiral", says Ambrose Evans-Pritchard in The Daily Telegraph. The economy keeps shrinking and the debt gets bigger: borrowing as a percentage of (contracting) GDP grows rapidly.

The underlying issue here is the straitjacket formed by the single currency. Before the euro, Portugal could have lowered interest rates and devalued its currency. But without these escape routes, only austerity and structural reforms notably a clampdown on prices and wages can help bolster competitiveness and growth. But these measures cause short-term pain and threaten to worsen a downturn in a slow-growing, over-indebted economy, locked into the single currency and a Europe-wide recession. Now, with unemployment at 18%, the welfare state widely deemed at breaking point and people turning against the cuts, social stability and Portugal's euro membership are under threat.