VZCZCXRO0829
RR RUEHAG RUEHDF RUEHIK RUEHLZ
DE RUEHLI #1341/01 1871518
ZNR UUUUU ZZH
R 061518Z JUL 06
FM AMEMBASSY LISBON
TO RUEHC/SECSTATE WASHDC 4952
INFO RUCNMEM/EU MEMBER STATES
RUEHPD/AMCONSUL PONTA DELGADA 0230
RUEATRS/DEPT OF TREASURY WASHDC
RUEHBS/USEU BRUSSELS

UNCLAS SECTION 01 OF 03 LISBON 001341 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD PO
SUBJECT: PORTUGAL - ECONOMY ON UPWARD TRAJECTORY 
 
REF: 2005 STATE 1446 
 
LISBON 00001341  001.2 OF 003 
 
 
Summary 
¶1. (U) Despite muted warnings over the last few months, the 
European Commission (EC) for Economic and Monetary Affairs 
Joaquin Almunia recently gave Portugal passing marks for its 
efforts to reduce its huge budget deficit and undertake 
structural reforms, in accordance with Growth and Stability 
Pact commitments.  Bank of Portugal Governor Vitor 
Constancio, who has been critical of the government in the 
past, also expressed support for the government's efforts but 
cautioned against end of the year spending which threatened 
to undercut gains made earlier in the year.  On the other 
hand, the OECD expressed concern in its April report by 
lowering key economic indicators for Portugal and recommended 
that the government take additional measures in order to 
reach its target of reducing the budget deficit to 4.6% of 
GDP in 2006.  End Summary 
 
Overview 
¶2. (U) In 2005, the newly elected Socialist government of 
Jose Socrates undertook a series of measures (reftel) to rein 
in Portugal's soaring deficit which was well on its way 
towards reaching 6.8% of GDP and to counter the loss of 
purchase power parity vis-a-vis the EU-25 average.  Its 
revised 2005 budget did not resort to extraordinary measures. 
 Instead it raised value-added tax rates, thereby greatly 
increasing revenue and preventing the deficit from growing 
beyond 6%.  It also introduced a multi-year Technology Plan 
that targets education, human capital, research and 
development, and public-private in an effort to make Portugal 
more competitive and attractive to foreign investment.  The 
economy stagnated, however, as GDP grew by a mere 0.3%. 
 
¶3. (U) The 2006 consolidated national budget aims to reduce 
the government deficit by 1.4% to 4.6% of GDP.  It has raised 
taxes on gasoline and tobacco, undertaken social security 
reforms by increasing contributions, raising the civil 
service retirement age, and reducing pension outlays to 
retirees.  It has also begun to restructure its civil service 
by downsizing several ministries and reducing their budgets, 
cutting health expenditures and creating an interagency 
oversight system to monitor investments over 250 million 
euros.  Perhaps most importantly, it has made major 
improvements in its public finance statistical reporting and 
created a technically independent commission to monitor the 
deficit, a move which helped to remove the EC's lingering 
doubts about the government's willingness and ability to 
implement the needed reforms. 
 
¶4. (U) In 2007, Portugal hopes to reduce its budget deficit 
by 0.9% to 3.7% of GDP by further increasing taxes on 
gasoline and tobacco, consolidating expenditure cutbacks 
resulting from 2006 reforms in health, pensions and public 
administration, and implementing a new civil service 
structure, to include civil service mobility and sliding 
salaries.  The 2008 Growth and Stability target brings 
Portugal in line with the "no greater than 3% budget deficit" 
Eurozone policy by decreasing it 1.1% to 2.6% of GDP. 
 
Growth Predictions 
¶5. (U) Given all the measures outlined above, the government 
maintains that it is on track to reach its Growth and 
Stability Pact goals - predicting a 1.1% increase in GDP in 
2006, a 1.8% increase in 2007, and a convergence with the 
EU-25 median of 2.1% by 2010.  The European Commission's 
prediction is slightly less optimistic, at 0.9% in 2006 and 
1.1% in 2007, due to lingering concerns with the government's 
efforts to control spending - namely social transfers, 
regional/autonomous zone transfers to the central government, 
and late payments collection.  On the positive side, the EC 
has removed its reservations regarding the nation's 
statistical methodology and collection.  The Bank of Portugal 
has indicated it will raise its 2006 estimate of 0.8% GDP 
growth and 2007 estimate 1.0% due to increases in private 
investment and exports, but has not yet done so. 
 
¶6. (U) However, the OECD has downgraded GDP growth to 0.7% in 
2006 because it believes Portugal must undertake additional 
measures to reach its targets and doubts the government's 
optimism with regard to efficacy of its budget consolidation 
measures.  In response to the OECD's April report, Finance 
Minister Fernando Teixeira dos Santos commented that Portugal 
would undertake additional measures if necessary.  Though the 
public has, by and large, been very supportive of the 
government's belt tightening measures, there was rumbling at 
the mention of further measures. 
 
Projected GDP (% change from previous year) 
 
LISBON 00001341  002.2 OF 003 
 
 
                        2006     2007 
Government              1.1      1.8 
European Commission     0.9      1.1 
OECD                    0.7      1.5 
Bank of Portugal        0.8      1.0 
 
Deficit Reduction 
¶7. (U) With specific regard to the budget goals outlined 
under the Growth and Stability Pact, the government remains 
committed to reducing its deficit to 4.6% in 2006 and 3.7% in 
2007, noting improvement in revenue collection.  Both the 
OECD and the European Commission predict that the budget 
deficit will reach 5.0% in 2006, with the former underscoring 
the need to strengthen consolidation efforts, increase taxes, 
control expenses, intensify reforms in social security and 
public administration, strengthen manufacturing 
specialization, and enhance education and personnel 
resources, and the latter expressing concern with the 
increase in social transfers and huge debt payments. 
 
¶8. (U) The EC predicts a budget deficit of 4.9% in 2007 in 
contrast to the government's estimate of 3.7% because the 
government has not yet introduced legislation to control 
public expenditures although it announced its attention to do 
so over a year ago and because it predicts GDP growth of only 
1.1% instead of Portugal's more optimistic estimate of 1.8%. 
 
Budget Deficit Projections (% of GDP) 
                        2006     2007     2008 
Government              4.6      3.7      2.6 
European Commission     5.0      4.9      n/a 
OECD                    5.0      n/a      n/a 
Bank of Portugal        n/a      n/a      n/a 
 
Unemployment Trends 
¶9. (U) With regard to unemployment, though the rate increased 
to 8.0% this year for the first time since the 1980s, the 
government predicts unemployment will stabilize around 7.7% 
in 2006 and drop to 7.5 % in 2007 due to salary adjustments. 
The OECD also predicts that unemployment will decrease in 
2007 to 7.7% due to relatively better economic conditions, 
but that real salaries will grow faster than productivity. 
EC predictions contrast with those of the government and the 
OECD, estimating that unemployment will reach 8.1% in 2006 
and 8.3% in 2007, with job creation being sluggish. 
 
Unemployment (% of eligible workforce) 
                        2006     2007 
Government              7.7      7.5 
European Commission     8.1      8.3 
OECD                    7.7      7.6 
Bank of Portugal        n/a      n/a 
 
Current Account Balance 
¶10. (U) As for the current account balance, the price of oil 
has further exacerbated the current account deficit, with the 
government predicting a deficit increase of 8.8% in 2006 and 
8.4% in 2007 due to a slight recovery in the balance of goods 
and services.  The Bank of Portugal predicts a current 
account deficit of 8.5% in 2006 and 8.8% in 2007.  Painting 
an even more pessimistic picture, the OECD predicts external 
debt will reach 9.6% of GDP in 2006, and the EC predicts it 
will reach 9.8% in 2006 and 9.6% in 2007 as oil costs 
continue to rise. 
 
Current Account Deficit (% increase over previous year) 
                        2006     2007 
Government              8.8      8.4 
European Commission     9.8      9.6 
OECD                    9.6      n/a 
Bank of Portugal        8.5      8.8 
 
Export Growth 
¶11. (U) And finally, with regard to export growth, Portugal's 
government predicts exports will increase by 5.7% in 2006 and 
6.1% in 2007, but notes that the country will continue to 
lose its competitive edge if the government does not take 
corrective action.  The Bank of Portugal and the OECD 
estimate that exports will grow by only 4% in 2006, again 
emphasizing the loss of competitiveness to Asia and the new 
EU members.  The EC predicts that exports will grow by 3.9% 
and 4.5% in 2007, underscoring that the position of 
industrial goods will continue to deteriorate vis-a-vis 
emerging markets. 
 
Export Growth (% change over previous year) 
                        2006     2007 
Government              5.7      6.1 
European Commission     3.9      4.5 
 
LISBON 00001341  003.2 OF 003 
 
 
OECD                    4.0      n/a 
Bank of Portugal        4.0      n/a 
 
Comment 
¶12. (SBU) The OECD's skeptical review provided a much needed 
reality check to an overly optimistic government.  Though 
Finance Minister Teixeira dos Santos continues to paint a 
best case scenario for Portugal's economic recovery, it is 
likely that Portugal will have to undertake additional 
measures to meet its targets as outlined under the Growth and 
Stability Pact.  Some have suggested that the government 
might reluctantly resort to one-off measures such as selling 
vacant government property.  Other suggest that the 
government decrease rather than increase taxes to stimulate 
the economy, something Teixeira dos Santos has said he would 
not consider until the economy is much stronger.  Still, post 
believes that the economy has turned the corner and that the 
government is on the right track, using its unprecedented 
four year term to ensure that reforms take root.  Despite the 
economy's upward trajectory, there is much concern that 
Portugal will continue to lose ground to Eastern Europe, 
given that it will take decades for the Technological Plan - 
with its focus on educational and personnel reforms - to take 
effect.  Some have even theorized that the lack of confidence 
most Portuguese currently have in their economy is linked to 
the country's early 2002 World Cup defeat and the resulting 
pessimism.  Perhaps Portugal's achievements in the 2006 World 
Cup will put the country back on the map literally - earning 
it new found respect both inside and out - and giving it the 
missing "can-do" optimism so sorely lacking in the nation's 
psyche. 
Hoffman