VZCZCXRO0804
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHLI #0049/01 0051710
ZNR UUUUU ZZH
R 051710Z JAN 07
FM AMEMBASSY LISBON
TO RUEHC/SECSTATE WASHDC 5458
INFO RUCNMEM/EU MEMBER STATES
RUEHPD/AMCONSUL PONTA DELGADA 0295
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 03 LISBON 000049 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EUR/WE, EUR/ERA, EB/OMA 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PO
SUBJECT: PORTUGAL'S ECONOMIC RECOVERY MODEST BUT CONVINCING 
 
 
LISBON 00000049  001.2 OF 003 
 
 
Summary and Overview: 
 
¶1.  Proving the skeptics wrong, Portugal's Socialist 
government managed to reduce the budget deficit to 4.6% in 
2006 from an all time high of 6.0% in 2005 and increase GDP 
growth to 1.4% from 0.3%.  Even the ever cautious Bank 
Governor noted that Portugal's economic recovery, though 
modest, was convincing. Parliament recently passed Portugal's 
2007 budget with its focus on science and technology (S&T), 
education and personnel resources, equitable social security 
distributions, and the EU Presidency. Whereas the 2006 budget 
strategy increased revenue via taxes, the 2007 budget aims to 
reduce the deficit to 3.7% via reduction of public 
expenditures and structural reforms. Socialists and 
opposition alike agree that the government must implement the 
more challenging reforms during the first half of 2007 as the 
entire administration's focus will have turned to Portugal,s 
EU Presidency in the latter half. 
 
Proving the Skeptics Wrong: 
 
¶2. Prime Minister Socrates was able to prove the skeptics 
wrong by reducing the budget deficit to 4.6% in 2006 from an 
all time high of 6.0% in 2005 and increase GDP growth to 1.4% 
from 0.3% during the same timeframe. Even the ever cautious 
Bank of Portugal Governor Vitor Constancio noted that 
Portugal's economic recovery, though modest, was convincing, 
adding that budget constraints had actually held GDP growth 
back by 0.6%. Naturally, Portugal's recovery was linked to 
the EU's recovery. However, Constancio asserted that 90% of 
Portugal,s growth was due to a 9% increase in exports - 
fueled surprisingly by an increase in oil exports. In 2006, 
Portugal had an excess of gasoline due to the increasing 
domestic purchase of diesel cars.) Although Portugal hopes to 
increase the use of its underutilized refinery, Constancio 
believes future growth should be supported by increased 
domestic demand rather than exports. 
 
             2007 Key Economic Indicators 
                   2006     2007     2008     2009 
Budget Deficit     -4.6     -3.7     -2.7     -1.5 
GDP Growth          1.4      1.8 
Inflation           2.5      2.1 
Unemployment        7.6      7.5 
Export Growth       8.6      7.2 
Import Growth       2.8      3.7 
 
Source: Government of Portugal 2007 Budget Proposal 
 
Defending the 2007 Budget: 
 
¶3.  In defense of the government's 2007 budget, PM Jose 
Socrates proclaimed that his administration had accomplished 
everything it set out to do in 2006 despite the nay-sayers. 
He commented that "Not only are we eliminating the deficit, 
but we are also implementing structural reforms that will 
guarantee that the country will never suffer another budget 
crisis....  We have gone from a country with a total absence 
of reform to being one of the most reform minded countries in 
Europe." On November 30, 2006, Parliament,s Socialist 
majority passed the 2007 budget, approving only nine of the 
800 proposed alterations. As expected, the opposition voted 
against the budget although some Social Democrats have 
admitted that the Socialists are taking economic measures 
which they should have taken while in power. 
 
                    2007 Budget Overview 
          (in billions of euros/Percentage of GDP) 
 
               2005              2006           2007 
 
Total     70.417 (47.8%)  70.669 (46.3%)   72,538 (45.4%) 
Expend- 
iture 
Total     61.523 (45%)    63.541 (41.7%)   66.628 (41.7%) 
Receipts 
Balance   -6              -4.6             -3.7 
Publ Debt 94,394 (64%)   102,948 (67.4%)  108,598 (68%) 
 
Source: 2007 Government of Portugal Budget Proposal 
 
Reallocating Resources: 
 
¶4.  Ranked by foreign investors as one of the least 
competitive countries in Europe, Portugal is hoping to 
increase productivity by strengthening S&T (the budget 
allocates a 64% increase in R&D funds), enhancing primary and 
secondary education, and bolstering worker qualifications. 
 
LISBON 00000049  002.2 OF 003 
 
 
The Minister of Primary and Secondary Education faces the 
particularly difficult task of bettering education with an 
ever-declining budget. Though consistently ranked as one of 
the most unpopular ministers in public surveys, everyone with 
whom DepCouns spoke had high praise for the Minister,s 
reforms, including her willingness to close schools with less 
than ten students and require teachers to double their hours 
from 15 to 30 hours a week. 
 
Preparing for the EU Presidency: 
 
¶5.  Portugal places great importance on its upcoming role as 
EU President during the latter half of 2007.  During this 
time, Portugal will focus on the challenges of enlargement, 
job growth and competitiveness, liberty, security, justice 
and immigration, and enhancing the EU's ability to respond to 
external challenges (e.g. UN peacekeeping, Africa, Russia, 
China and India). Despite this ambitious agenda, budget 
constraints have forced the government to allocate only 45 
million euros to the Ministry of Foreign Affairs (MFA) for EU 
Presidency-related activities. Although total government 
expenditure for the EU Presidency will be slightly greater 
than 51 million euros after incorporating all ministeral 
contributions, the MFA is relying heavily on corporate 
sponsorships to make up any shortfall.  As a reference, the 
Finnish Presidency allocated 70 million euros for its recent 
Presidency and the Germans have allocated 140 million euros 
for the current term. 
 
     Ministry Budget Allocation for EU Presidency 
                 (in thousands of euros) 
 
Foreign Affairs           45,000 
General State Charges        730 
Interior                      50 
Finance & Public Adm.        100 
Defense                    2,000 
Justice                    1,820 
Environment                   57 
Agriculture                1,206 
Public Works                   6 
Education                    250 
Culture                      323 
 
Total:                    51,542 
 
Source: Government of Portugal 2007 Budget Proposal 
 
Reducing the Budget through Structural Reforms ... 
 
¶6.  The government has promised not to raise taxes as it did 
in 2006 but instead aims to reduce the deficit to 3.7% in 
2007 via structural reforms and reduction of public 
expenditures. All agree that the government must tackle the 
most difficult challenges during the first half of 2007 
before the leadership is consumed by the EU Presidency. If 
not implemented by then, the government will not have the 
results necessary for a final push on its economic reform 
agenda and will not be able to trumpet them in the run-up to 
the 2009 national elections. 
 
... in Public Administration: 
 
¶7.  One of the more pressing problems is a bloated civil 
service. The government plans to eliminate 75,000 civil 
service positions by 2009 through attrition, retirement and 
mobility - a savings equivalent to 2% of GDP. In 2006, it 
eliminated 5,900 positions. In 2007, the government plans to 
introduce a new civil service system, revise compensation, 
introduce merit-based promotion, and eliminate a minimum of 
12,000 positions - a savings of 13.42 billion euros in 
personnel expenditures. 
 
... in Social Justice, Social Security and Banking 
 
¶8.  The government is also determined to reduce non-socially 
justifiable subsidies to wealthy and more equitably 
distribute welfare and social security benefits to the 
elderly and the poor. In 2006, it increased worker and 
employer contributions to the social security system. For 
2007, the government announced that it was closing banking 
loopholes and raising the sector's - one of the country,s 
most profitable - required contribution to the social 
security system by 180-230 million euros. Such actions have 
resulted in the nation's bankers and trade unionists calling 
Finance Minister Teixeira dos Santos arrogant. Despite these 
accusations, Finance Minister Teixeira dos Santos decided to 
proceed with the proposed reforms after having determined the 
 
LISBON 00000049  003.2 OF 003 
 
 
time for talk was over, according to Ministry sources. 
 
Ministry Expenditures: 
 
¶9.  The government has also cut total Ministry expenditures 
by 5% - about 2.390 billion euros or 1.56% of GDP. The public 
will be most directly affected by budget changes in the areas 
of education, health and Social Security. 
 
     Expenditure on Ministries 
       (in billions of euros) 
 
                Expend-    % Change in   % of       % of 
                itures     Consolidated  Central    GDP 
                           Budget from   Admin 
                           2006          Expenses 
 
Gen State         3.511       4.1         6.4        2.2 
Interior          1.682       4.6         3.1        1.1 
MFA (a)            .373       6.3         0.7        0.2 
Finance and      17.212       3.2        31.5        0.3 
Public Adm (b) 
Defense (c)       2.046       2.5         3.7        1.3 
Justice (d)       1.290      10.9         2.4        0.8 
Environment        .560      -8.4         1.0        0.4 
Economy (e)        .705     -46.2         1.3        0.4 
Agriculture and   2.058       5.7         3.8        1.3 
Fishing 
Public Works,      .954     -10.5         1.7        0.6 
Transportation and 
Communications 
Work and          7.184       5.9        13.2        4.5 
Social Solidarity 
Health            8.577      -0.4        15.7        5.4 
Education         5.842      -4.2        10.7        3.7 
Science & Tech    2.353       7.9         4.3        1.5 
and Higher Ed 
Culture            .236      -7.0         0.4        1.0 
 
Source: Government of Portugal 2007 Budget 
 
a - The Ministry of Foreign Affairs would actually suffer a 
5% decrease if not for the additional EU Presidency funds. 
b - Much of this expenditure is due to previously accrued 
debt. 
c - Much of this expenditure is due to prior equipment 
purchases. 
d - Increase in expenditure due to new accounting measures. 
e - Huge decrease in expenditure due to elimination of fees 
and services related to de-bureaucratization program. 
 
¶10.   Problems Remain: 
 
Despite having rounded the corner, Portugal still faces a 
number of hurdles. Eurostat figures reflect a drop of 
Portugal's per capita GDP from 80% of the EU-25 average in 
2001 to 71% in 2006, causing the country to drop three 
notches to 18th place in purchasing power parity, behind 
Greece, the Czech Republic and Slovenia. Such statistics 
raise doubts as to whether Portugal's GDP growth will ever 
converge with the EU's average. High taxes remain 
problematic. While the government has stated that it will not 
reduce taxes until 2009 to allow for reforms to take effect, 
some Social Democratic opponents have accused the government 
of delaying the decrease as an election ploy and want to see 
a tax reduction now to stimulate the economy. 
 
¶11.  Comment: Press reports indicate that despite a rocky 
start in July 2005, Finance Minister Fernando Teixeira dos 
Santos has won the respect of European Commissioner for the 
Economy and Monetary Affairs Joaquin Almunia for his hard 
work and determination to reduce Portugal's budget deficit 
below 3% by 2008. While acknowledging the country's strong 
progress on reforms, Almunia has warned that Portugal will be 
subject in 2007 to zero tolerance - i.e. no further reform 
delays. Teixeira dos Santos also enjoys the continued support 
of the Portuguese public - a reflection of the public's broad 
support for Socrates,s economic agenda.  The Portuguese 
understand that there is no quick fix for their current 
dilemma. In fact, Portugal has been held up by the EU as an 
example of what not to do when joining the Eurozone. 
However, most Portuguese appear determined to stick by the 
reforms until they bear fruit rather than ceding further 
ground to new EU member states. 
O'Neal