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RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
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R 311642Z MAR 08
FM AMEMBASSY LISBON
TO RUEHC/SECSTATE WASHDC 6732
INFO RUCNMEM/EU MEMBER STATES
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RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 03 LISBON 000793 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ELAB ETRD PO
SUBJECT: PORTUGAL'S ECONOMY SURPASSING EXPECTATIONS, 
BRACING FOR UNCERTAINTY 
 
REF: A. 07 LISBON 1839 
 
     ¶B. 07 LISBON 0049 
 
LISBON 00000793  001.2 OF 003 
 
 
Summary 
------- 
 
¶1.  For the second year in a row, the Government of Portugal 
has exceeded its own economic benchmarks, registering 1.9% 
GDP growth in 2007 vs. the projected 1.8 % and lowering the 
budget deficit below the eurozone 3.0% limit to 2.6%, a year 
ahead of schedule.  These positive results validate the 
austerity measures PM Jose Socrates has taken since 2005 to 
restructure the Portuguese economy, including reducing the 
size of the government, revamping social security, and 
consolidating various budgets.  Socrates has announced that 
he plans to loosen the economic belt in 2008, increasing some 
ministries' budgets, raising public investment, and lowering 
taxes.  Despite cautious optimism for 2008, the government 
acknowledges that many challenges and risks remain. 
Unemployment stands at 8.0%, the highest in twenty years, as 
job creation has not kept pace with restructuring.  The weak 
dollar and the sub-prime crisis will likely prove problematic 
as exports, one of the main engines behind Portugal's 
recovery, become more expensive and economic growth elsewhere 
in Europe slows down. 
 
Overview and 2008 Economic Strategy 
------------------------- 
 
¶2.  Since taking office in 2005, PM Socrates has focused his 
efforts on reversing the fortunes of the Portuguese economy. 
The Socialist Party leader took many difficult austerity 
measures to rein in the country's (then) exorbitant 6.1% 
budget deficit and implemented tough structural reforms to 
stimulate its stagnant economy which grew by only 0.3% that 
year.  In 2006, the government focus on increasing revenue 
via taxes resulted in a decrease in the budget deficit to 
3.9% vs. the projected 4.8%, and its efforts to overhaul 
public administration and to improve the trade and investment 
climate resulted in GDP growth of 1.4% vs. the projected 
1.1%.  In 2007, the government focus on reducing expenditures 
resulted in a decrease in the budget deficit to 2.6% vs. the 
projected 3.3%, and continued structural reforms resulted in 
GDP growth of 1.9% vs. the projected 1.8%.   The government 
's 2008 goals include reducing the budget deficit to 2.4% by 
increasing receipts by 0.3% and decreasing expenditures by 
0.3%.  (Note:  The 2007 reduction of the budget deficit below 
3.0% is a major accomplishment for the Socrates government. 
Not only did Portugal reduce the deficit below the 3.0% 
eurozone limit a year ahead of schedule as outlined in its 
2005 Growth and Stability Pact,  it registered the lowest 
budget deficit since the creation of the modern Portuguese 
republic in 1974. End Note.) 
 
¶3.  With more money in government coffers, Socrates has 
announced that he plans to loosen the economic belt in 2008, 
increasing public investment by 6%, raising primary current 
expenditures by one-quarter percent, and transferring on 
average 4.7% more money to local municipalities.  (Note: 
Transfers were frozen for the last two years.  End Note.) 
Some economists are calling for an even greater increase in 
public investment and for an overall reduction in taxes, and 
with the government announcing its intention to decrease 
selective taxes, it is no longer an issue of if, but when. 
 
            Percent Change 
            2005  2006  2007  2008*  2009* 
 
Deficit      6.1   3.9   2.6   2.4   1.8 
GDP          0.3   1.4   1.9   2.2   2.8 
Inflation          3.0   2.4   2.4   2.0 
 
*Projected 
Source:  Government of Portugal 
 
Challenges for 2008 
------------- 
¶4.  Despite Socrates's cautious optimism that moderate growth 
will continue in 2008, many challenges and risks remain.  If 
the reforms are to be sustainable, it is important that the 
government not ease unpopular measures, such as decreased 
social benefits or increased welfare contributions, in 
anticipation of 2009 legislative elections.  It is also 
important for the government to correct lingering imbalances 
with a special focus on ongoing fiscal consolidation and 
improvement of external financing requirements; and while the 
deficit is down and growth is up, reform of public 
administration is behind schedule. 
 
 
LISBON 00000793  002.2 OF 003 
 
 
¶5.  The sub-prime crisis and weakening dollar have affected 
European growth in general and Portuguese exports and 
investment in particular.  Unemployment also presents a 
continuing concern for the Portuguese government, as job 
creation has lagged.  While acknowledging these worrisome 
issues, Finance Minister Teixeira dos Santos has noted that 
Portugal is better prepared today to face these uncertainties 
than it was a few years ago.  Such assurances have done 
little to allay the public's pessimism, however.  Economist 
Antonio Mendonca, for instance, noted that, while Portugal is 
better prepared, it is "still not well prepared." On the 
positive side, the IMF reported in its October 11, 2007 
report that the banking sector is sound and well-supervised. 
(Note: Portugal has a tradition of seeing the glass half 
empty rather than half full on many issues.  Despite 
improving economic indicators, a Eurostat survey found that 
88% percent of Portuguese thought the economic situation was 
bad and 91% thought the employment situation was bad.) 
 
Export and Investment Growth 
----------------- 
 
¶6.  Exports and investment are the two external factors that 
have had the greatest impact on the Portuguese economy in 
recent years. Export growth has been the principal motor of 
the economic recovery as companies have restructured, 
becoming more productive and competitive.  Furthermore, 
businesses have begun to refocus their efforts on higher 
value products.  Fuel exports, in particular, have proven 
very lucrative as Portugal has begun to tap the excess 
capacity of its Sines refinery.  However, the dollar's 
devaluation will continue to hurt Portugal's export growth. 
As the European economy begins to slow down, the demand for 
Portuguese exports will likely fall, as over 70% of 
Portuguese exports are EU-bound.  Domestic demand, buoyed by 
investment and consumption, will somewhat counterbalance the 
decrease in export demand. 
 
¶7.  On the other side of the equation, the government already 
has in the pipeline close to 1.5 billion euros in foreign and 
national private investment.  These investments, mostly in 
automobiles and automobile parts, when finalized, will 
account for nearly half of the government's 2008 private 
investment goal.  In addition, increased investment is being 
reflected in the greater sales of cement and heavy vehicles. 
Furthermore, most economists expect the government to 
increase public investment by 6% in 2008 as part of its belt 
loosening campaign and by even more in 2009 in the run-up to 
that year's national elections.  Major projects in the works 
include a new airport and high-speed rail system. 
 
                  Percent Change 
                  2006  2007  2008* 2009* 
 
Gross Capital           2.6   3.3   3.1 
Fixed 
Formation 
 
Exports           9.1   7.0   4.9   6.0 
 
Imports           4.3   4.1   2.9   3.7 
 
*Projected 
Source:  Bank of Portugal 
 
Unemployment 
------------ 
 
¶8.  Unemployment will be the government's biggest challenge 
in 2008 and will likely become an election issue should 
conditions not improve prior to the 2009 elections.  At 8.0% 
in 2007, the rate of unemployment is the highest it has been 
in 20 years.  Exacerbating the situation, the government has 
fallen behind its job creation goal. Although the government 
expects job creation to accelerate in 2008, it does not 
expect unemployment to decrease until 2009 as more 
individuals lose their jobs due to economic restructuring. 
 
 
¶9.  The government's effort to reduce the size of the civil 
service by 75,000 positions by 2009 from an all time high of 
748,000 in 2005 further complicates the employment situation, 
as it has only succeeded in eliminating close to 40,000 jobs 
to date.  The government has established vocational centers 
to retrain employees who have lost their jobs as a result of 
economic reforms.  Many newly created jobs are in the mid- 
and high-tech fields and provide greater financial 
compensation than the national average.  The average eurozone 
unemployment rate was 7.1%. 
 
LISBON 00000793  003.2 OF 003 
 
 
 
                  2005  2006  2007  2008* 2009* 2010* 
 
Unemployment      7.5   7.6   8.0   8.0   7.6   6.9 
. 
*Projected 
Source:  Portuguese National Statistics Institute 
 
2008 Ministry Budget Highlights 
------------------- 
 
¶10.  In 2007, the government cut most ministries' budgets to 
help reach its budget deficit reduction goal of 3%.  Having 
successfully done so a year ahead of schedule, the government 
has increased the budget of several ministries central to its 
national growth policy, including the Ministry of Economy, 
which holds the energy portfolio, and the Ministry of 
Environment.  The Ministry of Economy's budget saw a 23.5% 
increase to be dedicated mostly to supporting small and 
medium-sized enterprises and the promotion of renewable 
energy.  The Ministry of Environment gained from a 13.7% 
decrease in its Carbon Fund contribution, 127 million euros 
in 2008 vs. 146.1 million in 2007.  The increase in the 
Ministry of Science and Technology and Higher Education's 
budget is designed to create a solid science and 
technological base and generate employment in that field, 
promote research and development and register new patents, 
and boost the number of doctorates granted.  The huge 
decrease in the Ministry of Public Works budget is due to the 
newly designated status of "state-owned enterprise" given to 
its roadway division.  All costs and revenue generated from 
roadworks will not be included in the budget.  With regard to 
Foreign Affairs, the government decreased that ministry's 
budget by 7.1% following completion of its EU Presidency on 
December 31, 2007.  The Ministry of Defense budget, which 
includes a 8.5% increase, focuses on restructuring and 
modernizing the armed forces, with particular attention paid 
to technical military cooperation and the implementation of a 
national oceans strategy.  The 8.5% increase is due, in part, 
to the new requirement that expenditures be allocated to the 
year in which the equipment is acquired, not the year(s) in 
which payments are made. 
 
Ministry                Percent Change Over 2007 Budget 
 
Internal Administration      -0.7 
Agriculture                   4.9 
Justice                       7.9 
Environment                  12.7 
Foreign Affairs              -7.1 
Finance                       4.9 
Economy                      23.5 
Public Works                -53.6 
Social Security               3.9 
Health                        0.9 
Education                     0.0 
S&T and Higher Education      8.9 
Culture                      14.9 
National Defense              8.5 
 
Comment 
------- 
¶11.  Prime Minister Jose Socrates, Finance Minister Fernando 
Teixeira dos Santos, and Bank of Portugal Governor Vitor 
Constancio all predict continued moderate economic recovery 
for 2008 and 2009 but acknowledge higher than usual 
uncertainty.  The European Commission, OECD and IMF believe 
the government's forecasts are too optimistic, and while 
Constancio may agree in some cases, he is quick to point out 
that the government has yet to revise predictions made before 
the acceleration of the global financial crisis. 
Nevertheless, the government achievements paint a mixed 
picture, with the country's 2007 GDP growth of 1.9% 
registering the highest in the last six years but coming in 
as one of the Eurozone's lowest.  Much work remains to be 
done before Portugal's economy converges with the European 
average.  Despite outward confidence and optimism, the 
government is concerned that Portugal's per capita GDP stands 
at 65.6% of the European average, having dropped to 19th 
place within the EU-27, behind Estonia, in 2008. This 
sobering reality check will likely keep the government's 
efforts focused on the economy as the country heads for 
legislative elections in 2009.  The economy, after all, will 
make or break the Socialist Party's chances at reelection. 
 
 
 
Stephenson