We’re all well aware of the 2008 Financial Crisis that resulted in a worldwide economic downfall. Among the many countries that were shaken, Southern European countries were among the worst hit. The 2008 crisis gave rise to the Eurozone Crisis in 2010, when the world realized that Greece could default on its sovereign debt, followed by potential default from Portugal, Italy, Ireland, and Spain. The unflattering acronym ‘PIIGS’ came into popular use after this, to describe these five member states of the European Union with unstable economies. Let’s walk through each country’s story on becoming one of the PIIGS, one-by-one.
For Portugal, the debt crisis dates back to before the Eurozone Crisis. It all began on April 25, 1974, with ‘The Carnation Revolution’ that put an end to 48-years of dictatorship. Trying to create a welfare state, it expanded its free public education system, introduced a social security system for all the citizens, announced a minimum wage, and also created national unemployment insurance in 1975. This increase in public spending, however, resulted in a small recurring balance of payments crisis right from 1974 onwards. Trade deficit remained at over 10% of GDP in the period 1974-83, and the country’s net borrowing requirements remained high despite IMF bailout (the oil shock of 1973 and 1979 aggravated the crisis).
Portugal formally joined the European Union in 1986, as part of the European integration process. However, it’s commitment to join the Eurozone, a monetary union of EU member states that have adopted the euro, came with a prolonged slump. Keeping in mind the prospect of euro accession, Portugal had lowered the minimum reserve requirements for its banking system from 17% (1997) to just 2% (1999). Easy credit, due to low-interest rates, resulted in an increase in both consumption and investment, which led to low unemployment and strong economic growth. Although Portugal experienced rapid economic growth in the years preceding the launch of the euro, the country’s performance dropped in the first year of adoption of the euro due to difficult adjustment to the new monetary system. Moreover, the inclusion of central and eastern European countries in the EU and entry of low-cost economies due to globalization adversely impacted Portugal’s two main export industries – textile and footwear.
Unlike the other members of PIIGS, where economic growth was substantially high before the crisis, Portugal experienced low growth since 2001. In fact, it was the only country besides Germany to experience a recession in 2003 (-0.9%); economic growth was very low, productivity growth was feeble, the budget deficit was large and the current account deficit was even larger. Even though Portugal began to regain competitiveness through salary disinflation and higher productivity growth, the current account deficits remained high due to many reasons – increased spending on education and skill development, increase in R&D investment (which put Portugal ahead of or at par with rest of the PIIGS), and high energy imports and prices.
Then came the 2008 Financial Crisis. Unlike the periphery countries, Portugal entered the crisis after a decade of anemic growth. In 2009, the depressed economy gave way to declining government revenues. Portugal’s budget deficit soared from 2.7% of GDP in 2008 to 9.3% of GDP in 2009. The trigger for the Eurozone Crisis in Portugal was the government’s decision in 2008 to expand the budget aggressively in response to the global crisis. Its banking system was strongly indebted and dependent on external funds, and so, when creditor countries cut back on lending in light of the 2008 crisis, the Portuguese banking system rapidly faced a funding crisis.
In 2010, the magnitude of Greece’s difficulties became obvious, i.e. the Eurozone Crisis began and the contagion affected all of the vulnerable euro-area economies, i.e. PIIGS. The consensus view was that the Eurozone Crisis was caused due to lax fiscal discipline; the governments of PIIGS had been living ‘beyond their means’ for too long. Portugal’s fate was not dependent solely on its own actions but also on the periphery countries’. Fears over the stability of Eurozone bonds spread to Portugal and bond yields rose rapidly. The main rating agencies lowered Portugal’s government debt rating from investment grade to non-investment grade, i.e. junk.
Under pressure from the European Central Bank (ECB), Portugal requested financial assistance through an IMF-EU program in 2011, following Greece and Ireland. The IMF and EU ultimately approved a €78 billion bailout package in May 2011, on the condition that Portugal was required to adopt austerity measures, i.e. fiscal consolidation (reduce deficits) through spending cuts and revenue increases. Though it made sense (stop spending if you have too much debt), the adjustment program suffered from a fundamental problem – misdiagnosis of the nature of the crisis. It focused more on austerity rather than targeting the balance of payments crisis. Thus, it resulted in job losses and lower disposable income owing to higher taxes and a decrease in government expenditure. 227,000 jobs were destroyed in 2012, 106% more than in 2011. Unemployment rose to 35.7% by the end of 2013, and since unemployment benefits were limited, only 44% of the unemployed could claim them. Social spending had been cut at the same time as a spike in social need. This led to a massive increase in the emigration of the young population, with around 120,000 emigrating in 2013 alone. However, Portugal had no choice. In choosing between accepting the terms of the bailout and defaulting on sovereign debt, the former was definitely the better option.
The adjustment program did benefit Portugal in some ways as it allowed it to maintain its international reputation, ensuring continued access to capital markets. Portugal could begin the process of regaining its credibility. Another positive impact was from the structural reforms it undertook and the benefits of eliminating barriers that had led Portugal to the debt crisis. And since Portugal followed the directions assiduously and made significant reforms, it emerged as one of the OECD’s top reformers during 2012-13. It regained access to the international capital markets in 2013 and made a clean exit from the program in 2014.
Leaving the harsh IMF-EU program was a bold move and it paid out. The economy expanded for fifteen consecutive quarters and GDP grew 2.7% in 2017 which was its strongest since the millennium; initiating a virtuous cycle to put its economy back on the map. It offered incentives to businesses, and the decision to boost spending had a powerful impact. Export revenues grew more than half since 2008, while imports grew by only a tenth; resulting in the net trade position improving by €20 billion (more than 10% of Portugal’s GDP). The pace of emigration slowed significantly since its peak in 2012-13. Bond yields fell almost 50% over 2017 to 1.7% and Portugal was re-awarded its investment-grade credit rating.
Still, the country is not yet out of the woods entirely. It is still a ‘relative backwater from a corporate perspective’. It is important to sustain reforms to ensure flexibility in the markets. Even though Portugal’s economy was struggling long before the 2008 crisis or the Eurozone Crisis, it is important to keep in mind the impact of cross-border contagion. Thus, structural reforms within the EU as a whole will be essential in preventing the crisis from going forward. Nevertheless, Portugal’s story of economic recovery has made it ‘a poster child’ for what could be done differently in the case of the European recovery.