25 February 2014

ECB/Praet & ESM/Regling: Portugal - "Clean" exit or precautionary programme?

Praet's interview in Expresso, 18.2.14

There are pros and cons to the different options. What is important is that the government can convince markets and other euro area countries and the European Union that the programme will continue without hesitation. Growth in Portugal has started to become sustainable, which is new. The main question is whether there will be any doubts about the continuity of the reform programme. The precautionary programme would certainly help to dissipate doubts. In a clean exit scenario, the Government should make a credible commitment to continuing the reform process. Ultimately, what matters is credibility. But it is the Government’s decision. My point is that for Portugal, independently of the options available, what is essential is being able to convince the markets and euro area partners that reforms will continue to be implemented.

I think the Government is right to wait a little longer before deciding on the post-programme options. Everything depends on the credibility of the reform process. Imbalances created over many years cannot be resolved in three years

Is there a risk that, without the precautionary programme, Portugal would not proceed with reforms?

There is obviously conditionality associated with the precautionary programme... A clean exit has no formal conditionality attached to it.

For the Government, the ECCL has a political price, due to conditionality, but I think that if it does not take the ECCL, the Government will face the issue of post-programme credibility whatever option it chooses. You can say you want a clean exit with enhanced post-programme monitoring, but whatever the case the country will face scrutiny from markets and other euro area mechanisms, especially since, after the programme, it still has to meet its obligation to reduce its deficit as laid down in the enhanced SGP. But, at the same time, the OMT programme, which was a kind of ECB bazooka, was not used. The German Constitutional Court said, “we cannot decide whether or not it is legal” and referred it to the European Court of Justice, which will make a decision, but not before May. Therefore, when Portugal leaves the bailout programme, it will not be able to request the OMT because it won’ t be available.

Looking at the interest rates, a precautionary programme would probably be better for Portugal

Not necessarily. The markets put a high value on the very tough policies that have been implemented. We have seen impressive results that have exceeded expectations. Market confidence has a lot to do with the willingness of the entire population to continue along this path, with or without a precautionary programme. In the end, the test is political.

Can the country continue to make these challenging efforts?

I think the break-up fear has disappeared, which is a very positive result. What is now important is the credibility of reforms. I think Portugal is on the right track. Of course the risk premium remains high, because the risk is still high. But I think that this domestic adjustment must - to the extent possible - continue in a balanced way. For Portugal in particular, I think that it is very good news that we are talking about the end of the current adjustment programme, with or without a precautionary programme. The key is to convey this message of credibility that Portuguese politicians - not just the government - continue to support reform. I know it’s not easy and I know that the European elections may have to deal with anti-European movements. Nevertheless, I think that the vast majority of European parties have come to the same conclusion, i.e. that for Monetary Union to work, we need stronger European institutions, not the opposite…

All these structural changes in Portuguese society are very difficult to bear

I agree with you, it’s a difficult situation. But what can you expect, what are the possible alternatives? There comes a time when countries have to make reforms, when you are in that situation. What would have been the consequences if these policies had not been adopted? I fully agree that the social and economic cost was much higher than it should have been, but I don’t see which other policies could have been followed at that time. Of course we can always think, as good planners, that we could have extended the time of the fiscal adjustment process, made it more gradual, made the measures more balanced, but there was no time and there were no European instruments to deal with this. I think we did what we had to do in Europe, including in Portugal.

What can we expect from the asset quality review and the new round of stress tests?

For us it is a very important issue. Some say that this exercise can be bad for growth because banks will deleverage faster and all that, but what we see today is the opposite; it is a contribution to the restoration of confidence in the banking system. If we look at the banking systems, Portugal, for example, was, last year, in terms of recapitalisation and restructuring, important. The problem, not only in Portugal, is the profitability of banks. In general, they have made great headway in terms of capitalisation, and we’ll see, with this exercise, if it is confirmed, because we analyse portfolios in great detail, but the question is about the profitability of the banking system in countries such as Portugal. Profitability is now the ultimate question. I think that recapitalisation in countries such as Portugal was extremely convincing, but the sector must be profitable again. With the recovery and the gains in efficiency that we see it should be so again, but this will be a very important test for 2014 and the industry must go back to being profitable target.

Full interview

Regling's interview in Diario Economico, 25.2.14

The troika’s programme is coming to an end. Will it be possible for Portugal to go back to the markets without a precautionary credit line?

Portugal has made very good progress with the existing programme; there was real progress in structural reform and fiscal adjustment. I know that for the population it may not look like there’s progress, because unemployment is still unacceptably high and the economic situation is not good. But we can see early indicators that demonstrate that there is progress. Competitiveness has improved, exports are growing, the current account deficit has disappeared… These are good indicators that the economy is moving in the right direction. And over time this will also become visible for the people in Portugal, because growth will become stronger and unemployment will continue to fall. I hope very much that the reforms continue, because that will certainly contribute to a good economic performance. What happens when this programme comes to and end? It’s a bit early to say. The Portuguese authorities were able to issue a 10-year bond last week. The interest rate is still bit high, but it’s a lot better than two or three years ago. In that sense, market access has been regained and I’m sure the government will monitor the situation in the next months before they come to a conclusion on which way to go.

Portugal is pre-financing 2015. If it manages to have a safety net for the next 12 months, will it have more room of manoeuvre to negotiate the precautionary credit line?

In general, a safety net helps market confidence – we could see something very similar in Ireland. Does it help to get the precautionary line? There are two sides to that: on the one hand yes, but on the other hand it may not be needed then to have the precautionary credit line. It depends on many elements.

So if we manage to finance the next 12 months, will we still need the safety net from the ESM?

I cannot say for sure. These are considerations that play a role, but I cannot tell you what happens when the safety net reaches a certain level. I’m sure it will be taken into account by your government – and it should be. I can’t take their place and try to decide for them. These are complex and important issues, they change all the time, but the size of funding is one of the elements I’m sure we are going to look at.

There are some sectors where the progress of the reforms didn’t meet the troika’s expectations, due to vested interests. How can we be confident that, after the troika leaves, those reforms will be made?

It’s a very important question, because the economic performance of Portugal in the next decade or so will depend on how that question is answered. Of course I hope that more progress will be possible. A lot has happened and I really want to recognise that, but Portugal also started the crisis with a huge backlog of reforms and one can see it in fact before the crisis that growth performance was very poor and the explanation is the lack of reforms and loss of competitiveness. Competitiveness is now probably restored, so if reforms continue, the reward in the medium term can be huge. We know from economic history that countries that do implement reforms will see higher growth. Not immediately – and that’s a political problem – but in the medium term.

But can we be confident that the reforms will be made?

It’s a good point. We have in the EU a big advantage that no country is on its own. They are all under permanent surveillance from each other – and this refers to all the 28, but particularly the 18 euro area countries. Even countries that are not in a crisis, like Germany, they get recommendations every year on how to remove obstacles to growth, how to make progress, and this will continue and will also be relevant for Portugal. So there will be good advice coming from partner countries and from the Commission. And also, after the end of this programme, there’s always something called enhanced surveillance by the European Commission for countries that have borrowed from the EFSF and ESM, so they will pay particular attention. We will also do that from our side, from the EFSF and ESM, because we also need to monitor the situation until we have been repaid. So there will be good advice even though it will be different than being under a programme.

If Portugal goes for a precautionary credit line, is it possible to have only the lighter conditions, like keeping up with the European rules that are in the Two-pack and the Six-pack?

A precautionary credit line would have lighter conditionality than a normal macro-economic adjustment programme, but how exactly it’s impossible to say now, it all would depend on the moment it would be requested and it’s up to the Commission to come up with a plan. But there has to be conditionality, there’s never lending from the EFSF or ESM without conditionality. There has to be an MoU signed by the finance minister and that would have conditionality.

Full interview