Wednesday 9 February 2011

The path ahead

“Long is the way, and hard, that out of trade deficit leads up to trade balance

I feel a little unease to edit Milton but I am searching for strong words to convey a truth that is hard to accept. It will take time and efforts to convince international investors that the Portuguese economy external position is sustainable. The news that exports are increasing is good. Notice that imports too are increasing and what ultimately matters for the current account balance is the difference between exports and imports. Consider the data published by the Portuguese statistical office: in 2010 exports of goods have increased by 15.7% (to 36.8b) and imports of goods have increased by 10.2% (to 56.8b). The trade balance for goods is negative and therefore contributes to increase the current account deficit. The fact that Portugal imports are still much larger than exports (1.5x) implies that the trade balance for goods has deteriorated by 2.1% and therefore contributes negatively on GDP growth. Now assume (imagine) that from this day on exports continue to increase by 15.7% per year and imports continue to increase by 10.2% per year. If that was true, net exports would start to improve in 2012 (contribution to GDP growth) and become positive in 2019 (finally helping the current account). These dates are wrong as they do not take into account the correct growth forecasts for exports and imports, but they convey part of a truth. It will take time to adjust the trade balance of goods. And the whole truth is that it will also require efforts to adjust the trade balance within our currency area. In a now classic paper, cited a few days ago in this blog by Pedro Martins, Olivier Blanchard described back in 2006 the difficulties and the efforts required for the current account adjustment to occur. And there is no doubt that the adjustment has to predominantly occur inside the euro area (Eurostat).

The day when the current account will become positive will be the day Portugal will start to repay its external debt. Policies aimed at bringing that day closer might be welcomed by external creditors.

Maybe one day the many euro area national debts will be guaranteed by the single currency area and become one. That would help decrease the income outflow. Maybe that day will not happen. Concessions from euro area creditors would certainly help. In any case Portugal debt must be brought on a sustainable path.


  1. "Et tu Brute?"

    Why do you need to convince internation investors that the Portuguese economy external position is sustainable?

    Isn't Portugal part of an integrated economy under one currency, with free capital flow?

    Concepts of external/internal debt make no sense at all in an integrated economy such has the Portuguese, its like saying California current account is unsustainable (don't know if it is) and that they will have problems atracting investment because of that, or saying the same about Alentejo...

    Debt decisions are individual and casuistic, an agreement between the lender and the borrower, usually based on the finantial and economic condition of the borrower, they have nothing to do with current account deficits (directly..)

    We borrow and pay in Euros, and there is perfect capital flow in the EU, so how is the current account deficit such a big deal, and what is the link with the government defict?

    We don't have a currency, remember....

  2. With the Single Currency, we've lost the early warning signs provided by FX pressures, and external debt accumulates until it becomes unsustainable. Some EURO analysts even beleived that CAB deficits no longer matter, an illusion that has come back to haunt us.

    With so much focus on the internal budget deficits, little is being done do cut imports, to reduce consumer credit, to provide incentives to save through positive real interest rates, etc.

    The way out of the debt crisis will probably require (1) restructurin of the existing external debt, public and private, (2) reducing the new debt needs by rebalancing of the CAB, with sharp cuts in imports because imports take a lot longer to grow and (3) sharp increases in domestic savings, from the public and business sectors to families.

  3. @ PPP Lusofonia

    I tend to agree with you although the restructuring of the debt is a delicate matter and should happen only if there is a large consensus by all parties (creditors, debtors, institutions). It would be probably easier is a eurobond existed: the restructuring could occur through a swap with the eurobond (with an haircut at market prices). But there is no eurobond and plain default might be very costly.

    To rebalance the current account, Portugal priorities are to 1. increase competitiveness and 2. increase domestic savings. A policy that favors savings and depress consumption will impact favorably on the trade balance and start the deleveraging of households balance sheet. To increase competitiveness the unit labor cost of producing in Portugal should decrease.