«There is no way out other than a deep cut in nominal wages. If this is not done Portugal will have another lost decade and be bankrupt even sooner. », Daniel Gros.
Daniel Gros, director of the Center for European Policy Studies (CEPS) published end of last week a hot commentary in the Financial Times, which reappeared in the CEPS Commentary newsletter. The title speaks for itself: “Greek burdens ensure some Pigs won’t fly”. CEPS is a think tank based in Brussels.
The article sorted out in a very hot week for credit default swaps (CDS) spreads of Greece (jump to 404 basis points last Friday) and Portugal (historical pick Tuesday with 166 bp) and with huge speculation in Greek debt from hedge funds, which are betting that the country has a truly probability of default. Worse in West Europe only Iceland with more than 676 bp. The price of the CDS means that investors who want to insure €10 million worth of Greek government debt against default for five years have to pay more than €400,000 a year. Regarding the Portuguese situation, it would mean around €170,000 more. The equivalent hedging price for a German government bond amounts to just €36,000. A huge gap.
PIGS was the acronym for Portugal, Italy, Greece and Spain. But now, after the Great Recession and the sovereign debt crisis it was reengineered for Portugal, Ireland, Greece and Spain. The traditional Club Med got a member from the North Atlantic cold waters and expelled Berlusconi’s paradise.
In his article, Gros explained that the acronym is misleading. There are fundamental differences inside the new Debt Champions Club. Basically, Ireland and Spain has saving rates much closer to the Eurozone average. “This implies that Spain and Ireland will be able to finance government deficits from their national savings”. In the case of Greece and Portugal, it’s the reverse: “With such low gross savings it is not surprising to find that neither Greece nor Portugal have been able to finance even a minimum level of net investment from domestic sources”. “Greece and Portugal are unique in their reliance on foreign capital to such a large extent”, he wrote. The 2008 numbers speak clearly: excepting Iceland (with a gross national saving of minus 10.5% of nominal GDP), the two countries had the lowest percentages for gross national savings: 7.1% of GDP for the Greeks and 10.2% for the Portuguese. Ireland has 16.9% and Spain 20%.
Gros also refers that Greece and Portugal have been showing negative net national savings for several years. In the case of Portugal since 2004. The Portuguese situation in 2008 was even worse than the Greek one. In the case of Greece reached minus 5.5% of GDP, and concerning Portugal was minus 6.7% of GDP, a jump of 2 and 1/2 percentage points from 2007. After a decline in 2007, the net national Portuguese savings jumped from minus 6.7 billion euros to minus 11.3 billion in 2008.
Greece and Portugal are unique in the Eurozone in this topic. An unsustainable scenario for a majority of analysts. In the case of Portugal, Gros will suggest a radical therapy, a cut in consumption of about 10 per cent of GDP – €16.7 billion. He concludes in his article in FT: “Saving a country that is consuming too much makes sense only if the entire body politic accepts that more than fiscal adjustment is required. Deep cuts in private sector wages and consumption are needed before any outsider should even consider stepping forward.”
Daniel Gros came to Portugal this week for a private conference near Oporto.
INTERVIEW by Jorge Nascimento Rodrigues © 2010, janelanaweb.com
Q: A cut of 10 pc of GDP in public and private consumption means 16.7 billion Euros. Last year private consumption contraction was 0.9 pc but public consumption rose 2.6pc. For 2010, the budget projections refer a rise of 1 pc in the private and a cut of 0.9 pc in the public consumption. Very far away from your suggestion. You mean a one year cut or a program until 2013? A such a larger contraction would provoke a profound depression or not?
A: If a country -like Portugal- lives above its means for a long time, consumption has to be cut. If wage costs are cut at the same time exports can make up for the employment lost in the non tradables sector. This is what Germany did after 1995. It took a long time, but it worked.
Q: Large part of the population has no capacity at all for savings. Only in the middle class we have a certain degree for savings, namely private pension savings. But with growing unemployment in the middle class, savings and unemployment subsidies are vanishing. In the upper-class you assist to a run away for off-shores (more than 2.3 billion net added to the stock abroad between January and October 2009). How the 10pc of GDP cut would fuel savings and potential domestic pool of money available for investment?
A: I yet have to find a country where people would not say that it was absolutely impossible to increase savings because consumption is already too low. This is not true. In Portugal consumption has increased each year over the last decade more than production. This has to change. Investment in Portugal will increase again if wages are lower so that it becomes profitable to produce in Portugal for exports.
Q: Others are suggesting that those measures will be politically unfeasible and that would be more pragmatic to fuel inflation and contract the consumption real purchase power. What do you think?
A: An increase in prices in Portugal would be counterproductive because Portugal must export more. There is no way out other than a deep cut in nominal wages. If this is not done, Portugal will have another lost decade and be bankrupt even sooner.