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• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00895R000100140003-2
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 17
• Document Creation Date: January 12, 2017
• Document Release Date: July 11, 2011
• Sequence Number: 3
• Publication Date: December 1, 1983
• Content Type: REPORT

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Directorate of Necret
Intelligence
Portugal:
Balance of Payments Easing
Secret-
EUR 83-10270
December 1983
268
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Directorate of
Intelligence
Portugal:
Balance of Payments Easing
Iberia-Aegean Branch, EURA,
are welcome and may be directed to the Chief
This paper was prepared b
Office of European Analysis. Comments and queries
Secret
EUR 83-10270
December 1983
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Secret
Portugal:
Balance of Payments Easing
Key Judgments Portugal is struggling to resolve its second balance-of-payments crisis in
Information available less than a decade. Following the successful 1977/78 IMF stabilization
as of 21 November 1983 program, a number of adverse developments abroad and economic policies
was used in this report.
we consider inappropriate swiftly eroded Portugal's external position again.
Last year the current account deficit soared to $3.2 billion, equivalent to 14
percent of GDP, while external debt approached 67 percent of GDP.
Realizing that Portugal cannot finance large current account deficits over
the long run, the Socialist-Social Democratic government of Mario Soares
installed after the April election agreed to implement another IMF
stabilization program. The government is introducing stringent measures
to trim $2 billion off the current account deficit by 1984, even though this
will produce a recession and higher unemployment. The Communist-led
trade unions almost certainly will try to capitalize on these side effects, but
we believe Lisbon is resolved to carry out its 18-month austerity plan.
After suffering acute foreign exchange shortages early this year, Lisbon is
beginning to repair its financial position. With the reductions in the current
account deficits that we foresee both this year and next and the receipt of
IMF assistance, Portugal will have most of the financing it requires
through 1984. Bankers' attitudes toward lending to Portugal are improv-
ing, as evidenced by the success of Lisbon's recent request for a Eurodollar
loan. We expect, however, that the Soares government will again have to
sell gold this winter to pay off a $300 million loan from the Bank for Inter-
national Settlements-in spite of the IMF's fears that further gold sales
may damage Portugal's creditworthiness.
Because of Lisbon's brightening financial outlook, we believe it highly
unlikely that Portugal will need a US bailout, as it did in 1978. Lisbon has,
however, requested a boost in US Commodity Credit Corporation credits-
from $620 million this year to $850 million next year-to finance
agricultural imports. And in negotiations concerning US use of the airbase
at Lajes in the Azores, Portuguese officials have won a promise of $145
million in US security assistance next year and $213 million in 1985-
roughly double the 1983 level.
The forcefulness of the current government has convinced us that Lisbon
will continue to make considerable headway toward curing its balance-of-
payments ills during the coming year, but we are less certain about
Secret
EUR 83-10270
December 1983
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Lisbon's prospects in this regard beyond 1984. A history of political
infighting, personal squabbles, and policy differences-not only between
the Socialists and Social Democrats, but also within the Social Democratic
leadership-lead us to believe that the present government may not be in
power long enough to fulfill its promise to carry out an extended
adjustment program. One potential source of discord is the presidential
election in 1985. Prime Minister Mario Soares does not have the Social
Democratic Party's support for his candidacy. If the Social Democrats
were to back someone else, the coalition could collapse. In view of the
record of stop-and-go economic policies since 1974, we suspect that a
successor government might be tempted to shift gears, pushing the country
toward a new round of balance-of-payments problems.
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Secret
Foreign Debt
Recent Austerity Measures
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Table I
Portugal: Balance of Payments
Trade balance
-2,002
-1,674
-2,175
Exports, f.o.b.
2,303
1,940
1,790
Imports, f.o.b.
4,305
3,614
3,965
Invisibles
1,173
855
886
Net-tourism
259
101
182
Worker
remittances
949
821
907
Interest
payments
NA
NA
NA
Other
NA
NA
NA
Current account
balance
Medium- and long-
term credit, net
Short-term credit,
errors, and omissions
Monetary
movements
Of which:
IMF credit
-829
-819
-1,289
274
-108
26
-83
-89
105
638
1,016
1,158
176
-2,532
-2,408
-2,632
-4,206
-5,194
-4,853
-3,650
-3,030
2,001
2,379
3,550
4,575
4,088
4,119
4,550
5,070
4,533
4,787
6,182
8,781
9,282
8,972
8,200
8,100
1,037
1,582
2,580
2,948
2,344
1,614
1,650
1,800
266
431
695
859
777
611
700
800
1,174
1,671
2,455
2,928
2,832
2,599
2,550
2,750
142
387
536
733
1,099
1,337
1,350
1,450
-261
-133
-34
-106
-166
-259
-250
-300
-1,495
-826
-52
-1,258
-2,850
-3,239
-2,000
-1,230
95
758
813
718
1,282
2,186
700
600
-30
228
594
1,398
1,268
1,224
-100
1,430
-160
-1,355
-858
300
-171
1,400
630
83
53
41
146
72
24
370
600
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Portugal:
Balance of Payments Easing
The Latest Crisis
The Portuguese economy in the late 1970s was barely
beginning to recover from the 1973/74 oil price
increases and the upheaval of the 1974 revolution
when a new round of oil price hikes and misguided
policy responses once again pushed Lisbon toward
bankruptcy. Following improvements in 1978 and
1979, the current account deficit more than doubled
from 1980 to 1981, to $2.9 billion. Because of the
1980 oil price shock and a smaller price increase in
1981, petroleum imports nearly doubled to about $2.6
billion. Despite Lisbon's success in trimming its trade
deficit in 1982, the current account deficit widened by
an additional $400 million. Invisibles, composed pri-
marily of tourism earnings and remittances, earlier
had largely offset the trade deficit but shrank by
nearly 50 percent in just two years. (See table 1.)F_
Exacerbating Portugal's problems, Lisbon's exchange
rate policy during the last three years has hindered,
rather than promoted, export growth. In 1980, Portu-
guese officials revalued the escudo by 6 percent
against a basket of 18 currencies in an unconventional
effort to slow the pace of inflation. Although the Bank
of Portugal later resumed monthly devaluations at a
set rate, these were not enough to keep up with the
inflation differential between Portugal and its major
trading partners. Compounding these errors, the
weight Portuguese officials assigned to the strong US
dollar caused the escudo to appreciate against other
European currencies. The resulting erosion of compet-
itiveness, coupled with the worldwide downturn in
trade, slowed the growth of exports. Despite Lisbon's
decision to devalue the escudo by 9.4 percent in June
1982, export competitiveness was lower on the aver-
age in 1982 than three years earlier.' (See table 2.L
Imports, meanwhile, remained buoyant because of the
rapid growth of domestic demand-up 16 percent
from 1980 to 1982, compared with the OECD average
' There are several measures of competitiveness. We used the ratio
of Portuguese consumer price inflation to a trade-weighted average
of inflation in 14 industrialized countries, adjusted for exchange
Table 2
Portugal: Indicators of Competitivenessa
1975 100.0
1976 102.0
1978
1979
1981
1982
80.4
80.5
a Compared to industrial countries. Adjusted for exchange rate
movements.
Note: A decrease in the ratio indicates an improvement in
competitiveness.
of about 1 percent. The upsurge resulted from Lis-
bon's easing domestic credit and boosting transfer
payments in 1980, which prompted a strong rebound
in private consumption and investment. As the trade
account deteriorated, Lisbon once again applied the
brakes, tightening monetary policy over the next two
years. Because the policies Lisbon adopted were con-
siderably less restrictive than those of the IMF pro-
gram years, however, the growth of domestic demand
leveled off at the relatively high rate of 4.3 percent.
As a result, the cumulative growth of import volume
from 1981 to 1982 was roughly twice as high as the
increase in export volume.
By discouraging saving, what we believe to have been
the mismanagement of interest rates also contributed
to the progressive deterioration of the current account
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Portugal experienced a balance-of-payments crisis
just six years ago. The current account deficit bal-
looned to $1.5 billion in 1977, compared with a
surplus of $348 million in 1973. This sharp reversal
of Portugal's traditional current account surpluses
reflected the oil price shock and the economic up-
heaval following the 1974 revolution. From 1973 to
1977, Portugal's oil import bill rose by 450 percent to
nearly $750 million, accounting for roughly half the
increase in Portugal's import bill. At the same time,
Portuguese authorities-intent on redistributing in-
come-permitted a 28-percent average annual in-
crease in nominal wages. Because they did not depre-
ciate the escudo fast enough to offset this wage
explosion, export competitiveness fell sharply, exac-
erbated by the loss of colonial markets, the world-
wide economic slowdown, and uneasiness abroad
about the country's political future.
Unable to finance its deficits with commercial loans,
Portugal quickly exhausted its hard currency re-
serves and turned taforeign governments and interna-
tional institutions for assistance. The World Bank,
the European Free Trade Association, and the UN
Development Program boosted assistance; European
central banks granted a total of $590 million in
short-term loans against gold collateral; and the US
Treasury-requiring repayment in kind provided
gold for sale on Portugal's account through the Bank
for International Settlements. After pledging nearly
half its gold, Lisbon still had a large financing gap,
and the government in 1977 was obliged to sell over
$500 million of gold. Another bailout was needed,
and 14 countries formed a consortium in June 1977
to lend Lisbon $750 million. Of this, the United
States contributed $300 million. For its part, the
IMF extended $340 million, utilizing its oil and
compensatory financing facilities, two credit tranches,
and a gold tranche in exchange for a stabilization
program that produced a spectacular recovery in
Portugal's current account in 1978 by sharply cur-
tailing domestic demand.
deficit. While inflation rose by 3.4 percentage points
in 1981 and a further 2.4 percentage points in 1982
(from 16.6 percent in 1980 to 22.4 percent in 1982),
the Portuguese authorities boosted time deposit rates
by only I or 2 percentage points. By 1982 the real rate
of interest for time deposits ranged between -9.3
percent and 0.5 percent, well below the corresponding
real rates of interest elsewhere in Western Europe.
$500 million in 1982, was clearly indicated by export
prices that increased at a pace well below the inflation
rate and by a sharp drop in tourist expenditures per
night. Worker remittances were also affected, as
guest workers abroad found themselves with less and
less incentive to repatriate their earnings. In addition,
negative real interest rates discouraged domestic sav-
ing, and a larger share of the increased consumption
Structural weaknesses in the Portuguese economy and
a number of external factors other than oil also
contributed to the progressive widening of the current
account deficit:
? From 1981 until early this year, Portugal suffered a
prolonged drought that reduced hydroelectric out-
put and crop yields, boosting oil and agricultural
imports. Efforts to reduce the country's dependence
on imported foodstuffs have run afoul of the ineffi-
ciency of the agricultural sector, where average
yields have sagged since the 1975 expropriations of
farmland.
? Export growth has been hampered by the concentra-
tion on low-technology goods, which have encoun-
tered growing protectionist sentiment in Western
markets and stiffer competition from newly indus-
trializing countries.
leaked into imports
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Political Responses to Economic Crises
The revolution of April 1974 ushered in a leftwing
military government whose economic policies were
often dictated by popular pressure. Extensive nation-
alizations and expropriations of farm land followed
on the heels of labor strikes and Communist-inspired
squatting. At the same time, Portuguese authorities
pushed hard to improve workers' living standards.
When imports inevitably surged, the government took
the politically expedient route of applying an import
surcharge and drawing down foreign exchange re-
serves, rather than clamping down on domestic de-
mand or devaluing the escudo.
The introduction of parliamentary democracy in
1976 heralded the beginning of an effort to address
Portugal's deepening balance-of-payments problems,
but political bickering and the constant turnover of
administrations handicapped economic policy mak-
ing. The elections in December 1979 finally gave a
legislative majority to the Democratic Alliance (AD),
a conservative coalition government, which was re-
turned to office with an even larger majority in the
scheduled election of 1980. The AD had the clout but
not the will to make an adjustment program stick.
Believing the turnaround in the balance of payments
allowed it more leeway, the AD eased monetary
policy to promote employment and investment and
permitted the budget deficit to rise to over 10 percent
of GDP. As the current account deficit quickly wors-
ened, Lisbon negotiated a $1.5 billion medium-term
Extended Fund Facility from the IMF in 1981.
Anxious to avoid a backlash, however, the AD
stopped short of signing the letter of intent. Lisbon
decided to pursue its own austerity program, but its
measures were not bold enough to prevent the current
account from sliding further into the red.
have to submit to an IMF stabilization program, but
? Since 1980 the economic slump in Western Europe
has dampened export earnings, tourism revenues,
and worker remittances.
Foreign Debt
A significant portion of Portugal's current account
deficits has been financed by external borrowing.
According to revised official estimates, the country's
negotiate an agreement.
Prodded by the IMF, the caretaker government did,
however, take the first steps toward adjusting ex-
change rate and monetary policy. After the realign-
ment of the European Monetary System in March,
foreign debt nearly doubled from 1979 to 1982 to
$13.6 billion-about 67 percent of the country's GDP.
Short-term debt was approximately $4 billion last
year, more than double the amount outstanding in
1979. The swift accumulation of debt reflects the
borrowing activities of public-sector companies, which
owed over 90 percent of the outstanding short-term
debt and over 40 percent of the outstanding medium-
and long-term debt in 1982. In compliance with the
Bank of Portugal's regulations, public enterprises
have financed imports of petroleum products and
cereals with short-term trade credits. These firms
have simultaneously undertaken some ambitious long-
term investment projects, funding them with medium-
and long-term loans. As foreign debt has mounted,
debt service payments have soared. Excluding short-
term rollovers, they amounted to $2.3 billion last
year-equivalent to 27.6 percent of the country's
foreign exchange earnings-despite falling interest
rates. (See table 3.)
Recent Austerity Measures
The disarray in Portugal's major political parties
early this year delayed the introduction of an econom-
ic adjustment program. In December 1982 Prime
Minister Francisco Balsemao, weary of political in-
fighting among his coalition partners, submitted his
resignation. The Democratic Alliance chose a succes-
sor, but the bleak prospects for the effectiveness of the
new government prompted President Ramalho Eanes
to set early elections for April. Balsemao stayed on as
caretaker Prime Minister, and, although he could not
persuade Parliament to prune government spending,
he did push through a number of austerity measures,
including substantial tax hikes; price increases of 15
to 30 percent for fuel, transportation, and electricity;
and the tripling of the import surcharge. Subsequent-
ly, the government imposed a 17-percent wage ceiling.
By this time, it was clear that Lisbon would again
the caretaker government lacked the authority to
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Table 3
Portugal: External Debt Burden
Short-term debt
Of which:
Medium- and long-term debt
Public-sector companies
External debt
Debt service payments/ foreign exchange earnings
Total debt service payments/ foreign exchange
earnings (includes rollover of short-term debt)
External debt/GDP
Short-term debt/external debt
Public enterprises' debt/external debt
a Revised IMF estimate.
Note: Data prior to 1977 are extremely sketchy.
2,397
1,583
1,651
2,397
3,289
3,917
2,230
3,837
5,616
6,581
7,726
9,665
1,384
2,385
2,664
3,220
4,121
4,627
5,420
7,267
8,978
11,015
13,582
17.0
22.5
27.6
62.5
48.1
65.9
28.4
30.5
36.4
39.5
49.7
66.7
51.8
29.2
22.7
26.7
29.9
28.8
39.8
36.6
46.7
51.3
54.2
56.6
Lisbon devalued the escudo by 2 percent and raised
the monthly rate of devaluation to 1 percent. Al-
though the Fund had recommended a much larger
devaluation, the Portuguese confided to Embassy
officials that they were unwilling to go along, fearing
the potential political fallout on the eve of an election.
In support of the devaluation, Lisbon simultaneously
announced increases of 3 to 4 percentage points in
deposit and lending rates. For the first time in over a
decade, interest rates for some time deposits were
significantly higher than the inflation rate.
The election produced a Socialist-Social Democratic
coalition government that showed considerable spunk
from the start. Within two weeks of taking office in
June, the Soares government had announced a 12-
percent devaluation of the escudo, raised petroleum
prices 11 to 30 percent, and virtually eliminated
subsidies for basic foodstuffs, causing their prices to
rise 15 to 133 percent. Lisbon subsequently suspended
public-sector investments and is now preparing to
abandon some projects altogether. Despite a likely
clash with the Communists, Soares has taken several
additional steps to redress structural problems. First,
the new government has opened up the banking,
cement, and fertilizer sectors to private competition.
To reform the agricultural sector, Lisbon has decreed
measures to restructure government monopolies, re-
turn part of the farmland seized during the revolution
to the original owners, and promote greater efficiency
in the collective farms and cooperatives. The Soares
government has also revised labor laws, which will
allow temporary layoffs for a maximum of two years
and permit shortened working hours. The only popu-
lar measure the new administration has offered is the
repeal of the 17-percent limit on wage increases.
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The Next Stage: An IMF Package
Although the Soares government apparently believed
that the measures it adopted in the early going would
suffice to obtain a standby loan, the Fund has insisted
upon additional policy changes and targets that Lis-
bon may find difficult, if not impossible, to meet.
These include:
? Limiting the current account deficit to $2 billion in
1983 and $1.25 billion next year.
? Reducing the budget deficit from about $3 billion
(12.6 percent of GDP) in 1982 to about $1.2 billion
(6 percent) next year.
? Holding foreign debt to $14.6 billion in 1983 and
$16 billion in 1984.
? Restricting domestic credit growth to 27.5 percent
in 1983 and 21.5 percent for 1984.
? Increasing deposit rates by 2 percentage points and
lending rates by 2.5 percentage points.
? Lowering or eliminating interest rate subsidies for
housing, investment, agriculture, and exports.
? Eliminating price subsidies on milk, fertilizer, and
transportation.
? Cutting wages by 4 percent in real terms.
? Restoring the import surcharge to 10 percent.
Budget and Foreign Debt Measures. In an effort to
comply with the IMF's tough budget targets, Lisbon
has agreed to implement further austerity measures.
According to Embassy reporting, the Socialists have
pushed through Parliament a one-time 2-percent tax
on fourth-quarter incomes and tax hikes on automo-
biles, stamps, gambling, and real estate. The Soares
government has also agreed to another rise in prices of
imported subsidized goods and petroleum products at
the beginning of 1984 and to monitor these controlled
prices on a monthly basis so that future import costs
to government trade monopolies will be completely
covered. Also in the offing are price increases for
goods manufactured by public enterprises, thus reduc-
ing operating losses subsidized by the state. Portu-
guese officials have found it difficult to cut spending
this year on uncompleted investment projects, but
they indicate that a much sharper cutback is planned
next year. Portuguese estimates for 1983 and 1984
lead us to conclude that the budget deficit should
remain under the Fund's ceilings.
Meeting the Fund's foreign debt targets also will
require Lisbon to reform past practices. To stay
within the IMF limits, Lisbon plans to curtail the
overseas borrowing of public enterprises by forcing
them to rely more heavily on internally generated
capital. In our view, this step probably signals the
central bank's intention to restrict short-term trade
financing. Even if these policies succeed in holding
foreign debt to $16 billion, this level of indebtedness
will, in our estimate, be approximately 75 percent of
GDP next year, which we project at approximately
$21 billion.
Credit Restraints. We believe that enforcing limits on
domestic credit growth is the most difficult task
confronting Lisbon. During the first half of this year,
domestic credit rose at an annual rate of 28 percent,
as the difficulty of obtaining international financing
forced companies to seek loans from Portuguese
banks. Recent increases in domestic lending rates and
planned reductions of interest rate subsidies should
discourage domestic borrowing. In our view, cuts in
interest rate subsidies are particularly important, as
the central bank subsidizes nearly 40 percent of the
total credit granted by banks and institutions. Interest
rate subsidies now range between 1.5 and 7.5 percent-
age points, allowing preferred borrowers to pay real
interest rates of -4.4 to 2.8 percent.
If higher rates fail to slow the growth of domestic
credit, we expect the government to threaten stiffer
penalties on banks exceeding their lending limits. In
the process, however, many private-sector companies,
already suffering cash flow problems, may go bank-
rupt. Given the high social costs of such develop-
ments, the Soares government may decide that it
cannot afford to stay within the limits set by the Fund
for next year.
Raising deposit rates should help stimulate saving,
curb consumption and capital flight, and help the
balance of payments. Due to the quickening pace of
inflation, real interest rates began to slide this sum-
mer. We estimate that the recent increases have
nearly restored real interest rates to their March
levels.
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Once Lisbon makes the price adjustments recom-
mended by the Fund, we expect inflation to pick up
again. At the end of September, inflation was running
at 28.5 percent because of sharp increases in transpor-
tation prices. We believe that farther price hikes for
foodstuffs may boost the December-over-December
inflation rate to 31 percent-2 percentage points
above the IMF's target. For the year as a whole, we
estimate that the inflation rate will be about 3
percentage points higher than in 1982. As smaller
adjustments will be needed next year to keep domestic
prices in line with international prices and with
production costs, the Portuguese may be able to shave
off 1 to 2 percentage oints from the, inflation rate.
(See graphic.
We believe the Soares government will have to exert
greater control over wage gains in order to cut real
wages as much as it has promised. Wage settlements
in public-sector enterprises-which have usually set
the pace for the private sector-probably will be more
strictly supervised. If tighter domestic credit does not
dissuade private-sector firms from granting large
wage hikes, however, Lisbon may be forced to reim-
pose a wage ceiling.
The Domestic Economic Outlook
In contrast to the previous stabilization program, the
IMF's prescription for improving Lisbon's external
position over the next 18 months clearly depends to a
large extent on slowing economic growth by reducing
real domestic demand. Lower real wages and higher
taxes will, we estimate, depress real disposable income
and induce a fall in private consumption by about 1.5
percent next year. In addition, sharp reductions in
government expenditures will cause public consump-
tion to stagnate. Together with a more restrictive
monetary policy and reduced public-sector invest-
ment, these policies should produce a decline in real
domestic demand of perhaps 2.5 percent this year and
4 percent next year. Real GDP will grow by 0.8
percent in 1983, according to Lisbon's projections, but
in 1984 we expect real GDP to fall by slightly more
than 1 percent. (See graphic.)
The stabilization program unquestionably entails
hardships for many Portuguese workers. By the end of
1984, real wages will, in our view, be at least 20
percent lower than in 1976 and unemployment will be
higher. Lisbon's plan to close a number of publicly
owned companies and to reduce the deficits of the
remaining enterprises is certain to lead to extensive
job losses. According to the press, 30 to 40 percent of
the 250,000 public-sector employees may be laid off.
If these reports prove accurate, this step alone would
raise the unemployment rate from 8.8 percent to 11
percent. In the private sector, a large number of firms
in financial difficulty-many already several months
in arrears on their payrolls-are awaiting changes in
the labor laws permitting them to shed excess labor-
ers. To soften the impact of the changes, the Soares
administration is formulating a comprehensive unem-
ployment compensation plan
Prospects for the Current Account Balance
Although the Soares government earlier thought it
could not possibly lower Portugal's current account
deficit even to $2.2 billion this year, figures for the
first half of this year suggest to us that Lisbon should
come close to meeting the Fund's $2 billion target and
may even overshoot it. Preliminary data show a $1.4
billion current account deficit for the first six months,
approximately $800 million less than the deficit for
the same period last year. Since Lisbon estimates that
the third-quarter deficit has fallen by over $300
million to $100 million, we believe that the deficit for
the second half probably will be no higher than $600
million.
Preliminary figures indicate that most of the improve-
ment in Portugal's external position has come from
trimming its import bill. Imports fell by over $600
million during the first half of this year, compared
with the same period in 1982. To buy time until other
measures cut demand, the Balsemao administration
drew down petroleum reserves-a one-time move that
probably accounted for one-third of the decline in
imports. Other factors holding down the import bill
have been tighter credit, import quotas, delays in
agricultural imports, administrative measures requir-
ing the substitution of domestically produced capital
goods for foreign merchandise, and declining food and
petroleum prices. Because destocking petroleum re-
serves was a one-shot measure, we believe that im-
provements in the last half of the year will be less
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impressive. Moreover, rising food imports-necessi-
tated by the drought earlier this year-may offset the
savings from lower prices. Consequently, we estimate
that for the full year Lisbon's austerity program may
slash imports by a total of about $800 million
We expect that export growth will contribute at least
$400 million to the reduction of the current account
deficit. The two devaluations, together with the accel-
erated monthly depreciation, will yield a 28-percent
depreciation this year-about 8 percentage points
higher than Portugal's inflation differential vis-a-vis
its major trading partners. Exports should respond to
this gain in competitiveness. For the full year, we
think exports should grow in volume by about 9
percent-double the increase forecast by the IMF in
May.
Invisibles earnings should, according to our projec-
tions, remain somewhat anemic this year. The only
bright spot is likely to be net tourism income. Al-
though first-half net tourism income was off some-
what compared with last year, the second-half results
promise to be much better than the same period last
year, as the 12-percent devaluation on 22 June should
encourage hotel owners to repatriate the earnings they
had channeled overseas. Worker remittances are like-
ly to remain weak this year because of the govern-
ment's delay in announcing a large devaluation of the
escudo and because the strength of the US dollar will
reduce the dollar value of remittances denominated in
West European currencies. In fact, we believe that
worker remittances will be slightly lower than they
were in 1982. We also anticipate that dockyard strikes
earlier this year and weak foreign demand for oil
tankers will lead to a dropoff in revenues from ship
repair. Meanwhile, interest payments should be up to
$1.35 billion, equal to about two-thirds of the deficit.
Lisbon stands a good chance of surpassing its 1984
current account target. Given the restraint on domes-
tic demand implied by lower credit and budget deficit
ceilings, imports will undoubtedly continue to fall in
1984, perhaps by $100 million. Exports may be up
$500 million, provided that Lisbon aggressively pro-
motes exports. We believe that its efforts to do so will
include an IMF-mandated adjustment of the monthly
rate of depreciation to 1.5 percent to offset an infla-
tion differential of 17 to 19 percentage points. With
the economic recovery gathering momentum in West-
ern Europe, net tourism receipts and worker remit-
tances should also pick up. It should be noted,
however, that we are assuming that more realistic
interest rates will restore confidence in the financial
system and discourage capital flight. Although inter-
est payments will be over $1.4 billion, the invisibles
surplus will, in our view, increase by $150 million.
Together with the reduction of the trade deficit, this
may bring the current account deficit below $1.25
billion. (See graphic.)
Financing the Deficit
Lisbon has experienced considerable difficulty in sat-
isfying its foreign exchange needs. Early this year,
bankers were reluctant to increase their exposure in
Portugal, and the Portuguese were able to raise a
Eurodollar loan in June only after they scaled it down
from $400 million to $300 million, submitted to
harsher terms, and compelled four nationalized do-
mestic banks to underwrite one-fifth of the credit. To
be sure, Lisbon's substantial gold reserves-currently
634.6 metric tons, worth $8 billion-virtually pre-
clude a liquidity crisis and make Portugal a better
credit risk than many countries with foreign debt
problems. The financial community, however, was
uncertain about the country's political and economic
future. As hard currency reserves began to dwindle to
less than two weeks of imports, the authorities had to
borrow a total of $1 billion from the Bank for
International Settlements (BIS).
A major problem has been the large volume of short-
term debt maturing this year. Because short-term
trade credits represent 28 percent of the total out-
standing debt, Lisbon's financial position has been
somewhat precarious. The refusal by Lisbon's com-
mercial creditors to roll over about $400 million in
trade credits during the first half of the year conse-
quently played a large part in precipitating the foreign
exchange shortage. Adding to these woes, the BIS
refused to roll over a gold-backed, short-term loan for
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Portugal: Selective Economic Indicators, 1974-84
Percent
Consumer Price Inflation
30
I . L
0 1974 75 80 83-
$400 million, forcing the Portuguese to sell 29.4 tons
of gold. A second BIS loan was specifically tied to the
sale of 23 tons of gold. We believe Lisbon probably
will sell part of its gold in December, as it is unlikely
to have enough hard currency to pay off a third BIS
loan for $300 million
In the wake of the IMF agreement, Portugal's access
to medium- and long-term commercial loans is begin-
ning to improve. US bankers report that the $300
million Eurodollar syndicated loan Lisbon brought to
the market in October was oversubscribed. Sixteen
major banks-including five US banks-have indi-
cated that they are willing to provide a total of $350
million. the favorable
response to the loan is due partly to the fact that the
higher spread-0.875 percentage point over LIBOR
or 0.5 percentage point over the US prime rate,
compared with 0.75 percentage point and 0.45 per-
centage point for the previous loan-more accurately
reflects the financial risk of lending to Portugal.
the loan will be signed on 28
November and that disbursement of the funds will
take place immediately thereafter. Lisbon will also
receive a two-year $150 million revolving acceptance
facility for financing imports, which was marketed at
Credits from other sources could total another $1
billion before the year is out. West Germany and the
European Investment Bank have granted loans for
approximately $100 million and $75 million, respec-
tively, that will probably be disbursed this fall. In
addition, roughly $300 million in mixed credits from
the US Commodity Credit Corporation (CCC) will
become available. On top of the first tranche of the
IMF standby loan of about $100 million--disbursed
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early in October-Lisbon received a $135 million
Compensatory Financing Facility (CFF) to cover
shortfalls in exports, tourism income, and worker
remittances that arose from March 1982 to March
1983. According to US Embassy reporting, a Portu-
guese application to the World Bank for a Structural
Adjustment Loan would be favorably received. Mean-
while, we expect Lisbon to receive about $50 million
under project loans and credit lines that have already
been committed by the World Bank
As a result of the reduction of the current account
deficit and the signature of the IMF letter of intent,
financial pressures are likely to ease somewhat next
year. Existing commitments from the IMF will meet
most of Portugal's needs and help to avert further
gold sales. In addition, Lisbon has disclosed that it
plans to negotiate a three-year Extended Fund Facili-
ty (EFF) with the IMF, perhaps for $1.26 billion. If
successful, this strategy would make a $210 million
tranche available to the Portuguese at the end of next
year, in addition to four tranches under the standby
loan totaling about $300 million. To help finance
agricultural imports, the Portuguese have requested a
boost in US CCC assistance from $620 million this
year, including mixed credits, to about $850 million
for 1984. These increments in balance-of-payments
support and US aid should help to counterbalance any
tightness in the international financial market next
year
Despite the shaky financial position of the major
publicly owned importing agencies, Lisbon has no
current plans, according to the US Embassy, to seek a
Lisbon's strategy now is to refinance short-
term trade credits with medium- and long-term loans.
Because Portugal has a low credit rating and because
medium- and long-term loans carry a higher risk, the
Portuguese are not likely, in our view, to tie down
enough of these credits to reduce the percentage of
short-term debt below 25 percent.
Prospects for Staying on Course
In our opinion, the Soares government has the will to
resist the pressures to relax its economic policies that
will inevitably develop during the 18 months of the
austerity program. According to the US Embassy,
Lisbon anticipates that workers will not passively
accept job losses and lower real wages, as they did in
1978, and that the financial distress of both public-
and private-sector firms will create social and political
tensions. We expect the Communist-dominated labor
confederation, for example, to launch a series of
strikes early next year in opposition to the adjustment
program. A general strike, however, is unlikely, as the
more moderate Socialist-leaning federation probably
will not lend its support. In the meantime, the coali-
tion government has announced that it will impose
stiff jail sentences on strikers.
After 1984, it is far from certain that Portugal's
leaders will stay the course. As the current account
deficit declines toward the end of next year and
Portugal's financial problems abate, the Soares gov-
ernment probably will, we suspect, find it difficult to
convince the public that the country must embark on
a three-year adjustment program under the IMF's
Extended Fund Facility to redress structural econom-
ic problems. Because of the high sensitivity of imports
to an increase in income and because of the debt
overhang, we expect the Fund to recommend con-
straining the growth of domestic demand. This pre-
scription would not permit Lisbon to ease the burden
of the austerity program being carried by the working
class.
Even if the Soares government proceeds with such an
unpopular plan, the chances that the coalition will
survive through 1987 to complete the EFF are, in our
view, small. The Socialists and Social Democrats have
a long history of policy differences, and the leaders of
the two parties are personally incompatible. Prime
Minister Soares will probably run for the presidency,
but he does not have the blessing of his coalition
partner. If the Social Democrats lend their support to
another candidate, the strains within the coalition
could lead to its downfall. If the coalition falls, we
expect that the successor government would be tempt-
ed to reflate the economy-repeating the mistakes
that led to the present crisis.
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