FRANKFURT (MNI) – Portugal’s deficit to GDP ratio would worsen in
2012 after a significant drop in 2011, if no further reforms are
undertaken, the European Commission suggested in its autumn forecast,
released Monday.

The Commission warned that the country’s underlying growth trend
remains weak and that a rebalancing from domestic consumption to exports
is essential for the economy.

After a budget deficit of 7.3% of GDP this year, the Commission
sees the shortfall narrowing to 4.9% of GDP next year and then mildly
increasing to 5.1% in 2012.

“Based on unchanged policies, the government deficit is expected to
remain essentially constant in 2012,” the Commission said.

“Revenue is expected to continue to be affected by the weak
economic momentum, while expenditure is projected to grow in excess of
sluggish nominal GDP. In particular, interest spending is expected to
increase rapidly,” it added.

“Measures put in place in earlier years to rein in spending are
expected to work towards expenditure containment, but they will not
yield a marked fall in the primary-spending-to-GDP ratio in a context of
rather low nominal GDP growth,” it warned.

General government gross debt is expected to be 82.8% of GDP this
year, 88.8% in 2011 and 92.4% in 2012.

“The rising debt levels should lead to a rapid increase in interest
spending, which is expected to be the fastest-growing spending item and
a major factor hindering improvements in the government balance in the
coming years,” the Commission predicted.

Portugal’s real GDP growth is expected to fall into negative
territory next year, at about -1%, after a 1.25% increase this year,
before a slight return to growth of 0.75% in 2012, the European
Commission said.

But there are risks to the current fiscal outlook, the forecast
warned.

“Notably, should the macroeconomic outlook turn out to be bleaker
than currently expected, fiscal prospects will be affected by lower tax
revenues,” the commission wrote.

“Indeed, given the uncertainty on a number of external and
financial variables, it cannot be excluded that the evolution of demand
stays below the present scenario,” it added.

Labor market developments are also expected to remain subdued and
“improve only towards the end of 2012, on the back of the recovery in
private investment activity,” the Commission wrote.

“Employment is forecast to decrease in each year between 2010 and
2012. Against this background and in the wake of a reduction in nominal
public sector wages, private sector wage growth is expected to be
moderate in the forecast period, thereby containing unit labour costs
and improving price competitiveness,” the Commission said.

The unemployment rate, according to the Eurostat definition, will
rise from 9.6% last year to 10.5% this year, then to 11.1% next year and
11.2% in 2012, the forecast said.

The Commission projection comes one day after the European Union,
the International Monetary Fund and the European Central Bank agreed to
a E85 billion rescue package for Ireland.

The European Union and the International Monetary Fund will provide
loans worth E67.5 billion, and Ireland will put up E17.5 billion of its
own money, the deal envisages. European Commissioner for Economic and
Monetary Affairs, Olli Rehn, said the interest rates on the loans would
be “close to or around 6%.”

Portugal is feared to be next in the queue for European financial
assistance, given the precarious situation of its public finances and
its weak economy. Last week the country approved its budget for next
year, which calls for savings of about E5 billion and a deficit cut from
an (originally) projected 7.3% of GDP this year to 4.6% next year.

Austerity measures include a 5% cut to civil servant salaries and
two-percentage-point increase in the VAT rate to 23%. Last week,
Portuguese workers held their first general strike in over 20 years to
protest the savings package.

On Friday, Rehn predicted that Portugal’s approval of its budget
“will reinforce confidence in its economy.”

“The budgetary strategy of Portugal is appropriate, with ambitious
fiscal targets and broadly appropriate measures to reach the deficit
target of 4.6% of GDP in 2011,” he added.

In early morning trading, spreads between 10-year Portuguese
government bonds and the benchmark German Bund narrowed 8 basis points
versus Friday, as investors unwound safe haven trades following the
Irish deal.

But later in the session, the spreads widened back slightly to only
a 6 bps difference versus Friday as investors started to question
whether the bailout really did enough to address the issue of long-term
solvency in the Eurozone.

Domestic political considerations in Ireland are also weighing on
confidence, as it is not yet assured that the government has enough
votes in the Dail (parliament) to pass its four-year plan of
budget-cutting measures, on which the E85 billion aid package depends.

–Frankfurt bureau; +49-69-720142, tbuell@marketnews.com

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