PARIS (MNI) – The Portuguese economy is expected to contract this
year under the weight of heavy budget cutting before eking out a modest
recovery in 2012, the Bank of Portugal said in its most recent economic
bulletin published Tuesday.

The central bank predicted the economy would shrink by 1.3% this
year before returning – just barely – to growth, with a rate of 0.6%, in
2012. The expected recession in 2011 would represent a swing of 2.6
percentage points in GDP from estimated 2010 growth of 1.3%.

“This development is marked by the process of adjustment of
accumulated macroeconomic imbalances and, in particular, by a
significant budget consolidation which underlies it,” the central bank
said.

It implied that the economy could end up being harder hit than the
current projections suggest, saying that risks to economic activity were
“strongly” on the downside. Those risks include the possibility of a
weakening in the global recovery, which would hit Portuguese exports, as
well as the potential need for additional budget cutting measures.

“The materialization of these risks would imply a more pronounced
contraction of economic activity than what is currently projected,” the
bank warned.

It also noted that its outlook for public finances included only
budget-cutting measures already approved or “with a high probability of
approval,” in keeping with European Union rules. In particular,
consolidation measures announced by the government on December 15 are
not included, the central bank said.

“In addition, the [fiscal] projections assume that recourse to
Eurosystem [i.e. ECB] refinancing will remain significant throughout the
[forecast] horizon, in a context of the persistent difficulties faced by
Portuguese banks in accessing wholesale market funding,” the bulletin
said.

Even excluding the possibility of additional economic weakness
should downward risks materialize, the central bank paints a pretty
bleak picture for 2011. Both private and public consumption are expected
to shrink after expanding last year. Investment is forecast to decline
by 6.8% after a 5% drop in 2010, while internal demand is seen dropping
3.6% after a small gain of 0.5% in 2010. Imports are expected to shrink
by nearly 2% after growing 5% last year, while export growth will
decelerate sharply.

Given the funding constraints faced by Portuguese banks, a return
to high investment rates will require an increase in domestic savings,
the bank said.

–Paris newsroom, +331-42-71-55-40; bwolfson@marketnews.com

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