Central Banks

Tuesday, November 29, 2011 - 09:36

Bank Of Portugal: Crisis Aggravation Makes Adjustment Harder

PARIS (MNI) - The deterioration of Europe's debt crisis over the past months is hitting Portugal's banking sector and making it more difficult for the country to execute its fiscal adjustment program, the Bank of Portugal said in its financial stability report published Tuesday.

The central bank noted that in the past six months, the "materialization of risks" to financial stability have intensified "substantially," both internationally and inside Portugal. "This aggravation of economic and financial conditions has resulted in a deterioration of profitability in the Portuguese banking system," it added. "In the short term, this trend towards aggravation of risks is likely to persist."

The bank warned that the situation "is increasing the challenges confronted by the Portuguese economy, as well as by the Portuguese financial system, given that the adjustment of economic imbalances must now be carried out in a much more adverse context, particularly as regards the expected trajectory of external demand."

The macroeconomic and financial outlook is characterized by "elevated uncertainty," principally attributable to the "persistence of doubts about institutional mechanisms for resolving the sovereign debt crisis in the euro area, and about the future path of the world economy and, consequently, the Portuguese economy."

Portugal, with a public debt ratio of over 100%, was forced earlier this year to take a E78 billion bailout from the European Union and International Monetary Fund. In exchange, it agreed to a series of structural reforms and deficit-cutting moves that included lower pay for public workers and an increase in VAT tax.

Lisbon committed to reducing its budget deficit from 9.8% of GDP in 2010 to 5.9% this year. But it became clear in the second half that it would miss that target and the government was required to implement additional austerity measures.

The Bank of Portugal said that the risks to Portugal's banking system and overall economy are "quite elevated in relation to historical reference points." It noted in particular the risks to the financial condition of households, individuals and businesses.

"The need for adjustment of macroeconomic and financial imbalances, which includes the process of budgetary consolidation, should exert a strong downward pressure on domestic demand in the short term," the bank wrote.

The report also noted the growing liquidity constraints faced by European banks and warned that if they choose to meet new capital ratio requirements by deleveraging, "there could be significant restrictions in the supply of credit, with consequences for the path of the European economy."

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

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