From EC Accession to EMU Participation: the Portuguese Disinflation Experience in the Period of 1984-1998

Abstract

In the early 1980s the Portuguese economy was characterised by severe macroeconomic disequilibria, an uncompetitive industry structure, significant distortions in product and factor markets and a substantial weight of the public sector in productive activities, inherited from the 1974 Revolution. Monetary policy was based on capital controls, credit ceilings and administratively fixed interest rates. Financial markets were thin and the availability of financial instruments was rather limited. Financial institutions (essentially banks) were mostly state-owned, undercapitalised and inefficient. In practice the banking system was geared to financing huge public sector borrowing requirements. The Treasury benefited from important sources of privileged financing, including extensive recourse to central bank financing. Exchange rate policy followed a crawling-peg to preserve the competitiveness of Portuguese exporters with a view to containing high and persistent current account deficits(1). The country was caught in a vicious circle of devaluation and inflation. In 1985, the year preceding EC accession, Portuguese real per capita income stood slightly above 50 per cent of the European Union (EU) average, reflecting the country’s low productivity levels. The implementation of the 1983 IMF stabilisation package had brought the current account back into balance and had put inflation and the general government deficit on a declining path. However, inflation still ran at 20 per cent (14 percentage points (p.p.) above the EU average) and the general government net borrowing exceeded 10 per cent of GDP, more than twice the EU average (Table 1). The poor economic performance of the 1970s and early 1980s had made it clear that macroeconomic stability and deep structural reform were necessary conditions for a sustainable convergence of the Portuguese real per capita income to the European level, and that a regime shift was warranted. Accession to the European Community (EC) underlined the authorities’ commitment to such a regime shift and provided the right incentives for the necessary changes. The general economic situation has strongly improved since EC accession. Nominal stabilisation and a rapid catching-up have taken place, reflecting the increased competition from integration in the Community market, the implementation of broadly appropriate macroeconomic and struc-

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