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Portugal: crisis or challenge?

Oortugal has seen one of its worst recessions in recent history over the past few years and it is only now emerging with export driven tepid growth in 2006. The government is running its operational budget deficits in excess of the 3% EU rule and its latest proposed 2007 budget continues with belt tightening measures such as reductions in social security and higher taxes, even touching upon reduced tax benefits for pensioners.

Productivity levels have stagnated and the country holds the dubious European record for having the worst drivers and road death accidents and highest incidence hypertension and diabetes. It has the EU's highest personnel costs of civil servants when expressed as a percentage of GDP, but perhaps this is not surprising in a country that has a paid allowance per kilometre for civil servants who need to walk on official business.

Added to these challenges, the latest proposed reductions in social security benefits are considerably harsh for higher paid and fast track employees who enjoy above
average salary increases throughout their careers, but companies have not been given any space to rectify this situation through reductions in their social security commitments and they may not offer tax effective employee benefit plans which are discretionary.

It would be a brave person, however, to write off a country that only a few centuries ago was the wealthiest nation in Europe, ruling an empire stretching from Brazil in the west, across the southern half of Africa to several city states in Asia. It shared its navigational skills, maps and expertise with Europe and thus allowed Europe to expand its control over much of the known world by dominating the seas. It has the second oldest university
in Europe.

This same country gave the Dutch its tulips and banking systems, while it brought chocolate to Europe and tea to the English. It took higher education (and curry) to India and firearms (and tempura) to Japan. Its capital, Lisbon, was razed to the ground in 1755 by a devastating earthquake and yet within a few years it had managed to rebuild the city with modern broad avenues and a grid system of roads that is still in evidence today.

Many people were concerned that Portugal would lose its competitive advantage when the EU expanded to 25 nations. The population has a natural tendency towards pessimism and there have even been suggestions that, in order to survive, Portugal should join forces with Spain and create a new country called Iberia. Yet amid this pessimism, children at school are being taught to work together and that success will come to those who embrace their objectives happily and in high spirits. This desire to work together to solve common problems is also manifesting itself in calls for the two main political parties to collaborate to solve the financing crisis in public expenditure. Businessmen across all industries are forming working groups and think tanks to launch initiatives that will get the Portuguese economy moving once again.

Portugal clearly sees itself as a key country within the EU and even more so after the expansion to 25 countries. Its legislation therefore reflects EU directives. For example the recent pension fund legislation now embraces all the transparency and governance regulations as specified in the EU Pensions Directive.

Companies, consultants and fund managers are working hard to introduce pensions committees that have at least one-third employee representation. Tax barriers have been removed to permit Portuguese companies to contribute towards pan-European pension plans and we expect that many multinationals will seek synergies and economies of scale through such arrangements. This will cause a dramatic change in the way in which mult-inational operations fund their pension arrangements. We have already seen that the harsh investment restrictions on pension plans that existed only a few years ago have been weakened considerably and thus companies now have enormous flexibility when setting investment policies for pension funds.

 

One of the major areas where reform is urgently needed is the national social security scheme. The system is crying out for reform and countless studies have recently been undertaken which show that the current system is financially unsustainable given Portugal's ageing society and changing working patterns. Indeed the country has already started a process to reform its social security. In 2002, the rules to calculate old age pensions were altered and instead of being based upon a person's earnings during the 10-year prior to retirement, benefits would be based upon a person's full career earnings, with earnings indexed to inflation.

The proposed 2007 reform continues this process and now all people retiring from the scheme will be subject to a greater or lesser extent to the career averaging calculations, as it is phased in proportionally to future years versus past years. This change alone will cause significant reductions in benefits especially for people whose earnings grow in excess of inflation. This clearly introduces major challenges to HR directors whose goal is to attract and retain key personnel who are indeed most affected by this alteration in rules.

Other major changes proposed are stricter control of unemployment and early retirement benefits. The government is also introducing the concept of a sustainability factor which effectively reduces benefits at the retirement age of 65 in direct proportion to the increase in the expected life of the population, at base 65. Global studies have tended to show that these increments in life expectancy are of the order of 0.25 to 0.5% per annum, or a reduction of 5% every 10 years. The government has also put a cap of €7,500 per month on pensions calculated using the old 10-year final average salary formula.

Pensions are no longer to be automatically increased in line with inflation and state pension increases will be linked through a complex formula to the growth in the economy and the relative size of the pension payment.

Employees will be offered the facility to contribute on a voluntary basis towards various investment vehicles administered and largely managed by the state, although the government has indicated that it will outsource some of the fund management activities to the private sector. All these new and complex regulations are causing companies to plan and implement employee communication programmes, not only to explain the new rules and duties of pension committees but also help their employees better understand what benefits they could expect from social security and hence better deal with corporate pension plan decisions where contribution levels are flexible.

As in most countries, social security will play a crucial role in Portugal over the coming years and thus any changes to the rules will directly affect how companies reward their employees, both in the short term and also with long-term incentive plans. As the Portuguese system becomes more flexible, this flexibility brings with it greater responsibility and complexity.

Although I have so far painted a somewhat bleak outlook, we have reasons to believe that there is a future and that future is starting to glow brightly! Indeed the country is continuing its age old tradition of welcoming foreigners, both as individuals and corporations.

The trend of encouraging foreign investment - as shown by recent initiatives of the government - has clear benefits: we need foreign investment and skills for our country to prosper. This will be achieved by smarter incentive programmes and an improving operating environment. The government has already introduced lower corporation tax rates, increased flexible labour legislation and has announced a new social security structure and pension plan environment thus demanding a more pro-active approach from its citizens.

The opinions expressed are the author's and do not necessarily reflect the opinions of his employer, Watson Wyatt in Lisbon, where he is a senior consultant.

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