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CNBC Exclusive Interview: Pedro Passos Coelho, Prime Minister of Portugal, Speaks With CNBC's Squawk Box

WHEN, CNBC EXCLUSIVE: Today, Friday, 16th May

WHERE: CNBC's Squawk Box in EMEA

Following is the unofficial transcript of a CNBC exclusive interview with Pedro Passos Coelho, Prime Minister, Portugal. Following is a link to the interview on CNBC.com: http://www.cnbc.com/id/101675888.

All references must be sourced to CNBC.

CNBC's Julia Chatterley (JC): So a very important few days for Portugal, pivotal few days I think in terms of exiting the bailout programme.

Pedro Passos Coelho, Prime Minister, Portugal (PPC): Well we have worked a lot to achieve a result like this. Three years of tough measures, a lot of sacrifices from the Portuguese people, but at the end we have been able to reconstruct some trust on the financial markets, trust in the people, and finally we are in a sustainable path to come back to growth, to growth .

JC: You've had some very turbulent times in the last few years, if I look back to just last year where there were concerns that actually the government may actually fall and we'd have to go to fresh elections in Portugal. Have there been times where you have wondered whether you would actually exit the bailout plan or whether you'd need another one?

PPC: Well a lot of people during the three years didn't believe you know the possibility to recover the situation and to exit the programme in a successful way. But I think in the government everyone believes that this exit of the programme is a result of the determination of the people, because if the Portuguese people didn't believe in the capacity the result, the final result would be very difficult indeed.

JC: In public it seems like a various times two, there were swords crossed among EU leaders. You've obviously met Angela Merkel many times. Do you believe that sufficient support was there from other countries?

PPC: Definitely yes. Don't forget that Portugal in 2011 had lost its ability to obtain finances and to [strengthen?] its economy and then was the solidarity of our European partners and of the IMF absolutely indispensible to solve the financial problem so we couldn't solve the problem without the programme of financial assistance, but of course they are not easy time for any country in an adjustment programme. So we have the financial support and the political support to adjust the economy, to rebalance the state, but we have to get the programme on our own ends to deliver and that's what we can see now.

JC: You keep talking about the people and what the Portuguese people have done and what it's cost them in a sense and now they're angry, so there's a cost for you too.

PPC: I don't know if the people is angry, I know that no-one likes to adjust his life his budget, his enterprise and so on. But no-one request the necessity to do it which is important, so I must stress people understood very well the difficult situation and their response was very important to maintain the commitment of the government to deliver the programme. We couldn't be successful without the support of the people.

JC: But now the socialists are leading in the polls, how do you turn this around? Because what you have achieved here surely isn't something you can complete in just one term, it takes more than that to see it through.

PPC: Well the socialists have a lot of responsibility in the situation in 2011. Now they can use some satisfaction in some sectors to appear like a good alternative to the next election. But we have more than a year until next election so I'm not worried about it, I am comfortable knowing that the socialists are the opposition because it's important for my country to offer in the future a responsible alternative to the Portuguese people and at correct time people will evaluate the necessity of changing the government or not, but it's not a discussion for nowadays.

JC: It's something we consider if we look at the situation for Portugal and I'm talking outside now of Portugal, we see country's cost of funding coming down, we see you exiting a bailout programme so the surveillance is going to be less and you say it's a long way away but we're talking only a year to the next general election potentially. So what's the risk that you pull back on the reforms because these are the questions that are being asked? There's reason for you to pull back.

PPC: I don't think there could exist a real risk to come back to any irresponsible government and to imprudent the budget policy. I think the general people, the general citizens know very well the cost of irresponsibility. So we will maintain the fiscal responsibility, the necessary support to maintain financial stability and we will boost the reform momentum because as you know for the past three years we had a reform agenda in structural change, very import and we must maintain to keep, to stick this momentum for the future.

JC: But how do you do that? How do re-energise that though? Because there's reform fatigue not just in Portugal but across Europe. I think if anybody knew what the magic potion was, they...

PPC: When you see positive results, you can show to the people the path you choose to make, makes sense. So now people understand better financial conditions than three years ago. We have less budget deficit, public deficit than other partners in Europe for instance like Spain or Ireland for instance. We have better conditions now to pay attention to job creation and the tradable sector of the economy. Our exports are still growing and leading the economic recovery in the country. So you can show to the people that structural change, financial stability and fiscal responsibility is a good way to get sustainable growth to the future.

JC: On my way to visit you I spoke to about ten different Portuguese people randomly, and I asked them how you were going to recover and they were all very concerned because they didn't say Portugal doesn't produce anything, it doesn't make anything. So if that's what they're saying.

PPC: Well that's a bad perception about the reality because Portugal has something like 170 euros in GDP per year. We lost in real terms around 4.6% GSP of real during the crisis. When you compare these losses with Greek losses or the Irish losses you can realise we didn't lose so much as them.

JC: But what sells Portugal now? What continues to boost growth?

PPC: Almost everything, almost everything. Don't forget we have good services in the tourism, we have good goods in the traditional industries and sectors as textile and so on. But we have the best products in nano tech, in itech and so on. Auto vehicles, electronic and electronic equipment so we have very diversified exports and more important than that we gain it for the past three years new market share since 2010 the Portuguese exports grew around 24% which I think the best European result. But generally we have gained around 10% market share, which means that our exports are very competitive now. So that means if our country recover its ability to be more competitive I'm not worried about the export capacity of the country. I think we have now better conditions to be more attractive for foreign investment. We have better business environment than beginning of the crisis. So I'm a strong believer in the future of my country.

JC: I want to go back to the idea of the message that you're sending in particular to the markets. You're reversing policies with regards to pensions, you're talking about raising wages in the public sector by about 20% in the next year and potentially beyond if that allow. These are things that the troika said need to be permanent changes.

PPC: Well I'm not changing the permanent effect of the measures we have adopted in the past. For instance we will change the income of the public officials of course but in return I will maintain the salaries, the build of salaries in the state. So I'm not doing…

JC: You're not stretching the budget…

PPC: ...more expensive for the people and for the taxes, repaying better for the public system. What I am doing now is decreasing the number of officials in the state so I can benefit of quantitative effect reducing the number of employees in the public sector.

JC: So the bottom line as far as you're concerned this is not about relaxing, this is about adjusting.

PCC: No of course. Don't forget these three years were very, very tough, no-one wants to spoil the sacrifices we have made. No-one wants a to go back to an unsustainable path to Portuguese economy.

JC: And that's why you were.

PPC: Since we joined the euro at the beginning in '99, the Portuguese economy lost competitiveness in very tough return, around 10% a year. In ten years we doubled the extra debt, who wants to come back to a path like that? We want to live in these new economic and monetary regime in the euro. We joined the first class of the euro zone and we want to keep Portugal inside of the euro and the European project. And for that we must adjust our economy, we need to maintain a high level of flexibility because that's the ability of the economy to adjust to asymmetric shocks for example. We need to invest in these structural changes to be competitive. In the past Portugal, Spain, Ireland too and other countries used monetary policy to gain artifice competitiveness. That's not available now for any country in the Euro Zone. Because when you have a single currency you cannot use monetary devaluation to protect your companies and promote your exports, that's why the fiscal adjustment was so tough in Portugal and in Greece and in Ireland and so on because we needed to effect nominal income in the public side of the economy but also in private economy. No-one wants to go in a second round of such irresponsible path.

JC: You just highlighted some of the challenges Portugal still do you think optimism we're seeing in markets are underestimating challenges you still face?

PPC: No, I don't think so, the markets know very well the financial situation of Portugal, of Spain, of Italy and so-on. The result after ECB policy is now showing first effects. No one doubts Europe's capacity to overcome the crisis. The main explanation of this trust and confidence in the recovery of these countries. In the second place, I think the first message that Portugal sent to the markets is a very important one. We are saying the bad years are in the back of course, but we didn't forget the situation. We will maintain our commitments to achieve the next year 2.5% of public deficit – and we are not only exiting the assistance program, we also expect to close the procedure for excessive deficit, which is important to reboot financial confidence in the financial market I think.

JC: So you don't think some exuberance we're seeing for Portuguese debt and other peripherals could evaporate at the first sign of trouble they'll evacuate quickly again?

PPC: Well it's always possible that in short term … that some volatility can arrive, but the tendency when you look at the middle and long term, you know that you are facing sustainable bets, which is important. Portugal this year will present a primary surplus for next year and I think through 2018 or 2019 we will present same pact, which means we will be able to reduce the public debt ratio.

JC: Because that's the problem, that's still huge.

PPC: Well, if you want to grant financial conditions for the public needs to attract more investment for the economy then you must maintain your commitment in the leverage in the economy on one side and the other side decreasing total debt of the state. There is no other way to do it. You must present primary surplus. We are presenting primary surplus and I want to maintain this path for the future.

JC: And the ECB? Surely further ECB support is critical for Portugal?

PPC: Well ECB is first of all... (inaudible)

JC: Do you want to see further ECB…

PPC: For the Euro zone, and for Europe as a whole. But I think ECB is a strong institution and um in the past 4 years it is one of the main responsible to this momentum of the recovery. Fragile, but recovery in Europe. But I'm not a sponsor of a different mandate for the European Central Bank. Look at the present situation, there are some risks of (pressure) but ECB is already sending the necessary message that we will be active to prevent any kind of deflection situation that you can create a permanent problem for the European economy. So, I don't think that ECB needs different instruments or different mandate to accomplish the main mission which is to maintain stability, financial stability in Europe namely in financial markets.

JC: What are you saying you don't want to see ECB buying Bonds, you don't want a different mandate, what do you mean?

PPC: (inaudible) I mean, for instance Quantitative Easing policy is not a normal policy for the ECB.

JC: So they shouldn't do it.

PPC: No one in the ECB, can tell we ever conceived a situation where a policy like this could be adopted but its not the mission of the ECB to improve the economic recover. For instance, in the past, financial fragmentation pushed the ECB for a more active position and of course the main reason was monetary policy was not successfully transmitted by the real economy. So, the ECB can intervene to avoid financial fragmentation. Now we know that for this purpose banking union is indispensible to give positive effect to the monetary policy. We are closing the banking union reform, which implies a better position to re-boost the recovery in the periphery.

JC: So you don't want to see QE from the ECB, what about credit easing. Do you want to see ECB buying loans from small and medium sized enterprises?

PPC: Well, they have in their mandate the possibility to do it -- IF necessary, IF necessary. and the ECB was very in a very good mood to signal that if deflation risks grow, in the next couple of months… some different policies could be adopted. The ECB mainstream attitude.

JC: And you would welcome that?

PCC: Of course, that's not surprising that the ECB can adapt their response, it's response to the real situation but I don't claim for the ECB an active role in the real economy. Why? Because it's important that the European economy can recover by its own possibilities.. and for that we need to extend a more comprehensive structural change, not only in the stressed countries in the periphery of Europe but also in the core of the European Union.

JC: Can I finally ask you about the geopolitical risks and divergent views on how we deal with Russia in Ukraine? Where does Portugal stand?

PPC: I don't feel that European Union has very different ideas on Ukraine or Russia. Of course, there is some difference between the country neighbours of Russia, Portugal or Spain. But we are together, saying what has happened in Crimea is not understandable. It is not respected in international law. We are together in saying that Russia must be a partner of the European Union and NOT as in the past a risk country for geo-strategic position … ? So we are sending strong messages saying we must avoid coming back to 20-30 years ago a cold war environment. We must avoid to waste time and money to create a more difficult risk to economic recovery in Russia and other emerging countries and economies and to Europe too. But for that, we must negotiate a different situation for stability and unity of Ukraine. And I'm in a position to say that everyone in European Council is very united about this vision.

JC: Do you think Russia is clear on what they want from situation?

PPC: I hope Russia (loud plane overhead, can't hear word)….can give good attention to our messages we don't believe in a war situation or something like that. But of course we must have rules, international law and rules to have good partnerships. Those rules are not being respected by Russia and I hope Mr. Putin can present a different attitude in his behaviour, not only about Ukraine but about NATO and European Union. I hope sincerely we can evaluate not the risks but the threats because when people start making threats to each other the final result can't be good for anyone.

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For more information contact:
Hugo Foulds, Director of Communications, EMEA
CNBC
t: +44 (0)20 7653 9398
e: hugo.foulds@cnbc.com