Economic and financial conditions in Portugal have further improved since the conclusion of the first post-programme surveillance mission in autumn 2014. However, the economic recovery continues to be held back by the remaining macroeconomic imbalances. While the authorities reiterated their commitment to budgetary consolidation, efforts to reduce the underlying structural budget deficit need to continue. The structural reforms undertaken during the financial assistance programme are increasingly having an effect. Nevertheless, the reform agenda to further enhance medium-term growth prospects, job creation and competitiveness remains challenging.
Economic activity is gradually recovering and it has become more broad-based, also supported by lower oil prices, a weaker exchange rate, improved financing conditions and improved business and consumer confidence. Exports continue to perform well, in line with increasing foreign demand and supported by favourable exchange rate developments. Domestic demand is driven by buoyant private consumption growth, on the back of improving labour market conditions, and more recently by recovering business investment. Looking ahead, economic activity is expected to further strengthen while remaining constrained by the high debt levels of the private and public sectors and the still high unemployment.
The improving economic growth and more favourable borrowing conditions are supporting public finances. The Government expects a nominal budget deficit of 2.7% of GDP in 2015, while the mission projects 3.1%. Although the nominal headline target under the Stability and Growth Pact (SGP) is coming within reach, the adjustment in the underlying structural deficit in 2015 (as well as in later years) is likely to fall short of SGP requirements, reflecting a fading consolidation effort. Savings from lower interest payments, stemming from favourable financing conditions, should be fully used for deficit and debt reduction. The debt-to-GDP ratio, which stood at 130% at the end of 2014, is expected to have peaked and should be on a downward path as of 2015. A continuation of public finance management reforms will be important to further enhance the control of budget risks.
The Portuguese banking sector continues to deleverage amid improving liquidity conditions. Although cost-saving measures are beginning to take effect, profitability of the banking sector remains challenging, also due to the high levels of non-performing loans. Banco de Portugal's macro-prudential toolkit is now available thus contributing to the effective implementation of macro-prudential policy. A more ambitious approach to corporate deleveraging would improve the conditions for productive investment. Corporate loan restructurings need to accelerate, supported by a continuous monitoring of the functioning of the strengthened framework for corporate debt restructuring, also with a view to further increase the resilience of the banking system as a whole.
The pace of structural reform implementation remains moderate. While the impact of labour market reforms adopted during the programme is increasingly visible, a more rigorous monitoring of the effectiveness of these and more recent measures remains essential. The impact of recent measures on the minimum wage and on collective agreements needs to be carefully assessed.
The mission was informed about recent policy developments in the network industries including ongoing privatisations. Efforts to reduce the excess rents in network industries are progressing at a subdued pace. Competition in these sectors should therefore be increased further. Overall, the mission recalled the importance of increasing the flexibility and competitiveness of the Portuguese economy to underpin the gradual economic recovery, strengthen its resilience to shocks and improve potential growth prospects. It therefore urged the authorities to establish an ambitious reform agenda for the future.
Borrowing conditions for Portugal have continued to improve, in line with developments elsewhere in the euro area. The authorities made use of the more favourable market conditions and advanced repayments of IMF loans received under the financial assistance programme. Recent episodes of financial-market volatility are, however, a reminder that managing high levels of sovereign debt remains a challenge for the Government.
The mission would like to thank the Portuguese authorities and the IMF for their constructive and open discussions. The next PPS mission will take place in autumn 2015.
- 12 Juni 2015