Economic and financial conditions in Portugal have remained broadly stable since the conclusion of the second post-programme surveillance mission in June 2015. However, the economic recovery continues to be held back by macroeconomic imbalances and rigidities in labour and product markets. While the authorities have committed to comply with European budgetary rules, the effort to reduce the underlying structural budget deficit needs to be significantly increased. As the mission concluded, discussions on this subject with the European Commission were ongoing. Progress in structural reforms lost momentum during 2015. Reforms need to be stepped up to further enhance medium-term growth prospects, job creation and competitiveness.
After a positive first half of 2015, real GDP growth slowed in the second half across all components. Looking ahead, economic activity is expected to expand at a moderate pace, held back by persistent deleveraging pressures in the private sector. Domestic demand is set to be the key driver of growth, while net exports are projected to make a negative contribution due to strong import growth. Exports continue to perform in line with foreign demand. Risks to the outlook are tilted towards the downside and are, in particular, related to uncertainties to the external environment.
The government estimates a headline deficit in 2015 of 4.2%. Excluding the resolution operation of Banco Internacional do Funchal (Banif) in December 2015, the deficit is estimated to have reached 3% of GDP. A nominal budget deficit of 2.6% of GDP in 2016 is included in the Portuguese Draft Budgetary Plan as submitted on 22 January, while the mission projects a figure markedly above 3%. The adjustment in the underlying structural deficit in 2016 reflects an insufficient consolidation effort. The debt-to-GDP ratio, which stood at around 129% at the end of 2015 is expected to continue its downward path, though more slowly than earlier expected. Moreover, the continuation of public finance management reforms will be important to further enhance the control of budget risks. Savings from lower interest payments, stemming from favourable financing conditions, should be fully used for deficit and debt reduction.
Banks continue to consolidate their balance sheets, albeit at a slower pace than previously observed, and have seen minor improvements in profitability. While the flow of new non-performing loans is decreasing, high levels of non-performing exposures continue to weigh negatively on profitability and capital. Although a series of measures have been taken over the past years to tackle the very high, albeit declining, level of corporate indebtedness, a more ambitious approach to corporate loan restructuring would improve the conditions for productive investment and further increase the resilience of the banking system as a whole.
Moreover, the mission urged the authorities to pursue an ambitious reform agenda. While the labour market reforms adopted during the programme are increasingly starting to deliver results, the reform effort needs to continue as labour market segmentation, long term and youth unemployment remain high. The impact of recent and planned measures on the minimum wage should be carefully assessed with respect to their impact on the wage structure and the employment prospects of the low-skilled. The enrolment in Vocational and Education Training has been increasing and monitoring of school outcomes is improving. However, the low skill level of the Portuguese labour force and the weak links between universities and businesses require further action. While efforts to improve the business environment continue, it is not clear whether other reforms, for example regarding the judicial system or the stocktaking of regulatory burden, will advance.
The mission also discussed recent policy developments aimed at improving competitiveness. In the area of network industries, no new efforts to reduce the port user costs and the electricity tariff debt are foreseen. The competitiveness impact and potential fiscal risks of the possible reversal of some privatisations and urban transport concessions were highlighted.
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.
Borrowing conditions for Portugal remain favourable, driven largely by European and global factors. However, compared to the stability programme for 2015, the budgetary strategy by the new government has increased the gross financing needs. More generally, financial markets have become more volatile, making financing the high levels of sovereign debt more of a challenge for the government.
The mission would like to express its gratitude to the Portuguese authorities and our counterparts at the International Monetary Fund for a close and constructive dialogue.
- 4 Februar 2016