08.12.2016 - Staff from the European Commission and from the European Central Bank visited Portugal from 29 November to 7 December to conduct the fifth post-programme surveillance (PPS) mission. This visit also served as specific monitoring by the European Commission in the framework of the EU Macroeconomic Imbalance Procedure. The mission was coordinated with the IMF's fifth post-program monitoring mission. Staff from the European Stability Mechanism also participated in the mission on aspects related to its Early Warning System.
The Portuguese economy continues its moderate recovery since the end of the adjustment programme in June 2014. Despite some positive developments, the recovery continues to be held back by elevated levels of debt in the private and public sector, high non-performing loans and rigidities in product and labour markets. In line with the Portuguese authorities’ commitments to fiscal consolidation, continued efforts to ensure sustainable debt reduction remain necessary. The pursuit of prudent fiscal policy and ambitious growth-enhancing reforms is key to improving Portugal's potential growth and its resilience to shocks, in particular amidst volatile sovereign yields and high financing needs in the medium term.
Macroeconomic growth in 2016 has been overall subdued. Economic activity in the third quarter was strong due to exceptionally buoyant net exports, only partly offsetting the weak developments in the first half of 2016. Growth for the first nine months of 2016 amounts to 1.1% of GDP and annual growth is projected to end up lower than initially forecast in early 2016. So far, private consumption has been the main driver for growth while investment remains subdued, although in the third quarter investment in machinery and equipment rebounded. A sustained strengthening of the recovery would depend on a continued positive external environment, including tourism, as well as on strong domestic demand, in particular stemming from business investment and from an increased absorption of EU structural funds.
Since the last PPS mission, the authorities took effective action in the form of a freeze in intermediate consumption in order to correct the excessive deficit in 2016, following the 8 August decision by the Council of the European Union. The authorities now expect to close the year with a deficit of 2.4% of GDP. The mission projects a final deficit somewhat higher than that, but still appreciably below 3%. On 29 November, the budget for 2017 was approved by Parliament. It shows only minor changes to the Draft Budgetary Plan which had been assessed by the European Commission as at risk of significant deviation from the adjustment effort required under the preventive arm of the Stability and Growth Pact. The risks seem contained if the budget is implemented as planned. The very high level of public debt and the associated high interest payments call for a clear consolidation strategy for the short and medium term. In particular, there is scope to enhance the efficiency of public spending in Portugal.
The Portuguese banking sector continues to be weighed down by low profitability, thin capital buffers as well as high and still increasing ratios of non-performing loans. In this context, continued efforts by banks to improve their soundness indicators as well as governance mechanisms are essential. Banks are actively looking for ways to strengthen their capital base and reduce costs through various measures. A more ambitious approach to enhance the tax, legal and judicial framework for corporate debt reduction and improved access to non-bank financing would help to strengthen the resilience of the financial sector. Some measures have already been taken; however, a comprehensive and targeted approach is still to be designed and implemented. The mission urges the authorities to decisively move forward on this matter by establishing an ambitious timeline with clear objectives.
Recent developments in the labour market are positive. This is evidenced by a decline in the unemployment rate and increases in job creation and in the labour force. The authorities aim to improve the effectiveness of public employment services, which is important as the share of long-term unemployed remains high. It is important to ensure an efficient working of the labour market by keeping successful measures in place. The main challenges are to tackle labour market segmentation more effectively through increased incentives to offer permanent jobs and to ensure that increases in the minimum wage take into account productivity growth and their impact on the overall wage structure.
Increasing potential growth and competitiveness remain central tasks for economic policy. This calls for further measures to increase the skills level in the economy and to tackle rigidities in product markets. As regards network industries, this includes more forceful measures to reduce the energy tariff debt. Renegotiations of port concessions have started again, and it is essential to ensure that these will actually translate into reduced costs for port users. The mission acknowledged the authorities' efforts to continue improving the business environment and to help the economy to become more attractive for investors. Nevertheless, policy gaps persist, in particular in the judicial system, that hamper a more flexible and efficient allocation of resources.
Overall, the mission recalled the need for a sustainable improvement of growth conditions, implying a consolidation strategy, a comprehensive approach to reduce corporate debt and weaknesses in the financial sector as well as a clear plan to boost potential growth and competitiveness. To underpin recognisable positive trends, it remains important to tackle internal risks, also to increase resilience and reduce vulnerabilities to adverse external developments.
The mission would like to thank the Portuguese authorities and the IMF for their constructive and open discussions.