22.06.2016 - Staff from the European Commission, in liaison with staff from the European Central Bank (ECB), visited Portugal from 15 to 22 June to conduct the fourth post-programme surveillance (PPS) mission. This visit also served as specific monitoring in the framework of the EU Macroeconomic Imbalance Procedure. The mission was coordinated with the IMF's fourth post-program monitoring (PPM) mission. Staff from the European Stability Mechanism also participated in the mission on aspects related to its Early Warning System.
The Portuguese economy is now in its fourth year of recovery from the crisis. Since the conclusion of the third post-programme surveillance mission in early February 2016, the pace of the recovery has however fallen short of expectations, thereby increasing the downside risks to the fiscal outlook, and financing conditions have worsened somewhat. The pace of the recovery continues to be held back by high indebtedness of all sectors in the economy and rigidities in labour and product markets. Over the medium term, further productivity- and resilience-enhancing reforms are needed to boost potential growth and ensure the steady convergence of Portugal’s per capita income toward the euro area average. The authorities have committed to comply with European budgetary rules. To achieve this, the effort to reduce the underlying structural budget deficit needs to be stepped up.
The pace of economic activity softened further in the first quarter of 2016, following the deceleration of real GDP growth already observed in the second half of 2015. While private consumption remained buoyant, export growth weakened as demand dynamics in the major export markets of Angola, Brazil and China declined. Moreover, the contribution of investment to growth was negative, held back by high corporate debt and policy uncertainty. Looking ahead, economic activity is expected to regain some momentum, mostly reliant on private consumption growth, while net exports are expected to contribute negatively. Private consumption is set to be supported in the near term by, inter alia, recent policy measures. However these measures are not expected to produce long-lasting effects and hence private consumption is projected to decelerate again in 2017. While downside risks to the outlook stem also from the external environment, they are mostly internal and related - inter alia - to the adequacy of domestic policy measures.
The government estimates the headline deficit to reach 2.2% in 2016. Cash-based fiscal data suggest that the budget execution has been broadly on track during January-April, but there remain significant uncertainties and risks for the remainder of the year. The mission projects a headline deficit figure closer to 3%. The adjustment in the underlying structural deficit in 2016 reflects an insufficient consolidation effort. To ensure a downward path of the debt-to-GDP ratio, which stood at around 129% of GDP at the end of 2015, continued consolidation efforts are needed. The continuation of public finance management reforms and a comprehensive expenditure review will be important to further enhance control over expenditures and to contain budget risks more generally.
The consolidation in the banking sector is to be further pursued as the high levels of non-performing exposures continue to weigh negatively on bank profitability and capital. Operating conditions in the financial sector remain challenging and contribute to prolonging the process of bank balance sheet repair. In this context, continued efforts by banks to improve their profitability, asset quality, and governance mechanisms are important. Although a series of policy measures have been taken over the past years to help to address the high, albeit declining, level of corporate indebtedness, a more ambitious approach to corporate loan restructuring would improve the conditions for productive investment and increase the resilience of the banking system as a whole. The mission concluded before the developments of 22 June related to the banking sector.
Determined policy action to tackle structural bottlenecks would increase resilience, competitiveness and growth potential. On the labour market, reform efforts should be stepped up as labour market segmentation, long term and youth unemployment remain high. Moreover, past achievements should be preserved. Labour market reforms undertaken during the programme, which e.g. strengthened the option of firm level agreements where needed, are essential for the adaptability of the Portuguese economy. The impact of the increase in the minimum wage, which now covers at least one fifth of all employees, needs to be carefully monitored, in particular as regards the employability of low-skilled workers and the overall wage structure.
The mission also discussed recent policy developments aimed at improving competitiveness. In the area of network industries, no new concrete measures to reduce the port user costs and the electricity tariff debt are planned. Efforts to improve the business environment are proceeding. The authorities now also envisage assessing the regulatory burden of new legislation on entrepreneurs, employees and consumers. The competitiveness impact and potential fiscal risks of the reversal of previously intended privatisations and urban transport concessions were stressed.
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. Together with a more substantial reduction of public and private debt, these are also the main issues for reducing excessive imbalances.
The mission would like to thank the Portuguese authorities and the IMF for their constructive and open discussions.