Staff from the European Commission, in liaison with staff from the European Central Bank, visited Lisbon from 5 to 12 June to conduct the eighth post-programme surveillance (PPS) review for Portugal. Staff from the European Stability Mechanism participated in the meetings on aspects related to its Early Warning System. The main objective of PPS is to assess the country’s capacity to repay loans granted under the former EU-IMF financial assistance programme and, if necessary, to recommend corrective actions.
Following strong growth of 2.7% in 2017, the economic expansion is expected to moderate somewhat to rates broadly in line with that of the euro area. Overall, real GDP growth remained broad-based and employment continued to grow strongly, bringing down the unemployment rate below the level recorded for the euro area. GDP growth is expected to remain buoyant in 2018 but to moderate further afterwards. Risks to the outlook have become more prominent, in particular stemming from external factors, and have been accompanied by increased volatility in bond markets.
The current favourable macroeconomic and financial conditions provide an opportunity to accelerate structural reforms, further reduce macroeconomic imbalances and increase Portugal’s resilience to shocks. In particular, elevated public and private sector debt weigh on growth and leave the economy vulnerable to adverse shocks and to a turn in the business cycle. Moreover, productivity compared to many euro area countries remains low and remaining rigidities in the economy present obstacles for resources to flow into more productive activities. An ambitious reform agenda strengthening skill levels and incentives for productive business investment would also invigorate the convergence of per capita income to the euro area average.
Further fiscal consolidation will be important for ensuring a steady decline in the still very high public debt level. The current favourable cyclical conditions together with the decline in interest payments should be used for further structural adjustment to build up fiscal buffers. The commitment of the Portuguese authorities to use windfall gains to reduce the general government debt ratio is therefore welcome. However, the currently planned structural adjustment is at risk of deviating significantly from the requirements of the Stability and Growth Pact. This strengthens the case for containing expenditure growth, including by more efficient spending and expenditure control for state-owned enterprises and in the health sector in line with the Country-Specific Recommendations by the Council.
Portuguese banks have made considerable progress in strengthening their balance sheets, but remaining vulnerabilities in the banking sector need to be addressed. Supported by the favourable macroeconomic and financing environment, banks have reduced non-performing loans (NPLs), increased capital levels and improved their profitability, thus reducing near-term financial sector risks. Nevertheless, NPLs remain at high levels, in turn, weighing on banks’ profitability, funding and capital costs. High NPLs also hinder a more efficient allocation of resources in the corporate sector and thus weaken potential growth. Decisive efforts are therefore needed to reduce NPLs further. Progress in improving banks’ profitability would help to strengthen capital buffers and reduce the vulnerability of the sector to external shocks or a weakening in macroeconomic conditions. The Banco de Portugal has announced macro-prudential measures, which are welcome against the backdrop of the ongoing expansion in the real estate sector, the strengthening in household lending and remaining fragilities in household balance sheets. These developments will require close monitoring.
Addressing impediments to investment, increasing productivity and further improving the business environment remain key for strengthening potential growth. In this context, the authorities’ efforts to upgrade skill levels of the population and reduce administrative burden are highly welcome. The continuous positive labour market developments also seem to be supported by structural policies started during the macroeconomic adjustment programme. This notwithstanding, it remains essential for policies to continue supporting the adaptability of the labour market. In this respect, the wide use of temporary labour contracts might primarily be better addressed by making open-ended contracts more flexible rather than by introducing new restrictions for temporary contracts. As regards the minimum wage, a continued monitoring and analysis of its impact on the overall wage structure and on employment opportunities for less skilled workers seem important. Moreover, despite significant improvements over the last several years, further increasing the efficiency of the judiciary would positively impact the business environment.
The mission would like to thank the Portuguese authorities for the fruitful and open discussions.
The next PPS mission is planned to take place in the autumn of 2018.
15 June 2018