Staff from the European Commission, in liaison with staff from the European Central Bank, visited Lisbon from 28 November to 6 December to conduct the seventh post-programme surveillance (PPS) review for Portugal. This was coordinated with the International Monetary Fund’s post-programme monitoring visit. Staff from the European Stability Mechanism also 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.
The economic recovery has gained further momentum. Economic activity has accelerated and has become more broad-based, with a pick-up in investment and exports alongside continued growth in consumption. Employment has grown even faster than GDP, particularly in labour-intensive services related to tourism, while wage growth has remained overall subdued. Although GDP growth is expected to remain strong in 2018 on the back of further export and employment growth, it is projected to moderate over the medium term.
The current favourable macroeconomic and financial conditions provide an opportunity to address Portugal’s persistent macroeconomic imbalances. In particular, elevated public and private sector debt and prevailing rigidities in the economy weigh on medium-term potential growth and leave the country vulnerable to shocks. Moreover, the limited intermediation capacity of the banking system on account of gradually declining, but still high NPL ratios, limits investment.
Further fiscal consolidation will be important for ensuring a steady decline in the still high public debt level. The current favourable cyclical conditions together with the decline in interest payments should be used for furthering structural fiscal adjustment to ensure a sustainable budgetary position over the medium term. However, the currently planned structural adjustment is at risk of deviating significantly from the requirements of the Stability and Growth Pact (SGP). This strengthens the case for containing expenditure growth and using gains from lower interest expenditure for accelerating public debt reduction. In this context, progress in broadening the spending review is very welcome, even if more ambitious savings targets could be considered. In a similar vein the Country-Specific Recommendations by the Council regarding expenditure control for state-owned enterprises and in the health sector as well as the pension system remain valid.
The recovery of the Portuguese banking sector continues, while key vulnerabilities remain. Near-term risks emanating from the Portuguese banking sector have been markedly reduced compared to last year as the major banks managed to attract new capital. Nevertheless, banks continue to face important challenges, including high non-performing loans, weak profitability and thin capital buffers. The transition to new accounting and regulatory standards (in particular IFRS 9 and MREL) may put further strain on existing capital buffers. Also in this view, banks should improve profitability by, for example, further reducing their cost base. The platform to enhance coordination of NPL management, which is being developed by banks with the support of the authorities, and the strengthened framework for corporate debt restructuring are important initiatives in this regard.
Addressing impediments to investment and further improving the business environment will be key for strengthening potential growth. In this context, the authorities’ efforts to improve the relatively low skill level of the Portuguese labour force and to support innovation are highly welcome. The measures implemented under the adjustment programme contributed to the recent positive developments in the labour market. This notwithstanding, increases in the minimum wage should take into account productivity growth and the impact on the overall wage structure and thereby employment opportunities for less skilled workers. Moreover, the gap between permanent and temporary labour contracts should primarily be addressed by making the former more flexible rather than by introducing restrictions for the latter. Despite significant improvements over the last several years, further increasing the efficiency of the judiciary will positively impact the business environment. Increasing potential growth would also require implementing further measures to improve the efficiency of product markets, most notably in the energy and transport sectors as well as in business services.
The mission would like to thank the Portuguese authorities for the helpful and open discussions.
The next PPS mission is planned to take place in the spring of 2018.
7 December 2017