Staff from the European Commission and from the European Central Bank visited Portugal from 26 June to 4 July to conduct the sixth post-programme surveillance mission. Staff from the European Stability Mechanism also participated in the mission on aspects related to its Early Warning System.
Compared to the last mission, the short-term economic and financial situation of Portugal has improved. The recovery has accelerated further and important progress has been made in addressing near-term risks. Overall, Portugal’s economic adjustment building on the basis of the macroeconomic adjustment programme has been commendable. Going forward, the challenge is to maintain the momentum. In this regard, further ambitious growth-enhancing reforms and sustained fiscal consolidation are essential to improve the economy’s resilience to shocks and the medium-term growth prospects.
Economic activity grew buoyantly at the beginning of 2017, continuing a trend which started in the second half of 2016. Real GDP growth in 2017 is now projected to strengthen further. It also became more broad-based. Soft indicators continue to strengthen and business investment has recently started to contribute to the recovery. Moreover, economic activity is supported by dynamic growth in the export sector, and in particular in tourism, but lately also in the construction sector. Looking further ahead, the growth momentum is expected to ease as some of the tailwinds gradually fade away. Sustaining the robust growth in the medium-term will depend on continued efforts to carry forward and build on past and present reform efforts.
Since the last mission, the Council of the European Union closed the Excessive Deficit Procedure (EDP) on 16 June following a deficit outturn of 2.0% of GDP in 2016 and slightly lower deficit forecasts for 2017 and 2018. However, fiscal accounts may be negatively impacted by the statistical treatment of capital support to the financial sector. Moreover, the adjustment in the underlying structural deficit is at risk of a significant deviation from the requirements of the Stability and Growth Pact, reflecting an insufficient structural consolidation effort. It is therefore important to implement the necessary measures to guarantee the required fiscal adjustment in 2017 by containing expenditure growth while gains from the improved economic environment should be used to accelerate deficit and debt reduction. The very high level of public debt of 130% of GDP, which is expected to fall only gradually as of this year, also calls for a clear, expenditure-based medium term consolidation strategy. In particular, there is scope to enhance the efficiency of public spending in Portugal, for example by stepping up efforts to broaden the expenditure review to cover a significant share of general government spending across several policies.
The recovery of the Portuguese banking sector has made good progress, but is not yet complete. Portuguese banks have further deleveraged, reduced costs and strengthened their capital base. Nevertheless, the sector continues to be weighed down by low profitability, limited capital buffers as well as still high, although somewhat decreasing, ratios of non-performing loans. In this context, continued efforts by banks to improve their financial soundness as well as internal governance are essential. Corporate loan restructurings for viable firms need to be accelerated while loans for non-viable firms should be worked out. The platform to enhance coordination regarding non-performing loans 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. The mission urges the authorities to decisively move forward with a comprehensive strategy on this matter by establishing an ambitious timeline with clear objectives. Particular attention should be devoted to strengthening the legal and judicial framework with the aim to facilitate the restructuring and stabilisation of viable firms and the speedy exit of non-viable firms.
Recent developments in the labour market continue to be positive. This is evidenced by a decline in the unemployment rate and increases in job creation and in the labour force. This is not least due to successful reforms implemented by Portuguese authorities a few years ago. Such measures should be continued to ensure an efficient working of the labour market, as suggested in earlier post-programme documents but also recently by the OECD. While lately more open-ended than temporary jobs have been created, main challenges remain to tackle labour market segmentation more effectively through increased incentives to offer open-ended jobs, including via changes in regulation, 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 of the essence. In addition to labour market policies, this calls for further measures to increase the skill levels in the economy and to improve the efficiency and competitiveness of product markets, namely in the energy sector, transport, business services and judiciary. This includes more forceful measures to reduce the elevated electricity tariff debt, improve the functioning of the transport sector, foster competition in business services and continue to increase the efficiency of the judiciary, in particular tax and insolvency courts.
Overall, the mission recalled the need to facilitate sustainable and balanced economic growth, also implying a medium-term consolidation strategy, a decisive approach to reduce corporate debt and address 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. This would also help to increase resilience and reduce vulnerabilities to adverse external developments.
The mission would like to thank the Portuguese authorities for their constructive and open discussions.
5 July 2017