Via IMF (Den Internationale Valutafond)

Portugal: Staff Concluding Statement of the 2019 Article IV Mission

May 17, 2019

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

Portugal’s expansion is in its sixth year, with unemployment now below
pre-crisis levels and improved private and public leverage ratios.
Growth is expected to ease to 1.7 percent in 2019, still above its
medium-term potential. Although the main sources of risk are external,
strong policies at home are needed to make Portugal more resilient.
Banks’ overall health has improved significantly, but still high
nonperforming loans and low-profitability continue to demand attention.
The government’s target for the nominal fiscal balance appears within
reach, but the high ratio of public debt warrants additional fiscal
effort. Public policies should foster higher productivity, investment,
and saving to boost balanced long-run growth.

Economic activity is expected to moderate further in 2019.
The economy grew 2.1 percent in 2018, down from 2.7 percent in 2017. The
second half of 2018 was marked by a deceleration, coinciding with weaker
economic activity in Europe. In 2019, the mission team forecasts real GDP
growth to ease to 1.7 percent, and subsequently to move towards its
estimated medium-term potential of 1.4 percent – implying very slow
convergence to average euro area livings standards.
Consumer prices also decelerated in 2018, and inflation is expected to
remain low. Falling steadily over the past five years, the unemployment rate was 6.5 percent (seasonally adjusted) in the first
quarter of 2019. Employment growth is expected to moderate in 2019. The
external current account shifted into deficit in 2018, and is projected to
continue posting moderate deficits in coming years.

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The risks to the growth outlook have increased since last year.

As illustrated by the recent volatility in euro area activity indicators
and the downward revision of real growth forecasts for Europe in 2019 by
the IMF, the European Commission, and the European Central Bank, external
risks are significant, and include a further deceleration in Europe and a
range of other external risks. As a small open economy integrated in the
European and global economies, Portugal would directly feel the negative
consequences of weaker external growth and rising protectionism. A
disorderly Brexit might be especially felt through tourism. Domestically,
vocal groups are pressing for more spending. Maintaining strong domestic
policies is essential to mitigate external risks and ensure the continued
reduction of vulnerabilities associated with still high public and private

The target for the nominal fiscal balance in 2019 appears feasible.

The headline fiscal balance improved by 2.5 percent of GDP in 2018,
reaching -0.5 percent of GDP. This improvement was driven by a large drop
in bank recapitalization costs, a declining interest bill,
stronger-than-potential economic growth, and tight budget
execution—resulting in a small increase in the structural primary balance
relative to 2017. Despite the higher-than-budgeted transfer to Novo Banco
under the contingent capitalization mechanism, the 2019 nominal fiscal
deficit target of -0.2 percent of GDP looks feasible, with buoyant revenue
and capital spending now projected somewhat lower than budgeted. Moreover,
the deficit is projected to be eliminated in 2020 under unchanged policies.
The public debt ratio should decline again in 2019, and in the absence of
adverse developments, is expected to fall to about 100 percent of GDP in
2024—a clearly positive prospect.

Greater fiscal effort would help build more resilience.
The authorities should aim to consider additional fiscal efforts now and in
the coming year to build policy space by reducing still-high public debt
more rapidly and better differentiate Portugal from other high-debt
countries. Such space would also help to prepare for upcoming pressures on
spending from an aging population and to guard against unanticipated
adverse events. Accordingly, the mission recommends an additional 1 percent
of GDP tightening of the structural primary balance over the next two
years, taking advantage of a still favorable environment, including
supporting monetary conditions. In the event of a material downturn in
economic activity, a neutral fiscal stance would be appropriate as long as
the public debt ratio remains on a downward trajectory (which supports
moderate sovereign interest rate spreads), allowing the nominal deficit
temporarily to widen as a result of slower growth.

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The composition of public spending needs rebalancing.
Ongoing efforts to prioritize public investment in areas such as healthcare
are welcome, as is the rise in investment projected in the Stability
Program; but needs are pressing. As noted by the Fiscal Council, the latest
official projections of the government wage bill for coming years are
significantly higher than projected last year, implying additional pressure
on the public finances—even within the solution given to the difficult
question of career progressions. The stop-and-go cycle of career
progressions since 2005 (years before the program period) has been
disruptive for both the government and public servants, and raises
questions about the sustainability of these frameworks in the face of
economic fluctuations. A comprehensive review of the level, composition,
and rules of public employment would lay the basis for better controlling
the trajectory of current spending, without sacrificing service delivery.
In addition, the pension system could benefit from targeted adjustments
with the aim of curbing projected aging-related expenditure increases over
coming years and reducing inequality among pensioners, which is high by
European standards.

Supervisors should maintain the focus on furthering the ongoing bank
balance sheet repair.

Bank capital ratios have been boosted by the 2017-18 capital augmentations,
profitability has improved, and non-performing loans have markedly
decreased, but banks continue to face challenges. Although
it remains below Euro Area standards, asset quality has steadily improved,
with the nonperforming loan (NPL) ratio declining to 9.4 percent at
end-2018, with a provisioning ratio above 50 percent.
The banking system has reported positive profits since the beginning of
2017, but these remain low relative to pre-crisis levels and below the
cost of equity.
The mission recommends that supervisors ensure that banks continue to
follow through on their NPL reduction targets and strengthen their
corporate governance, internal controls, and risk management, and encourage
banks to step up efforts to improve operational efficiency and
profitability. An effective financial supervision model must ensure the
independence of supervisors, support timely and informed decision making,
be cost efficient, and provide a leading role for the central bank in
macroprudential matters. One of the main goals of the financial supervision
reform bill before Parliament is to enhance coordination among the three
sectoral supervisors. The bill has features that could improve the current
system. Nevertheless, the three national sectoral supervisors (Banco de
Portugal, Comissão do Mercado de Valores Mobiliários, and Autoridade de
Supervisão de Seguros e Fundos de Pensões) have raised legitimate concerns
regarding the bill that merit careful consideration in Parliament before
this bill is passed into law.

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Strengthening medium-term growth requires higher investment and

A more streamlined regulatory environment, stronger product market
competition, improved skills, and more efficient use of labor are key to
raising productivity and investment, which are needed to raise potential
growth. Further progress in promoting competition in the network industries
– notably energy and transport – is important for supporting
competitiveness. Enhancing labor market flexibility by making permanent
contracts less rigid is important for Portuguese firms’ ability to process
adverse shocks.

Fostering higher private saving is required for balanced growth.
Corporate and (especially) household saving are below the corresponding
Euro Area averages. Sustaining higher investment rates without creating new
external imbalances requires stronger domestic saving rates. The
authorities should issue the regulations needed for the complementary
second-tier occupational pension schemes, as called for in existing
legislation. They should also explore options, including tax incentives, to
encourage the use of well-regulated complementary occupational and
individual retirement saving schemes.

The mission would like to express its gratitude to the Portuguese and
European authorities and other interlocutors.


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