Portugal: IMFConcluding Statement of the 2017 Article IV Mission

Portugal’s near-term outlook has strengthened considerably, supported by a pick-up in investment and continued growth in exports, as the recovery in the euro area has gained momentum. Portugal has also made commendable progress in addressing near-term risks. The strong 2016 fiscal outturn has allowed Portugal to exit the Excessive Deficit Procedure, while the 2017 fiscal deficit target also appears well within reach. There has also been notable progress over the past year to stabilize the banking system, although addressing banks’ large stock of non-performing loans and dealing with the substantial corporate debt overhang remain medium-term challenges. Progress on these fronts would facilitate more effective intermediation of financing to broad-based private investment, which is essential to support strong growth over the medium-term. Sustained strong growth, together with continued public debt reduction, would reduce vulnerabilities arising from high indebtedness, particularly when monetary accommodation is reduced.

1. Economic activity has gained momentum in 2017, supported by continued strong growth in tourism and related construction. Tourism revenues appear on track for a fourth consecutive year of near double-digit growth, while investment in the sector has supported a marked rebound in the construction sector in the first half of 2017. There are also signs of a broad-based pickup in exports, boosted by the robust euro area recovery. Meanwhile, domestic confidence indicators have strengthened significantly and employment continues to rise. House prices have also experienced further increases in 2017, supported in part by non-resident real estate investment. As a result, real GDP growth is projected to accelerate to around 2.5 percent in 2017 and remain at 2 percent in 2018.
2. Portugal has also made commendable progress over the past year in addressing near-term risks. The 2016 fiscal outturn was significantly better than expected, reflecting strong efforts to contain spending. This allowed Portugal to exit the Excessive Deficit Procedure that had been in place since 2009. Stability and confidence in the banking system has also improved markedly over the past year, including through the public recapitalization of Caixa Geral de Depósitos and the ongoing sale of Novo Banco. Meanwhile, BCP has received a large capital injection and BPI has been taken over by Spain’s CaixaBank. Improved market sentiment toward Portugal has contributed to a sharp narrowing in sovereign debt spreads since mid-March.
3. The pickup in growth implies that this year’s headline fiscal deficit target of 1.5 percent of GDP is well within reach. Stronger growth, together with the authorities’ strong commitment to contain spending, should allow the headline deficit to be achieved comfortably. The favorable cyclical conditions provide an auspicious opportunity for a more ambitious reduction of public debt this year, in support of the authorities’ medium-term targets set in the Stability Program. Durable structural fiscal consolidation remains essential to ensure the sustainability of public finances, with the financing environment likely to be less benign as monetary accommodation is eventually reduced. An adjustment focused on reform to improve public spending efficiency would likely be more growth-friendly and help reinforce investors’ perceptions of the predictability of the tax regime over the investment horizon.
4. In addition to the recent increases in capital, Portuguese banks are liquid and continue to make progress on deleveraging. Nevertheless, they face numerous challenges, including low asset quality, weak profitability and limited capital buffers. The outstanding stock of non-performing loans (NPLs) declined by 0.3 percentage points in 2016 to 17.2 percent of total loans under the European Banking Authority definition, with the weakness in asset quality particularly concentrated in the corporate sector. Banks have reduced operational costs, but this has been insufficient to offset the drag on profitability from low interest margins and higher loan loss impairments.
5. Ambitious efforts are needed by banks to strengthen their balance sheets, which would improve financial intermediation and help raise potential growth. Recent steps to raise capital need to be accompanied by a comprehensive cleanup of banks’ balance sheets and reduction in corporate debt. This should include a credible and time-bound plan for efforts across banks to write-off, restructure or sell non-performing assets. The NPL enhanced coordination platform being developed by banks with the support of the authorities is an important initiative that could facilitate banks’ efforts in this regard. These efforts will need to be supported by strengthening banks’ business models and improving profitability, including through further cost-cutting. Banks will also need to implement the new provisioning standards and build additional buffers.
6. Raising the economy’s growth potential will also require further structural reforms to boost investment and productivity. Ongoing initiatives along a number of fronts could help in this regard. The recent growth in investment has been in part financed through internal sources of funding by corporates. However, investment levels would need to increase substantially to raise the economy’s medium-term growth potential. This would require a more flexible labor market where wage increases are aligned with productivity, allowing Portugal to take advantage of higher-skilled entrants to the labor force while safeguarding competitiveness. Structural reforms should also focus on the bottlenecks that continue to influence investors’ perceptions of the business environment, including inefficient judicial processes and the complexity of regulations governing the operation of enterprises.

The mission would like to express its gratitude to the Portuguese authorities and other interlocutors for a close and constructive dialogue.

Portugal: Selected Economic Indicators
(Year-on-year percent change, unless otherwise indicated)
				Projections
			2016	2017	2018
Real GDP			1.4	2.5	2.0
Private consumption			2.3	2.2	1.8
Public consumption			0.5	0.6	0.5
Gross fixed capital formation			0.1	6.9	5.7
Exports			4.4	7.6	5.2
Imports			4.5	7.3	5.1
Contribution to growth (Percentage points)
Total domestic demand			1.5	2.6	2.2
Foreign balance			-0.1	-0.1	-0.1
Resource utilization
Employment			1.2	1.6	0.9
Unemployment rate (Percent)			11.1	9.7	9.0
Prices
GDP deflator			1.6	2.2	1.7
Consumer prices (Harmonized index)			0.6	1.6	2.0
Money and credit (End of period, percent change)
Private sector credit			-3.7	-0.5	0.1
Broad money			-0.4	4.3	3.2
Fiscal indicators (Percent of GDP)
General government balance			-2.0	-1.5	-1.4
Primary government balance			2.2	2.6	2.7
Structural primary balance (Percent of potential GDP)			3.0	2.7	2.5
General government debt			130.4	125.8	122.6
Current account balance (Percent of GDP)			0.8	0.6	0.5
Nominal GDP (Billions of euros)			184.9	193.8	201.1
Sources: Bank of Portugal; Ministry of Finance; National Statistics Office (INE); Eurostat; and IMF staff projections.

EU underlines Portugal’s recovery from debt crisis


Portugal’s recovery from the eurozone’s debt crisis reached a milestone on Monday as the EU said the country, which needed an international bailout, was no longer in breach of the bloc’s budget rules.Brussels’ verdict underlines Portugal’s turnround after its rescue by eurozone governments and the International Monetary Fund in 2011 and reflects the improving economic environment for the single currency area, where growth has picked up and unemployment is at an eight-year low.
The European Commission on Monday said Portugal’s budget deficit fell to 2 per cent of gross domestic product in 2016, well below the limit of 3 per cent set out in its budget rules and the lowest since the country joined the eurozone in 1999.
Brussels expects the deficit to stay roughly the same until the end of its forecast in 2018.“It is really a very good and a very important, piece of news for Portugal, for the Portuguese economy, for the Portuguese people,” said Pierre Moscovici, the EU’s commissioner for economic affairs.
He said the country had suffered “what was by any measure, a major crisis”.Portugal’s finance ministry said the decision showed “confidence in the Portuguese economy is now spreading to international institutions”.Only three eurozone members — France, Spain and Greece — remain in the “corrective” part of the EU’s stability and growth pact rules, compared with 24 countries at the height of the continent’s crisis six years ago.
Countries must make progress towards bringing budget deficits to below 3 per cent of GDP and reducing debt to 60 per cent of GDP.
 
Greece is poised to leave the corrective procedure at the end of its bailout next year, the commission said.Valdis Dombrovskis, the EU commission vice-president responsible for the euro, said trends were “overall positive and we should use this window of opportunity to make European economies more competitive, resilient and innovative”.
Brussels warned that recovery was “uneven and still vulnerable”, highlighting bad loans clogging up the eurozone’s banking system and imbalances between different countries’ competitiveness and economic performance.
The commission’s recommendation that Portugal be allowed to exit the euro area’s “excessive deficit procedure” was one of a number of so-called country-specific recommendations.
Finland, which has suffered the worst downturn in the eurozone outside the southern member states, was given more time to meet targets as its government plans a series of major economic reforms to the its pensions and labour market.
Croatia, a non-eurozone state, will also exit the “excessive deficit procedure” along with Portugal.Portuguese prime Minister António Costa’s “anti-austerity” government has confounded critics by cutting the deficit to its lowest level in more than 40 years, with the country benefiting from a brightening world economy and the European Central Bank’s two-year stimulus experiment.
Growth in the first quarter was 1 per cent higher than in the previous quarter, raising expectations that growth will exceed the government’s forecast of 1.8 per cent in 2017 — the best in seven years.Mr Costa wants credit rating agencies to lift Portugal’s rating above “junk” status, which would cut its borrowing costs further.
Only DBRS, a small Canadian rating agency, rates Portuguese debt as investment grade. Moody’s said last week that it would only consider a move to investment grade should the government make further strides to bring down the deficit.Portugal’s debt-to-GDP ratio remains above 130 per cent, the joint highest in the eurozone after Greece.
Private sector debt, as measured in households and companies, is also high at 172 per cent of GDP.Although the jobless rate has fallen just below 10 per cent, average unemployment over the past three years, a measure of economic health used by the EU, remains at 12.8 per cent, above the minimum recommended level of 10 per cent.Portugal’s fragile banking sector also troubles investors and the EU.
Average profits fell 7 per cent last year, the second worst performance in the EU after Italy, while non-performing loans accounted for almost a fifth of total lending.

Take a bow Mario Draghi – has the ECB chief saved the Eurozone?

Growth forecasts revised up. Inflation forecasts revised down. Jobs being created. Take a bow Mario Draghi. Urged on by its proactive boss, the European Central Bank has achieved what looked impossible until recently: it has got the eurozone economy moving again.
Draghi should milk the applause while he can because the eurozone’s sweet spot won’t last for ever. It didn’t in the US and it didn’t in the UK, two countries that pursued exactly the same macro-economic strategy as the ECB, only earlier.

Like the US Federal Reserve and the Bank of England, the ECB has cut interest rates to the bone and cranked up the electronic printing presses. Moreover, Draghi plans to continue with the current plan for some time to come. True, the ECB's latest meeting in Tallinn, Estonia decided that further interest rate cuts were no longer on the agenda and that the risks to the economic outlook were balanced rather than tilted to the downside.
But there was not the remotest suggestion that borrowing costs were going to rise, nor that the ECB’s quantitative easing programme would end – or even be tapered away – any time soon. Draghi wants to make absolutely sure that the recovery is assured and inflation is closer to its target before taking his foot off the pedal. Again, this follows the example of the Fed and the Bank of England. 

No question, the ECB is in a far better place than it was this time five years ago, when the economy was dipping in and out of recession, unemployment was rising and there were real fears that Italy and Spain would be the next dominoes to fall in Europe’s debt crisis. The fact that they weren’t was due to Draghi’s insistence in July 2012 that the ECB would do "whatever it takes" to defend the Euro.
It is clear, however, that ultra-low interest rates and QE are generating the same sort of labour market recovery as in the US and the UK: 5 million jobs have been created in the past three and a half years in the eurozone, but as Draghi admitted on Thursday many of them are low quality, part-time or temporary posts. That’s why falling unemployment is not being accompanied by higher wages, and it is also why underlying inflation remains weak. Ultra loose monetary policy can only do so much: it is a painkiller not a cure.