Public Information Notice: IMF Concludes Article IV Consultation with Portugal

November 20, 2000

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On October 20, 2000, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Portugal.1


Portugal's economy has prospered since the mid-1990s, guided by prudent macroeconomic policies and steady progress on structural reform. The fruits of this strategy have been evident on many fronts, with strong output and employment growth; a reduction in unemployment to one of the lowest rates in the euro area; and historically low inflation. Participation in the euro area provided an anchor for expectations and facilitated a reduction in interest rates, ushering in a period of domestic-demand led growth with high rates of investment and the rapid expansion of credit to the private sector. However, after a prolonged period of economic expansion, there are signs of macroeconomic imbalances that are not sustainable. Private sector bank debt (in relation to GDP) is now the second highest in the euro area, and the rising indebtedness of domestic residents has been reflected in a widening of the external current account deficit (including transfers) to a projected 9 percent of GDP in 2000, the highest among advanced economies. Tight labor markets have contributed to wage and unit labor cost increases that are well above those in the euro area, and a differential in core inflation (excluding energy and food) of 1-2 percentage points remains.

Domestic demand has gradually decelerated in 1999/2000, but remains the engine of economic growth. With the revival of exports, GDP growth is expected to accelerate to 3¼ percent in 2000 from 3 percent in 1999. Private consumption has cooled from its blistering pace in 1998, but is still growing faster than incomes as households continue to adjust to the earlier decline in interest rates with a further drop in their savings rate. As elsewhere in Europe, exports began to rebound in the second half of 1999, compensating for the slowdown in domestic demand. Monetary conditions remain expansionary from a Portuguese perspective, as the impact of rising European Central Bank (ECB) interest rates has been offset by the euro's weakness. The monetary stance has contributed to strong growth in monetary and credit aggregates. And while the year-on-year growth of credit to households decelerated to about 20 percent by mid-2000—amid high household debt levels and rising interest rates—credit to nonfinancial corporations has continued to rise strongly at above 25 percent on an annualized basis. Banks financed the expansion of credit predominantly by reducing their holdings of government paper, contracting loans in the euro area interbank market, and issuing bonds and new equity.

Fiscal consolidation stalled during 1998-99. Rapidly rising government expenditure resulted in weakening of the primary structural balance and left the overall structural deficit at the highest level in the euro area. For 2000, the budget envisaged a decline in the deficit by ½ percentage point of GDP to 1.5 percent of GDP. Successive government decisions to cut petroleum taxes to help stabilize domestic prices have lowered revenues in 2000 (by ½ percentage point of GDP) and have led to a projected deficit of 1.9 percent of GDP, excluding expected receipts of 0.4 percent of GDP from the sale of licenses for universal mobile telephone service.

Near-term prospects for economic activity point to steady GDP growth of around 3¼ percent in 2000-01, with the strength of exports likely to offset a further slowdown of domestic demand. Growth prospects benefit from accommodative monetary conditions and the weakness of the euro, which is facilitating a rebalancing of growth toward the tradables sector. Following an upward adjustment in domestic petroleum prices in late March, inflation increased to 3½ percent in early fall 2000. The main risks to growth relate, on the downside, to a slowdown in external demand and an abrupt appreciation of the euro, and to a decline in construction activity if interest rates were to increase by more than expected. On the upside, continued strong employment growth may result in a rebound in consumer spending.

Executive Board Assessment

Executive Directors commended the authorities for their stability-oriented policies and structural reforms that had led to rapid output growth, a low level of inflation, and one of the lowest levels of unemployment in the euro area. After seven years of robust economic growth, there were, however, growing signs of macroeconomic imbalances that needed to be addressed. In particular, the rapid rise in private sector credit and the widening of the external current account deficit were becoming serious concerns. Moreover, tight labor markets had contributed to labor cost increases well above the euro area average and there was a persistent inflation differential vis-à-vis the euro area.

Directors noted that these developments were, in part, indicative of the relatively advanced cyclical position of the Portuguese economy, and, against this background, Directors discussed the policy options facing the authorities in dealing with these macroeconomic imbalances. They noted that the euro area monetary policy was accommodative, given the cyclical position of the Portuguese economy, and therefore the burden of adjustment fell on fiscal policy and supply side enhancing measures.

Directors agreed that further fiscal consolidation was necessary to slow aggregate demand. They considered that a sizable improvement in the structural fiscal balance over the coming years would be both timely and desirable. In this connection, Directors expressed concern about the slippage from the deficit target in 2000 (net of receipts from the sale of universal mobile telephone licenses), which was related in part to a lowering of petroleum taxes. Some Directors stressed that expenditure control should be tightened, with a view to limiting the size of the slippage.

Directors noted that the draft 2001 budget included a welcome deceleration in the growth of current primary expenditure. Nevertheless, several Directors pointed out that expenditures were still budgeted to rise in relation to GDP, compared to the expected outcome for 2000. As a result, fiscal consolidation continued to rely heavily on fairly optimistic revenue projections at the time of slowing domestic demand. Expenditure restraint, therefore, was seen as a key priority. Directors also viewed the recently launched initiatives to improve the equity and efficiency of personal and corporate income taxes as a step in the right direction. Generally, Directors felt that concerns about macroeconomic imbalances would have called for a more ambitious target in the year 2001.

Turning to the medium term, Directors saw the authorities' objective of budget balance over the cycle as appropriate. Most Directors thought, however, that the pace of fiscal adjustment should be accelerated. Achieving budget balance would leave sufficient room―and a useful role―for the full play of automatic stabilizers. Moreover, it would result in a sizable decline in the public debt-to-GDP ratio, an important result given the need to deal with the pending fiscal implications of an aging population.

Turning to public expenditure, Directors acknowledged the authorities' commitment to curtail the growth of public spending, particularly the wage bill, but called for a more determined effort to reduce expenditure over the medium-term. They observed that Portugal's Stability Program, as well as budget plans for 2001, were less ambitious in this area than in most other euro area countries. The desire to maintain a competitive tax environment underscored the necessity for additional cuts in primary current outlays. Directors endorsed the authorities' intention to introduce a medium-term budgetary framework, and "budgeting by objectives," which they viewed as a useful tool for guiding reforms in key areas of public expenditure, including the wage bill and health care.

In the financial sector, Directors viewed the high levels of private bank debt and continued strong expansion of credit as posing important challenges for financial sector supervision and regulation. They welcomed recent steps taken to curtail credit expansion and to strengthen the safety margins of the financial system. To better align capital and provisioning requirements with risk, Directors endorsed the implementation of stress testing and scenario analysis, as proposed by the Basle Committee on Banking Supervision. Directors welcomed the planned strengthening of insurance supervision, and noted that the proposed council of supervisors should improve supervisory coordination, particularly for financial conglomerates. Some Directors suggested that Portugal should participate in the Financial Sector Assessment Program (FSAP).

Directors noted that the central economic challenge facing Portugal over the medium-term was to secure higher productivity growth, accelerating real income convergence with the rest of the euro area. Directors welcomed the progress made in the area of structural reforms, particularly in reforming product markets and privatizing major state enterprises. Measures to enhance competition, such as the creation of a fully independent antitrust authority, would be welcome steps. Looking ahead, the authorities were urged to continue with plans regarding public sector reform, as envisaged in the Stability Program, as well as undertake reforms in the areas of health care and pensions. These reforms were desirable from the standpoint of strengthening the fiscal position as well as improving the competitiveness of the economy. Directors viewed Portugal's low levels of educational attainment as a major obstacle to the more skill- and technology-intensive growth envisaged at the European Union Summit in Lisbon, and they noted the need for improving the efficiency of spending on education and training.

Directors commended Portugal's development assistance to poorer countries, and called on the authorities to raise ODA to the UN target. They encouraged Portugal to support full European Union trade liberalization of imports from the least developed countries.

Directors expressed concern that macroeconomic surveillance and policy making were hampered by statistical weakness, notably for real sector statistics. These shortcomings needed to be addressed quickly.

Portugal: Selected Economic Indicators

  1997 1998 1999 2000 1/ 2001 1/

Real economy (change in percent)          
Real GDP 3.7 4.2 3.0 3.3 3.2
Domestic demand 4.9 6.6 4.8 3.4 3.2
CPI (year average, harmonized index) 1.9 2.2 2.2 2.7 2.9
Unemployment rate (in percent) 6.7 5.0 4.4 4.1 4.0
Gross national saving (percent of GDP) 22.0 21.4 20.0 18.2 17.9
Gross domestic investment (percent of GDP) 25.2 26.2 26.6 27.3 28.1
Public finance (percent of GDP)          
Central government balance 2/ -3.3 -2.6 -2.6 -2.3 -2.2
General government balance 2/ -2.5 -2.1 -2.0 -1.5 -1.1
Public debt 59.4 55.2 55.1 55.1 52.4
Money and credit (end-period, percent change)          
Total domestic credit 3/ 11.6 16.8 19.9 25.4 ...
National contribution to euro area M3 3/
6.3 6.8 9.8 9.9 ...
Interest rate (period average)
Deposit rate, 91-180 days 4/ 4.9 3.9 2.8 3.2 ...
Ten-year government bond yield 4/ 6.4 4.9 4.8 5.6 ...
Balance of payments (percent of GDP)          
Trade balance -9.5 -11.0 -12.5 -14.5 -15.5
Current account 5/ -3.2 -4.8 -6.6 -9.0 -10.2
Net official reserves (in US$ billions, end of period) 6/ 20.3 21.6 14.1 13.9 ...
Exchange rate regime Euro area member
Present rate (November 2, 2000) US$ .86 per euro
Nominal effective rate (1995 = 100) 7/ 98.1 97.0 95.7 93.3 ...
Real effective rate (1995 = 100) 7/ 99.1 99.3 98.8 97.1 ...

Sources: Bank of Portugal; Ministry of Finance; and IMF staff estimates and projections.

1/ Staff projections unless otherwise noted.
2/ Data for 2000 includes receipts of 0.4 percent of GDP from the sale of licenses for universal mobile telephone service. Figures for 2001 reflect
Stability Program deficit target.
3/ Data for 2000 refer to year-on-year growth rates through August.
4/ Data for 2000 correspond to average for January-September.
5/ Includes capital transfers.
6/ Data for 2000 correspond to June.
7/Data for 2000 correspond to July.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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