Public Information Notice: IMF Concludes  2003 Article IV Consultation with Portugal

March 22, 2004

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2003 Article IV consultation with Portugal is also available.

On March 15, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Portugal.1


A prolonged, euro-entry-related expansion ended in a recession in mid-2002, and real GDP declined significantly in 2003. Private consumption contracted as households adjusted to high indebtedness levels and rising unemployment, and these factors also reined-in a housing boom. Investment demand was also negatively affected by relatively high corporate leverage ratios and by weakening demand prospects. Moreover, fiscal policies needed to be tightened at this juncture as the opportunity to advance fiscal consolidation was missed during the previous economic expansion. The decline in domestic demand led to a sharp fall in imports, while exports held up relatively well. As a result, the external current account deficit, while still sizable, narrowed markedly over the past two years.

Persistent inflation differentials vis-à-vis the euro area have contributed to considerable losses in competitiveness, but inflation differentials have recently fallen significantly in the wake of the recession. Large wage differentials (not compensated for by higher productivity growth) contributed to inflation rates above the euro-area average in recent years. The recent appreciation of the euro has added to losses in price and cost competitiveness. However, with economic activity and labor market conditions remaining weak, consumer price inflation fell to close to the euro-area level by end-2003.

While private sector credit growth continued to decline significantly in 2003, it remained above growth in nominal incomes. As a result, private sector credit ratios increased further and are well above the euro-area average. The rise in loans continued to exceed the growth in core deposits, and banks financed the gap largely with medium- and long-term debt securities.

Notwithstanding very weak economic conditions, the fiscal deficit was limited to 2.8 percent of GDP in 2003. The outturn benefited from substantial revenues from one-off measures (amounting to 2.5 percent of GDP), including asset sales, the takeover of the postal pension fund as well as the securitization of tax and social security arrears. It also reflected some progress in containing public expenditures, including on wages, but the structural deficit (excluding one-off measures) improved at best marginally in 2003. The 2004 budget targets a fiscal deficit of 2.8 percent of GDP, but staff estimates point to significant slippages, absent further measures.

The authorities and staff expect real GDP to grow by around 1 percent in 2004, well below the euro-area average. The projected recovery remains subject to sizable risks, including those related to stronger domestic balance sheet adjustments in view of high indebtedness levels, and to a further appreciation of the euro.

Executive Board Assessment

Executive Directors commended the Portuguese authorities for the progress achieved in containing the fiscal deficit, strengthening financial sector resilience, and moving forward with structural reforms. This has contributed to ongoing adjustments of large imbalances, including a deceleration in the rise in household indebtedness and a narrowing of the external current account deficit. Directors observed, however, that the task of correcting the imbalances and associated vulnerabilities and laying the foundation for a durable investment rebound and sustained real income convergence is far from complete. Accordingly, the authorities face the difficult challenge of pursuing their fiscal and structural reform agenda with determination in a context of continuing weak domestic demand.

Directors underscored that a robust and sustainable economic recovery hinges on strengthening competitiveness, including to cope with the effects of euro appreciation and the challenges arising from EU enlargement. Along with structural reforms, this will require sufficient wage moderation. Directors welcomed, in this context, the policy of continued wage moderation for the public sector, which they expected to provide an important signal for private sector wages, and encouraged continued close cooperation with the social partners in this area.

Directors commended the authorities' efforts to contain the fiscal deficit in line with the requirements of the Stability and Growth Pact, despite sharply deteriorating economic conditions. The adjustment had rightly focused on expenditure measures, with some of them, including the reduction in public sector employment, expected to yield further savings in coming years. Nevertheless, fiscal consolidation has continued to rely extensively on one-off measures, and, as a result, the underlying fiscal deficit remains large, even when accounting for the impact of the recession. While welcoming the consolidation target for 2004, Directors pointed out that additional measures should be considered—and would likely be needed—to ensure that the budget targets are fully secured.

Concerning the medium term, Directors supported the government's objective of an evenly-paced fiscal consolidation by about ½ percentage point of GDP per annum until 2007, to be achieved through high-quality adjustment measures. A sustained effort toward this objective will be needed to strengthen public sector saving and help achieve further reductions of the external current account deficit. To strengthen the credibility of the consolidation path, Directors called on the authorities to establish a clear timetable for the elimination of one-off measures over the next few years, by replacing them with durable expenditure reductions.

Directors, accordingly, welcomed the focus of the fiscal adjustment program on expenditure restraint, including through efficiency improvements in public services and health care. They urged the authorities to press ahead with the vigorous implementation of the civil service reform, and to extend hiring limits to all parts of the public sector. Directors emphasized the need to proceed with further reforms of aging-related spending, and viewed early progress in this area as indispensable for securing fiscal solvency. They encouraged the authorities to fully implement the recommendations of the fiscal Report on the Observance of Standards and Codes (ROSC), and to give priority, in this context, to strengthening budget planning and control and moving toward comprehensive multi-year budget targets.

Directors recognized that reductions of the tax burden could enhance economic growth prospects. At the same time, however, they stressed that the growth benefits of tax cuts will depend on corresponding expenditure reductions, which—along with improved tax administration—will help safeguard the fiscal consolidation objectives. In this regard, they noted that expenditure cuts to offset the revenue losses arising from the corporate tax reductions in 2004 still need to be put in place.

Directors noted that financial sector performance had generally held up well during the recession, supported by earlier supervisory and regulatory initiatives. Nevertheless, against the backdrop of historically high private sector indebtedness and risk concentrations, especially to the real estate sector, potential vulnerabilities remain. These require continued supervisory vigilance. In particular, Directors underscored the need for careful monitoring of capital and provisioning levels and for assessing financial institutions' resilience on the basis of regular stress tests. They also considered that market-based discipline could be enhanced by further strengthening disclosure requirements. Directors strongly welcomed the intention to request a more in-depth financial sector review under the Financial Sector Assessment Program (FSAP) in 2005. They commended the authorities' ongoing efforts to combat money laundering and terrorism financing.

Directors underscored that raising the productivity of the Portuguese economy from its below-EU average level remains key to securing a durable convergence in living standards. Progress in this area will depend on sustaining ongoing reform efforts in a range of areas. Steps will be needed to improve general education and vocational training, and to encourage research and development. While the establishment of a fully independent competition authority is welcome, the authorities should make further efforts to strengthen competition, including through implementing the government's privatization program and facilitating market entry and exit. Directors welcomed recent reforms to add flexibility to labor market arrangements, and saw scope for further steps to address Portugal's restrictive employment dismissal restrictions.

While progress has been made in improving the timeliness and coverage for some fiscal data, Directors encouraged the authorities to address remaining statistical shortcomings expeditiously, including in the area of real sector data.

Directors urged the authorities to continue to actively support further trade liberalization in the context of the Doha Round. They also encouraged efforts toward raising Portugal's official development assistance.

Portugal: Selected Economic Indicators, 2000-04





2003 1/

2004 1/

Real economy (change in percent)


Real GDP






Domestic demand






CPI (year average, harmonized index)






Unemployment rate (in percent)






Gross national saving (percent of GDP)






Gross domestic investment (percent of GDP)







Public finance (percent of GDP)


General government balance






Primary balance






Public debt







Money and credit (end-period, percent change)


Total domestic credit






National contribution to euro area M3 2/







Interest rates (end-period)


Deposit rate, up to 2 years 3/






Ten-year government bond yield







Balance of payments (percent of GDP)


Trade balance






Current account (including capital transfers)






Net official reserves (in US$ billions, end of period)







Exchange rate


Exchange rate regime

Euro-area member


Present rate (March 15, 2004)

US$1.23 per €1


Nominal effective rate (1995 = 100)






Real effective rate (1995 = 100)







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


1/ 2003 is estimate and 2004 is staff projections.

2/ Excludes currency in circulation held by non-bank private sector.

3/ Data refer to new deposits for 1997-2002 and to the stock of outstanding deposits thereafter. Before 2003 deposit rate with 91-180 day maturity is reported.


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.


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