Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Portugal

October 24, 2006

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. The Staff Report for the 2006 Article IV Consultation with the Portugal is also available

Public Information Notice (PIN) No. 06/124
October 24, 2006

On October 18, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Portugal.1


A gradual economic recovery is underway after a largely flat outturn in 2005. Year-on-year GDP growth accelerated to 1 percent in the first half of 2006, on the strength of a pickup in exports and resilient private consumption, though investment remained weak. Meanwhile, the unemployment rate reached a seven-year high of 8 percent in the last quarter of 2005, before moderating to 7.3 percent in the second quarter of 2006. Due in part to an increase in the rate of the Value-Added Tax in mid-2005, inflation rose to 2.7 percent in the first half of 2006. The current account deficit (including capital transfers) widened to 8.1 percent of GDP last year.

High private indebtedness (especially among households), weak competitiveness, and significant fiscal consolidation are expected to weigh on growth in the near future, but stronger foreign demand is forecast to lead to a better external contribution to growth than in previous years. Real GDP is projected to grow by about 1.2 percent in 2006 and 1½ percent in 2007.

The authorities have committed to reduce the fiscal deficit from 6 percent of GDP in 2005 to below 3 percent of GDP by 2008 without recourse to one-off measures. The 2006 budget targets a reduction in the deficit to 4.6 percent of GDP. A little more than half of this year's deficit reduction is to come from the full-year impact of revenue measures announced last year, with the balance coming mostly from savings in the public wage bill and intermediate consumption. Several major structural fiscal reforms are expected to contribute to achieving the medium-term deficit targets, including measures to streamline the public sector, flexibilize the civil service, and overhaul the social security system for private sector workers. Steps are also underway to improve the efficiency of spending on health and education, and to modify the system of local government financing.

A Financial Sector Assessment Program mission undertook an extensive review of Portugal's financial system, finding it to be generally sound. The banking sector has proven resilient to the economic downturn: indicators point to improved capitalization, solid profitability and low nonperforming loans. Strong growth of bank lending to households, especially for mortgages, has led to a continued increase in the private sector credit-to-GDP ratio, which reached about 150 percent by the end of 2005 (the highest value in the EU). Bank lending remains concentrated among a limited number of large corporates (albeit within supervisory limits), and the exposure of banks' employee pension schemes to the stock market is relatively high. However, the FSAP mission considered these risks to be manageable.

Executive Board Assessment

While welcoming the modest recovery of output growth and recent progress on economic reforms, Executive Directors concurred that Portugal continues to confront considerable challenges to accelerate growth and resolve large fiscal and external imbalances. Directors encouraged the authorities to use the opportunity provided by the current favorable environment to address these challenges through a coordinated approach, noting that decisive progress in each area could generate a virtuous cycle of faster growth and adjustment in the medium term.

Directors considered the government's strategy to be broadly appropriate, but underscored that firm and sustained implementation remains essential to its success. They supported the focus on expenditure-based fiscal consolidation to bring the deficit under 3 percent of GDP by 2008 without one-off measures; on structural fiscal reforms to contain aging-related spending, raise the efficiency and quality of public spending, and promote the sustainability of the public finances; and on reforms to enhance competition in product markets and improve the business environment, so as to spur productivity growth.

Directors concurred that achievement of the 2006 fiscal deficit target of 4.6 percent of GDP would be important to ensuring the credibility of the adjustment effort, and welcomed the authorities' commitment to reinforce budget measures, if necessary, to achieve the deficit target. Going forward, they stressed the importance of shifting the fiscal effort from reliance on revenue measures toward the spending side in order to address the root cause of current fiscal weaknesses, namely, the steady rise of spending-especially on pensions and wages-over the last decade. This will require moving forward with planned reforms to the civil service, to the structure of the public sector, and to the social security system for private sector workers. Directors urged the authorities to work toward decisive implementation of these structural fiscal measures. They also supported ongoing efforts to improve arrangements for local and regional government financing, and the authorities' consideration of a multiyear budget framework with explicit expenditure ceilings.

Directors recognized that additional fiscal adjustment would be needed beyond 2008 to ensure long-term sustainability and to create scope for automatic fiscal stabilizers to operate in future downturns. Forecasts of aging-related spending point to large increases in pension and health expenditure in the coming years, and a sustained effort will therefore be needed to prevent the public debt from rising sharply over the long term. It would be important to reevaluate the adequacy of any medium- to long-term fiscal target periodically in light of developments with output growth and health and pension spending.

Directors stressed the need for progress with structural reforms aimed at supporting the continued transformation of the Portuguese economy and its public sector, by strengthening domestic competition, improving the business environment, and increasing government efficiency. They welcomed the Government's Technological Plan and recent steps to remove bureaucratic and regulatory impediments to business, as well as the authorities' intention to accelerate legal processes and ease licensing burdens for firms. Directors saw the reinvigorated privatization process as a key component of the overall strategy to reduce the role of the state in the economy and enhance efficiency. They also supported the work of the Competition Authority, and called for continued efforts to enhance competition, especially in key network sectors. Efforts to upgrade the educational system should also remain a priority.

While welcoming recent changes to the unemployment compensation system, Directors encouraged the authorities to pursue more fundamental labor market reform. They noted that strong nominal wage growth even in the face of increases in the unemployment rate, high rates of long-term unemployment, and heavy reliance on fixed-term contracts and self-employment all point to the presence of significant rigidities in labor markets. Against this backdrop, Directors recommended measures to increase labor market flexibility, including changes in collective bargaining provisions to allow greater responsiveness to individual firm conditions, with a view to raising productivity, promoting wage moderation, and strengthening the economy's overall competitive position.

Directors welcomed the finding by the FSAP that Portugal's financial system is sound, well managed, competitive, and well supervised. They encouraged the authorities to implement the FSAP recommendations, and called on the authorities to continue to monitor risks closely. Continued vigilance will be important in a context of relatively high levels of household and corporate debt, concentration of bank lending to the real estate sector and to a limited number of large corporates, and exposure of banks' employee pension schemes to the stock market. While the financial system's profitability and solvency buffers appear to be capable of absorbing even severe disturbances to the macroeconomic environment, Directors cautioned that the system's capacity to respond to shocks should be reassessed periodically.

Directors looked forward to increases in Portugal's official development assistance toward the U.N. target level.

Portugal: Selected Economic Indicators, 2002-07

  2002 2003 2004 2005 1/ 2006 1/ 2007 1/

Real economy (change in percent)


Real GDP

0.8 -1.1 1.2 0.4 1.2 1.5

Domestic demand

0.0 -2.2 2.3 0.7 1.1 1.4

CPI (year average, harmonized index)

3.7 3.3 2.5 2.1 2.6 2.2

Unemployment rate (in percent)

5.0 6.3 6.7 7.6 7.7 7.6

Gross national saving (percent of GDP)

17.4 16.9 15.9 13.0 12.6 12.6

Gross domestic investment (percent of GDP)

25.2 22.8 22.9 22.3 22.4 22.4

Public finance (percent of GDP)


General government balance

-4.2 -5.3 -5.3 -6.0 -4.6 -3.7

Primary balance

-1.3 -2.5 -2.7 -3.3 -1.7 -0.8

Public debt

55.5 57.0 58.6 64.0 67.6 68.7

Money and credit (end-period, percent change)


Total domestic credit

2.9 2.0 2.0 2.1 ... ...

National contribution to euro area M3 2/

-1.1 4.3 5.7 5.8 ... ...

Interest rates (end-period)


Deposit rate, up to 2 years 3/

2.9 2.0 2.0 2.1 ... ...

Ten-year government bond yield

4.5 4.4 3.6 3.5 ... ...

Balance of payments (percent of GDP)


Trade balance

-10.4 -9.1 -10.5 -11.4 -11.9 -11.5

Current account (including capital transfers)

-6.4 -4.0 -5.7 -8.1 -8.2 -8.2

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

15.9 11.5 10.7 10.9 ... ...

Exchange rate


Exchange rate regime Euro-area member


Present rate (August, 2006) US$1.28 per €1


Nominal effective rate (2000 = 100)

101.3 104.6 105.4 105.6 ... ...

Real effective rate (2000 = 100)

104.9 109.6 110.6 110.7 ... ...

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

1/ 2005 is estimate, and figures for 2006 and 2007 are projections.

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

3/ Data refer to new deposits for 2002 and to the stock of 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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