Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Portugal

October 11, 2007

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 (use the free Adobe Acrobat Reader to view this pdf file) for the 2007 Article IV Consultation with Portugal is also available.

Public Information Notice (PIN) No. 07/126
October 11, 2007

On September 28, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Portugal.1


A modest recovery is finally underway. Growth rose to 1.3 percent in 2006, led by strong external demand, which is driving a notable rebound in export growth. In response, corporate investment shows signs of strengthening, but overall domestic demand remains relatively weak. While employment and participation rates have risen, unemployment has edged up to 7.9 percent in the second quarter of 2007. Inflation has remained consistently higher than the euro area average despite a still-significant output gap and sluggish demand. The current account deficit (including capital transfers) remained around 8½ percent of GDP last year.

Real GDP growth is projected to strengthen to about 1.8 percent in 2007 and 2008, though the tensions in financial markets have increased the downside risks. Robust external demand is forecast to lead to a positive contribution from the external sector, while domestic demand is expected to remain subdued. Private consumption is forecast to remain constrained by weak employment growth and high indebtedness. While some corporate balance sheet restructuring has occurred, still-high enterprise debt levels and tighter credit conditions may restrain any rebound in investment. With the envisaged fiscal consolidation, modest further structural reforms are projected to prompt a gradual recovery in competitiveness and productivity.

The overall fiscal balance improved sharply from a deficit of 6.1 percent of GDP in 2005 to 3.9 percent of GDP in 2006, outperforming the original deficit target of 4.6 percent of GDP. The improvement was mostly driven by much-needed reduction in primary spending. Reflecting stronger-than-expected fiscal outturns in 2006, the authorities have lowered their deficit targets for 2007 and 2008. The restructuring of the central administration will play a central role in achieving fiscal consolidation goals and improving productivity. Recent reforms to the social security system have significantly improved the long-term sustainability. Important steps to move to performance-based budgeting are underway.

Portugal's financial system remains sound and well supervised and appears to have weathered the recent tensions in financial markets relatively well, though risks remain. While intensified competition has resulted in a slight deterioration in banks' liquidity ratios, average loan-to-value ratios are in line with other EU countries, and nonperforming loans remain low. High household and corporate debt remains the main source of risk to the financial system, but the Financial Sector Assessment Program (FSAP) exercise last year found that the financial system could withstand even severe macroeconomic disturbances. In accordance with the Bank of Portugal's plans, and also in line with the FSAP recommendations, the Bank of Portugal has further strengthened its supervisory capacity with the adoption of a new risk rating system, a Household Wealth Survey has been finished, and housing price statistics have been enhanced.

Executive Board Assessment

Executive Directors welcomed Portugal's modest economic recovery in 2006 after several years of sluggish growth. Directors commended the decisive action taken by the government to correct fiscal imbalances, reform the social security system, and improve the business environment.

Nevertheless, Directors recognized that the underlying economic situation remains challenging and that external competitiveness remains weak. Much remains to be done to achieve higher trend growth and income convergence with the European Union. Moreover, Directors noted that downside risks to the near-term outlook have risen recently as a result of the disturbances in international financial markets and the projected slowdown of growth in the United States. They emphasized that overcoming Portugal's imbalances will require that the authorities build on the reform momentum to further consolidate the public finances, streamline the public sector, and boost productivity and competitiveness.

Directors commended the authorities for a fiscal deficit reduction that went beyond their already ambitious target for 2006, without recourse to one-off measures. They particularly welcomed the expenditure-based nature of the consolidation and the buoyant revenue growth. This strong performance owes much to the authorities' commitment to strictly adhere to expenditure targets, enhance local government finances, and improve tax administration.

Directors welcomed the authorities' intention to accelerate the pace of fiscal consolidation in 2007 and 2008, and to save any revenue overperformance and take contingency measures in case of spending overruns. A number of Directors considered that somewhat more ambitious deficit targets for 2007 and 2008 seem warranted given the continuing revenue boom, and would enhance the credibility of achieving the government's medium-term objective of reducing the structural deficit to half a percent of GDP in 2010.

Directors welcomed progress in restructuring the central administration. They noted that the process is entering a critical and challenging phase of moving significant numbers of civil servants to the special mobility pool, and emphasized the importance of following through to achieve the envisaged fiscal consolidation and to boost productivity.

Directors stressed that there is no room for a discretionary reduction in the tax burden in the near term. But they saw scope for building on the recent improvement in the efficiency of tax administration by further simplifying some tax laws and procedures. Directors also welcomed the plan to move to performance-based budgeting and a medium-term budgeting framework, which could substantially improve the efficiency of public spending, and recommended that the timetable not be unduly demanding.

Directors stressed the need for a comprehensive structural reform strategy to significantly enhance Portugal's competitiveness and growth. They stressed that key components of this strategy involve strengthening productivity, including by enhancing contestability in the nontradable sector, and addressing the cost side of competitiveness through policies that foster wage moderation.

Directors encouraged the authorities to address labor market rigidities more fully. They welcomed the "New Opportunities" program to upgrade skills and the establishment of a commission to consider labor market reform, noting that the latter should be quickly followed up by concrete measures. In particular, most Directors stressed the need to ease employment protection legislation, end the automatic extension of collective contracts, and make procedures less cumbersome. Concern was expressed about the authorities' recent decision to sharply increase the minimum wage.

Directors noted that strengthening ongoing product and service market reform could help support reform in general by boosting competitiveness and consumer welfare. They welcomed the important progress in enhancing the business environment and increasing competition in the energy sector, while noting that much more remains to be done. In particular, Directors emphasized the need to enhance competition in network industries and some service sectors, and to strengthen the judicial system.

Directors welcomed the finding that the financial system is sound and well supervised, and that bank liquidity remains adequate despite recent financial market disturbances. They noted, however, that some risks have risen in light of these disturbances, and advised continued vigilance by the supervisory authorities given the large foreign borrowing by banks and the high indebtedness of the corporate and household sectors. Directors welcomed the progress made with implementing last year's FSAP recommendations.

Portugal: Selected Economic Indicators, 2001-2008
  2002 2003 2004 2005 2006 /1 2007 /1 2008 /1

Real economy (change in percent)


Real GDP

0.8 -0.7 1.3 0.5 1.3 1.8 1.8

Domestic demand

0.0 -2.0 2.4 0.8 0.3 1.0 1.3

CPI (year average, harmonized index)

3.7 3.3 2.5 2.1 3.0 2.5 2.4

Unemployment rate (percent)

5.0 6.3 6.7 7.6 7.7 7.4 7.1

Gross national saving (percent of GDP)

17.1 16.8 15.3 12.7 12.6 12.7 12.6

Gross domestic investment (percent of GDP)

25.2 22.9 23.0 22.5 22.0 21.9 21.7

Public Finance (percent of GDP)


General government balance 2/

-4.2 -5.2 -5.4 -6.1 -3.9 -3.3 -2.4

Primary balance 2/

-1.3 -2.5 -2.8 -3.4 -1.1 -0.4 0.4

Public debt

55.5 56.8 58.2 63.6 64.8 65.1 64.9

Money and credit (end-of-period, percent change)


Total domestic credit 3/

6.5 6.6 7.3 7.4 10.6 ... ...

National contribution to euro area M3 4/

-1.1 4.3 5.7 5.8 3.4 ... ...

Interest rates (end-period)


Deposit rate, up to two years 5/

2.9 2.0 2.0 2.1 2.7 ... ...

Government benchmark bond yield

4.5 4.4 3.6 3.5 4.0 ... ...

Balance of payment (percent of GDP)


Trade balance

-10.4 -9.1 -10.4 -11.3 -10.7 -10.0 -9.6

Current account (including capital transfers)

-6.6 -4.2 -6.2 -8.5 -8.6 -8.4 -8.4

Net official reserves (in U.S.$ billions, end of period)

15.9 11.5 10.7 10.9 9.4 ... ...

Exchange rate


Exchange rate regime -- euro-area member


Present rate (September 28, 2007) U.S.$1.42 per euro


Nominal effective rate (2000=100)

101.3 104.6 105.4 105.6 105.8 ... ...

Real effective rate (2000=100)

104.9 109.6 110.6 110.7 111.4 ... ...

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

1/ 2006 is estimate, and figures for 2007 and 2008 are projections.

2/ Excludes one-off measures.

3/ The annual growth rates are obtained from the relation between the outstanding amounts and the monthly transactions, which are calculated from the outstanding amounts corrected for reclassifications, write-offs/write-downs, exchange rate changes, and price revaluations.

4/ Excludes currency in circulation held by nonbank private sector.

5/ Data refer to new deposits for 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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