## cr18273

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### EXECUTIVE SUMMARY — Recent developments
- Real GDP growth: 2.7 percent in 2017.
- Growth in 2018:Q1: 2.1 y-o-y (0.4 percent q-o-q).
- Investment and tourism:
  - Investment in equipment and machinery grew vigorously in 2017 and 2018:Q1.
  - Tourism growth remained strong but capacity constraints emerging (example: Lisbon Airport).
- Labor market:
  - Unemployment fell from 10.1 percent in December 2016 to 7.1 percent in April 2018.
  - Labor force participation rose; employment creation broad-based.
- Output gap: estimated to have narrowed in 2017 and to turn positive in 2018.
- Inflation:
  - Headline inflation: 2 percent y-o-y in June 2018.
  - Core inflation: 1.5 percent.
- Unit labor costs: increased in nominal and real terms; compensation per worker grew on average while labor productivity declined in the past two years.
- External and trade:
  - Imports of goods increased strongly, reducing the goods trade balance by more than one-percentage point of GDP in 2017.
  - Growth in exports of services (led by tourism) limited overall decline in goods and services balance to 0.3 percentage points.
  - Current account balance: essentially unchanged in 2017.
- Fiscal outcomes:
  - Underlying fiscal balance improved in 2017.
  - Headline fiscal deficit widened to 3.0 percent of GDP owing to one-off payments (2.0 percent of GDP) mainly associated with bank recapitalization costs.
  - Primary structural stance tightened by 0.4 percent of GDP.
- Financial markets and banking:
  - 10-year sovereign spreads around 130 basis points vis-à-vis the German bund in late July 2018 (down from over 300 bps in early 2017).
  - S&P and FITCH upgraded Portugal to investment grade in 2017.
  - ECB purchases supported bond markets, though their importance has waned.
  - Credit contraction essentially halted; new loans rising especially to households; new loans to firms in dynamic tradable sectors accelerated.
  - Banking sector: average CET1 ratio rose 2.5 percentage points since end-2016 to 13.9 percent at end-2017.
  - NPLs fell by EUR 9.4 billion from EUR 46.4 billion at end-2016 to EUR 37.0 billion at end-2017; NPL ratio 13.3 percent of gross loans at end-2017 (from 17.2 percent).
  - Impairment coverage ratio: 49.4 percent at end-2017 (from 45.3 percent at end-2016).
  - Liquidity coverage ratio: 173.4 percent at end-2017 (minimum 100 percent required since January 2018).
  - Novo Banco: loss of nearly €1.4 billion in 2017; impairments of €2 billion mostly related to assets covered by the contingent capital agreement.
- Authorities’ Stability Program 2018–2022 view: 2018:Q1 deceleration largely temporary; April and May 2018 data indicated an acceleration of exports.

### OUTLOOK AND RISKS
- Staff baseline growth projections:
  - 2018: Real GDP growth projected at 2.3 percent.
  - 2019: 1.8 percent.
  - Medium term: gradual moderation under a baseline with no new significant reforms.
- Drivers: investment and exports remain drivers at a slower pace; private consumption eases somewhat.
- Labor market and inflation:
  - Employment growth expected to decelerate; average unemployment projected to decline below 7.5 percent in 2018.
  - Staff projects consumer inflation of 1.7 percent for 2018 and 2.1 percent over the medium term.
- External sector: 2018 external current account balance expected to deteriorate somewhat owing to strong import demand.
- Fiscal projections and public debt:
  - Headline fiscal deficit projected at 0.7 percent of GDP in 2018.
  - Public debt projected at 121 percent of GDP at end-2018 (down from 126 percent in 2017).
  - Public debt projected to decline to 103 percent of GDP by 2023 assuming a largely unchanged structural primary balance after 2018 and no major one-off expenditures.
- Downside risks (Annex II), especially external, tilt downward:
  - Significant weakening of growth in the euro area.
  - Renewed market instability related to policy uncertainty in key euro area countries.
  - Additional tightening of global financial conditions affecting highly leveraged firms and households.
  - Turn toward protectionism affecting export-oriented value chains.
  - Additional increases in real labor costs harming corporate profits.
  - Policy slippages or erosion of past reforms.
- Upside: exports and tourism could continue to surprise positively if bottlenecks are eased; further reforms could strengthen the economy.
- Authorities’ view: Stability Program sees growth above 2 percent in coming years; authorities cite at least 40 percent of prospective 12-month needs in government cash buffers.

### MACRO-FINANCIAL ISSUES AND POLICIES
- Deleveraging and indebtedness:
  - Net flow of loans to households turned positive in 2017 for the first time since 2011.
  - End-2017 debt ratios: household debt 73.4 percent of GDP; NFC debt 139.1 percent of GDP.
  - Euro area medians: household debt 56.2 percent of GDP; NFC debt 124.9 percent of GDP.
  - Mortgages: long maturities averaging 33 years.
  - Household saving rate: 5.4 percent of disposable income in 2017.
- Macroprudential measures (Banco de Portugal; Box 1):
  - Effective July 1, 2018, under ‘comply or explain’.
  - Main provisions:
    - LTV ratio for new mortgages for primary residence cannot exceed 90 percent (80 percent for purposes other than primary residence).
    - DSTI ratio should not exceed 50 percent, with limited exceptions.
      - For variable/mixed rate loans, banks must calculate DSTI assuming interest rate increases of 100 basis points for loans with maturity below five years, 200 basis points for maturities between five and 10 years, and 300 basis points for maturities over 10 years. Income net of taxes and social security contributions used.
    - Mortgage maturity capped at 40 years; average maturity of new credit agreements should gradually converge to 30 years by 2022.
    - Consumer credit maturity capped at 10 years.
    - New loans to be granted with regular payments of interest and capital.
  - Staff welcomes activation and calls for close monitoring and supplementation if warranted.
- Banking sector resilience and supervision:
  - Continue implementing NPL-resolution strategy.
  - Supervisors should press banks to strengthen risk management and corporate governance.
- Policy balance:
  - Staff view: strong macroeconomic policies have worked and should be sustained.
  - Recommendation to frontload fiscal consolidation envisaged in the Stability Program 2018–2022 to avoid procyclicality.

### NONPERFORMING LOANS (NPLs) — stock, composition, and policy response
- At end-2017:
  - Stock of NPLs: EUR 37 billion (13.3 percent of total loans).
  - About half of NPLs covered by provisions.
  - Majority correspond to loans to NFCs (SMEs), bulk concentrated in three banks.
- Authorities’ NPL resolution strategy three pillars:
  - (i) Supervisory actions under the SSM: regular updates, targets, monitoring and enforcement.
  - (ii) Legal, judicial and fiscal reforms to remove impediments to NPL resolution.
  - (iii) Measures to improve management of NPLs and develop secondary markets for troubled loans.
- Staff assessment: welcomes progress; encourages maintaining momentum and strengthening bank risk management and corporate governance.

### BANK PROFITABILITY AND HEADWINDS
- Net interest income remains main source of profits; moderate levels noted (last obs. 2017Q4).
- Profitability pressures:
  - Deposit rates bottoming out.
  - Funding costs increasing due to MREL issuances.
  - Competition from Fintech and nonbank financial institutions intensifying.
  - High nonperforming assets continue to drag on profitability.
  - Updating business models may involve upfront costs (e.g., branch closures).

### HOUSING MARKET DEVELOPMENTS AND RISKS
- Housing prices:
  - Declined 18 percent in real terms over 2010–13; increased about 20 percent in real terms up to 2017 (7.9 percent in 2017).
  - Price increases concentrated in Lisbon, Porto and the Algarve.
- Transactions:
  - Driven largely by transactions on existing dwellings by non-residents.
  - Share of housing transactions financed by Portuguese mortgages reached 41 percent in the last quarter of 2017.
- ECB May 2018 Financial Stability Review: suggests incipient signs of overvaluation in the residential real estate market.
- Recommendation: improve quality of real estate data, analytical tools, monitor mortgage markets, and evolution of risks to banks.

### EXTERNAL BALANCE AND OUTLOOK
- External position:
  - Current account surplus of 0.5 percent of GDP in 2017; staff projects a moderate deficit over the next several years as domestic demand increases and tourism growth subsides.
  - Staff see a current account shortfall of about 2–4 percent of GDP in the medium term.
  - EBA REER results suggest an overvaluation of about 5–10 percent.
- NIIP and external debt:
  - NIIP: about -106 percent of GDP at end-2017 (declined from peak of -118 percent in 2014).
  - Gross external debt: 211 percent of GDP in 2017.
  - Substantial improvement of NIIP would require sustained current account surpluses over the medium term.
- Policy recommendations: quality upgrades, innovation, structural, fiscal, and financial policies, and maintenance or improvement in price competitiveness.

### FISCAL ISSUES, TARGETS, AND RECOMMENDATIONS
- Fiscal outcomes and projections:
  - Controlling for CGD capitalization, budget closed 2017 with overall deficit 0.9 percent of GDP (lower than original 2017 forecast of 1.6 percent).
  - Stability Program 2018–2022 (April 2018) 2018 target: -0.7 percent of GDP.
  - Staff expect authorities will meet the 2018 target.
  - Staff project public debt to GDP ratio to decline to 103 percent of GDP by 2023 assuming unchanged policies.
- Structural primary balance and spending pressures:
  - Structural primary balance would deteriorate by about 0.3 percent of GDP in 2018 when temporary factors removed.
  - Unfreezing of career progression estimated net cost EUR 200 million in 2018 (0.1 percent of GDP).
  - Gradual transition to a 35-hour week in public sector continues; public investment remains low by cross-country and historical standards.
- Recommendation: front-load fiscal consolidation
  - Stability Program envisages a 1.5 percent of GDP adjustment in the primary balance (minus one-offs) over 2018–22.
  - Staff suggests considering a one percent of GDP tightening of the structural primary balance cumulatively over 2018–2019 and aiming to over-perform on the official overall balance target for 2018.
  - Rationale: build policy space, accommodate contingent liabilities (e.g., Novo Banco), shorten time to reduce public indebtedness.
- Debt context:
  - Portugal’s debt to GDP ratio is 40 percentage points above the euro area average of 86.7 percent of GDP in 2017.
  - Faster, sustained strengthening in structural primary balance could shorten time to reach 85 percent of GDP by three or more years, depending on growth and interest rate assumptions.
- Expenditure and structural reforms:
  - Recommend durable expenditure reform focusing on current balance to preserve public capital.
  - Reforms to public employment and pensions needed; medium-term revisit of ‘grandfathering’ of existing pensioners recommended.

### BUDGET MONITORING, HEALTH SECTOR ARREARS, AND PUBLIC ACCOUNTING
- Budget monitoring and control need improvement.
- Health sector:
  - About €1.4 billion in 2017–18 injected to clear arrears; without addressing root causes this is unlikely to provide durable results.
  - Recent initiatives (e.g., joint unit by health and finance ministries) are positive; effectiveness should be monitored.
- Local governments: should not delay transition to integrated accrual-based public accounting.

### ANNEX I — PUBLIC DEBT SUSTAINABILITY ANALYSIS (DSA) — Baseline and risks
- Baseline debt and projections:
  - Public debt in 2017: 126 percent of GDP.
  - Debt fell by 4.2 percentage points of GDP in 2017.
  - Primary balance in 2017: 0.9 percent of GDP.
  - Interest bill in 2017: 3.9 percent of GDP.
  - Public debt projected to decline from 126 percent of GDP in 2017 to 103 percent of GDP in 2023 (decline of 22 percent of GDP over six years).
  - Contributions to projected reduction:
    - Cumulative reduction from primary balance: 19 percentage points of GDP.
    - Cumulative reduction from real GDP growth: 11 percentage points of GDP.
    - Interest bill expected to decline from 3.9 percent of GDP in 2017 to 2.9 percent of GDP in 2023.
- Risk assessment:
  - Elevated debt leaves Portugal highly vulnerable to macroeconomic and financial shocks.
  - Debt will exceed 85 percent of GDP high-risk threshold throughout forecast horizon.
  - Government gross financing needs (GFN) expected to remain below 20 percent of GDP high-risk threshold; 2021 amortization profile implies a spike to 17 percent.
  - Total economy external financing requirement: 50 percent of GDP.
  - Skew of risks: to higher debt; recommendation to raise structural primary balance gradually.
- Stress test scenarios (2018–2023):
  - Growth shock: -2.3 percent applied in 2019 and 2020 → debt rises to 124 percent of GDP.
  - Primary balance shock: -1.7 percent of GDP applied in 2019 and 2020 → debt rises to 117 percent of GDP in 2020.
  - Interest rate shock: 350bps over 2018–23 → debt 3 percent of GDP higher than baseline by 2023.
  - Standard contingent liability shock: equal to 10 percent of GDP → debt higher by 10 percent of GDP.
  - Severe combined shock: raises debt above 130 percent of GDP.
  - Upside scenario (authorities achieve overall balance in Stability Program): debt of 99 percent of GDP by 2023.
- Novo Banco contingent liabilities (Box A2):
  - Sale to Lone Star October 2017 included Contingent Capital Agreement.
  - Resolution Fund retained 25 percent of shares and exposed to covered troubled assets.
  - Cumulative limit to compensation payments: €3.89 billion (2 percent of 2017 GDP) over eight years.
  - Resolution Fund payment to Novo Banco: €792 million (0.4 percent of GDP) in 2017.
  - Resolution Fund borrowed about €430 million from the government to finance part of this payment.
  - Novo Banco reported a loss of nearly €1.4 billion in 2017; impairments €2 billion.

### ANNEX II — RISK ASSESSMENT MATRIX (selected risks and policy responses)
- Loss of investor confidence:
  - Relative Likelihood: Low
  - Impact: High
  - Policy response: Strengthen policy buffers; avoid backtracking on reforms.
- Rising protectionism and retreat from multilateralism:
  - Relative Likelihood: High
  - Impact: High
  - Policy response: Stronger macro-financial and structural policies.
- Weaker-than-expected global growth / Euro Area slowdown:
  - Relative Likelihood: Medium
  - Impact: High
  - Policy response: Step up structural reforms; clean up corporate and bank balance sheets.
- Sharp tightening of global financial conditions:
  - Relative Likelihood: High
  - Impact: High
  - Policy response: Implement policies supporting growth, fiscal adjustment, balance sheet clean-up, and a strong banking system.
- Note on coding: "low" <10 percent; "medium" 10–30 percent; "high" ≥30 percent.

### ANNEX III — EXTERNAL SECTOR ASSESSMENT
- NIIP and external debt:
  - NIIP: -105.7 percent of GDP in 2017 (declined from -118.6 percent in 2014).
  - Gross external debt: 211 percent of GDP in 2017.
  - Both expected to decline but at decelerating rate as current account moves to deficit.
- Current account:
  - Current account surplus 0.5 percent of GDP in 2017; projected to deteriorate with rising import demand.
  - Staff assesses a current account shortfall of about 2–4 percent of GDP needed in the medium term to strongly improve NIIP.
- REER and competitiveness:
  - EBA index regression suggests overvaluation of 4.9 percent for 2017.
  - Applying model elasticity and current account gap suggests REER overvaluation in range of 5 to 10 percent.
- Policy responses:
  - Sustained fiscal consolidation and structural reforms to improve competitiveness and potential growth.
  - Continued fast reduction of NPLs while keeping adequate capital buffers.

### ANNEX IV — LABOR MARKET DEVELOPMENTS AND PRODUCTIVITY
- Potential growth and labor:
  - Long-term potential growth estimated around 1¼ percent (1.5 percent in per capita terms).
- Labor market indicators:
  - Activity rate 66.2 percent in 2017 (EU 64.7; EA 64.2).
  - Labor force participation increased by 0.8 percent in 2017; projected to recover further by about 0.2 percent per year.
- Skills and composition:
  - Low-skilled workers: 47 percent in 2017 (EU average 18 percent).
  - Self-employment: 14.3 percent in 2017 (EU average 13.4 percent).
- Policy implications: address labor market segmentation, foster skill formation, and support human capital to mitigate demographic pressures.

### ANNEX V — PAST RECOMMENDATIONS (implementation status, selected)
- Labor market: safeguard program-era flexibility; progress partially implemented.
- Financial sector:
  - Boost internal capital generation: partially implemented.
  - Remove impediments to NPL resolution: implemented.
  - Address regulatory challenges (IFRS9, MREL): implemented; four-year transition period for MREL noted.
- Fiscal sector:
  - Public sector payments discipline: partially implemented; arrears persist.
  - Structural primary adjustment: not implemented for 2018.
  - Wage bill control: partially implemented; wage bill grew 0.3 percent in real terms.
  - Pension reforms revisit: not implemented.
- Fund relations and statistics:
  - Quota: 2,060.10 SDR Million.
  - Extended Arrangements outstanding: 3,862.69 SDR Million (187.50 percent).
  - Data provision: adequate for surveillance; SDDS+ adherence noted.
- Structural reforms and initiatives: education and skills measures, judicial and insolvency reforms, Capitalizar program, energy sector measures, and continued focus on improving business environment and investment.

### STAFF APPRAISAL — Key recommendations
- Frontload fiscal adjustment envisaged in the Stability Program 2018–2022 to take advantage of favorable cyclical conditions and build policy space.
- Continue NPL-resolution strategy; press banks to strengthen risk management and corporate governance.
- Monitor credit standards closely and be ready to adjust macroprudential measures.
- Strengthen domestic saving to finance private investment and improve external position.
- Implement structural reforms to raise sustainable growth: soundly financed investment, productivity and skills improvements, enhanced business conditions, streamlined regulations, and more flexible institutions and markets.
- Next Article IV consultation: staff recommends standard 12-month cycle.

*International Monetary Fund staff compilation based on the provided Portugal country chapter content.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### RECENT DEVELOPMENTS
- Real GDP growth reached 2.7 percent in 2017, driven by re-energized investment, robust exports, and stable consumption.
- Growth decelerated to 2.1 y-o-y (0.4 percent q-o-q) in 2018:Q1, owing to weaker exports and temporary factors (AutoEuropa and Galp unscheduled stoppages; unusually rainy March affecting construction).
- Investment in equipment and machinery grew vigorously in 2017 and 2018:Q1; tourism growth remained strong but is beginning to face capacity constraints (for example, in Lisbon Airport).
- Unemployment fell from 10.1 percent in December 2016 to 7.1 percent in April 2018, with labor force participation rising and broad-based employment creation.
- Output gap estimated to have narrowed in 2017 and to turn positive in 2018.
- Headline inflation rose to 2 percent y-o-y in June 2018; core inflation was 1.5 percent.
- Unit labor costs increased in nominal and real terms; compensation per worker grew on average while labor productivity declined in the past two years.
- Imports of goods increased strongly, reducing the goods trade balance by more than one-percentage point of GDP in 2017; growth in exports of services (led by tourism) limited the overall decline in the goods and services balance to 0.3 percentage points. Current account balance essentially unchanged in 2017.
- The underlying fiscal balance improved in 2017; headline fiscal deficit widened to 3.0 percent of GDP owing to one-off payments (2.0 percent of GDP) mainly associated with bank recapitalization costs. Primary structural stance tightened by 0.4 percent of GDP.
- 10-year sovereign spreads around 130 basis points vis-à-vis the German bund in late July 2018, down from over 300 bps in early 2017. S&P and FITCH upgraded Portugal to investment grade in 2017.
- ECB purchases supported bond markets, though their importance has waned.
- Credit contraction has essentially halted; rising new loans especially to households. New loans to firms in dynamic tradable sectors with better risk profiles have accelerated.
- Banking sector: average CET1 ratio rose 2.5 percentage points since end-2016 to 13.9 percent at end-2017.
- NPLs fell by EUR 9.4 billion from EUR 46.4 billion at end-2016 to an NPL ratio of 13.3 percent of gross loans at end-2017 (from 17.2 percent).
- Impairment coverage ratio increased to 49.4 percent at end-2017 from 45.3 percent at end-2016.
- Liquidity coverage ratio reached 173.4 percent at end-2017 (minimum of 100 percent required since January 2018).
- Novo Banco recorded a loss of nearly €1.4 billion in 2017, driven by impairments of €2 billion, most related to assets covered by the contingent capital agreement.
- Authorities’ Stability Program 2018–2022 view: 2018:Q1 deceleration largely temporary; April and May 2018 data indicated an acceleration of exports.

### OUTLOOK AND RISKS
- Growth projections (staff baseline):
  - 2018: Real GDP growth projected to decelerate to 2.3 percent.
  - 2019: 1.8 percent.
  - Medium term: gradual moderation under a baseline with no new significant reforms.
- Drivers: Investment and exports to remain important drivers, at a slower pace; private consumption eases somewhat.
- Labor market: Employment growth expected to decelerate; average unemployment projected to decline below 7.5 percent in 2018, supporting moderate real wage growth.
- Inflation: Staff projects consumer inflation of 1.7 percent for 2018 and 2.1 percent over the medium term.
- External sector: 2018 external current account balance expected to deteriorate somewhat owing to strong import demand.
- Fiscal projections and public debt:
  - Headline fiscal deficit projected at 0.7 percent of GDP in 2018.
  - Public debt projected at 121 percent of GDP at end-2018, down from 126 percent in 2017.
  - Public debt projected to decline to 103 percent of GDP by 2023 assuming a largely unchanged structural primary balance after 2018 and no major one-off expenditures.
  - Trajectory remains subject to significant risks (Annex I).
- Downside risks (Annex II), especially external, tilt downward:
  - Significant weakening of growth in the euro area would negatively affect Portugal.
  - Renewed market instability related to policy uncertainty in key euro area countries could increase Portuguese bond yields and raise borrowing costs.
  - Additional tightening of global financial conditions could affect highly leveraged firms and households (short-term and variable-rate loans), weaken banks’ balance sheets through higher NPLs and lower government bond values.
  - A turn toward protectionism in the global economy could impact Portugal via European export-oriented value chains.
  - Additional increases in real labor costs could hurt corporate profits.
  - Risk of policy slippages or erosion of past reforms as expansion continues.
- Upside possibilities: Exports and tourism could continue to surprise positively if bottlenecks are eased; further reforms could strengthen the economy.
- Authorities’ view: Stability Program sees growth above 2 percent in coming years; main downside risks from EU developments; authorities cite at least 40 percent of prospective 12-month needs in government cash buffers.

### POLICY DISCUSSIONS — MACRO-FINANCIAL ISSUES AND POLICIES
- Deleveraging and indebtedness:
  - Net flow of loans to households turned positive in 2017 for the first time since 2011, driven by consumer loans and mortgages.
  - For NFCs, positive net flow of financial debt due to intra-group lending by non-residents; NFCs continued to reduce borrowing from the domestic banking system.
  - Household saving rate was 5.4 percent of disposable income in 2017.
  - End-2017 debt ratios: household debt 73.4 percent of GDP; NFC debt 139.1 percent of GDP.
  - Euro area medians: household debt 56.2 percent of GDP; NFC debt 124.9 percent of GDP.
  - Mortgages: long maturities averaging 33 years.
- Macroprudential measures deployed by Banco de Portugal (Box 1):
  - Measures aim to prevent overexposures to residential mortgage and consumer loans and minimize household default risk amid low interest rates and heightened competition.
  - Include limits on maturities, loan-to-value (LTV), and debt-service-to-income (DSTI) ratios.
  - Design considers risk of rising debt service burdens as interest rates normalize.
  - Banks began implementing limits early in July (2018).
  - Staff welcomes activation of these macroprudential tools when credit standards were starting to ease, noting that tighter LTV, DSTI, and loan maturities will bolster resilience of financial institutions and households to variations in real estate prices, interest rates, and incomes.
  - Staff calls on authorities to closely monitor effectiveness and to supplement measures if warranted.
- Banking sector resilience and supervision:
  - Continued implementation of NPL-resolution strategy recommended to address lingering vulnerabilities.
  - Supervisors should continue to press banks to strengthen risk management and corporate governance to avoid future NPL build-up and erosion of capital buffers.
- Policy balance:
  - Staff view: strong macroeconomic policies have worked and should be sustained.
  - Frontloading fiscal consolidation envisaged in the Stability Program 2018–2022 would avoid procyclicality by taking advantage of favorable cyclical conditions and would be prudent given future uncertainties.
- Growth and structural policies:
  - Faster sustainable growth needed to reduce vulnerabilities and converge toward EU average productivity and income.
  - Strengthening growth requires fostering soundly financed investment and continuing improvements in productivity and skills.
  - Investment can be spurred by enhancing business conditions, streamlining regulations, and increasing flexibility and responsiveness of institutions and markets, building on past reforms.

*International Monetary Fund. EXECUTIVE SUMMARY, Portugal, August 21, 2018.*

### 14.      Although declining, the stock of NPLs remains a concern. At end-2017, the stock of NPLs

### cr18273 - 14.      Although declining, the stock of NPLs remains a concern. At end-2017, the stock of NPLs

### Nonperforming Loans (NPLs) — stock, composition, and policy response
- At end-2017, the stock of NPLs stood at EUR 37 billion (13.3 percent of total loans), with about half of the NPLs covered by provisions.
- The majority of NPLs correspond to loans to NFCs (SMEs), with the bulk concentrated in three banks.
- Elevated stock of NPLs is tying up resources in the economy and holding back bank profitability.
- Authorities’ NPL resolution strategy based on three pillars:
  - (i) Supervisory actions (under the SSM): requesting regular updates of banks’ NPL reduction strategies, setting targets for NPL reduction, and monitoring and enforcing implementation.
  - (ii) Legal, judicial and fiscal reforms to remove impediments to NPL resolution.
  - (iii) Measures to improve management of NPLs and develop secondary markets for troubled loans.
- Staff assessment: welcomes progress reflected in the significant reduction of the NPL stock; encourages authorities to maintain momentum and press banks to strengthen risk management and corporate governance.

### Bank profitability and headwinds
- Net interest income remains the main source of Portuguese banks’ profits and remains moderate (chart reference: Net Interest Income (Percent of total assets); last obs. 2017Q4).
- Profitability pressures identified:
  - Deposit rates bottoming out.
  - Funding costs increasing due to MREL issuances.
  - Competition from Fintech and nonbank financial institutions intensifying.
  - High nonperforming assets continue to drag on profitability.
  - Updating business models can involve upfront costs (e.g., closing physical branches).

### Macroprudential measures on new mortgage and consumer loans (Box 1)
- Measures announced February 2018; effective July 1, 2018, under principle of ‘comply or explain’.
- Main provisions:
  - LTV ratio for new mortgages for primary residence cannot exceed 90 percent (80 percent for purposes other than primary residence).
  - The DSTI ratio should not exceed 50 percent, with some limited exceptions.
    - For variable or mixed rate loans, banks must calculate DSTI ratios assuming interest rate increases of 100 basis points for loans with maturity below five years, 200 basis points for maturities between five and 10 years, and 300 basis points for maturities over 10 years. For these calculations, income is net of taxes and social security contributions.
  - The maturity of mortgage and related loans is capped at 40 years, and the average maturity of new credit agreements should gradually converge to 30 years by 2022.
  - For consumer credit agreements, the maturity of new loans should not exceed 10 years.
  - New loans should be granted with regular payments of interest and capital.

### Housing market developments and risks
- Housing prices: after a decline of 18 percent in real terms over 2010–13, prices increased by about 20 percent in real terms (7.9 percent in 2017), especially in Lisbon, Porto and the Algarve region.
- Transactions:
  - Increases driven largely by transactions on existing dwellings by non-residents.
  - Share of housing transactions financed by Portuguese mortgages has been growing since 2015, reaching 41 percent in the last quarter of 2017.
- ECB May 2018 Financial Stability Review: suggests incipient signs of overvaluation in the residential real estate market.
- Recommendation: continue to improve quality of real estate data and related analytical tools, and monitor mortgage markets and evolution of risks to banks from real estate developments.

### Authorities’ views on financial sector issues
- Deleveraging: authorities noted nonfinancial private sector’s debt-to-GDP had fallen by 47 percentage points since 2012; continuing deleveraging is key to resilience.
  - Positive net flow of loans to households in 2017 driven by consumer loans; newcomers to credit market accounted for largest contribution.
  - Non-resident sector main contributor to positive net flow of total credit to corporations with access to international securities markets; financing partially channeled to domestic affiliates via intra-group loans.
- Addressing NPLs: authorities highlighted NPL reduction over last two years and measures underway:
  - EU level: implementation of the Action Plan to Tackle Non-Performing Loans in Europe.
  - National measures include:
    - Continuous improvement of legal, judicial and tax framework, including establishment of a common decision body between the tax authority and the social security administration for restructuring negotiations.
    - Enhancement of in-court restructuring and insolvency frameworks (including digitalization).
    - Introduction of measures to speed up out-of-court settlement procedures.
    - Ongoing actions to put in place an early warning mechanism and development of a simplified regime to facilitate transfer of NPL portfolios.
    - Strong execution of bank-level NPL reduction plans and operationalization of the platform for integrated management of NPL cross-exposures.
  - Authorities also indicated strong economic growth would contribute to NPL reduction.
- Bank profitability: authorities expect determined implementation of cost-cutting and income diversification strategies, aided by improved economic outlook, to ease pressure on profitability.
- Mispricing and excessive risk-taking: authorities see no signs of systematic mispricing or excessive risk-taking; point to February 2018 macroprudential measures as preventive.

### External balance and outlook
- Portugal’s external position remained weaker than consistent with medium-term fundamentals and desirable policy settings in 2017 (Annex III).
- Strong improvement in current account since the crisis due largely to rising goods exports and tourism.
- Net International Investment Position (NIIP) remains deeply negative; substantial improvement would require sustained current account surpluses over the medium term.
- EBA model-based estimates: suggest there was no current account gap in 2017.
- Staff projection: current account balance to turn into a moderate deficit over the next several years as domestic demand increases and tourism growth subsides.
  - Staff see a current account shortfall of about 2–4 percent of GDP in the medium term.
  - EBA results on the REER suggest an overvaluation of about 5–10 percent.
- Policy recommendations: continued and sustained quality upgrades and innovation, supported by appropriate structural, fiscal, and financial policies, and maintenance or improvement in price competitiveness.

### Fiscal issues, targets, and recommendations
- Fiscal targets and outturns:
  - Controlling for the capitalization of CGD, budget closed 2017 with an overall deficit (0.9 percent of GDP), lower than original 2018 budget target (1.1 percent of GDP).
  - Stability Program 2018–2022 (April 2018) included a more ambitious 2018 target of -0.7 percent of GDP.
  - Staff expect authorities will meet this target, with improvement driven by smaller expected one-offs, favorable cycle effect, and declining interest bill.
  - Staff project public debt to GDP ratio to decline to 103 percent of GDP by 2023 on assumption of unchanged policies.
- Structural primary balance and spending pressures:
  - When temporary factors removed, structural primary balance would deteriorate by about 0.3 percent of GDP in 2018.
  - Spending pressures acute for wages: unfreezing of career progression estimated net cost of EUR 200 million in 2018, or 0.1 percent of GDP (subject to upward risk).
  - Gradual transition to a 35-hour week in public sector continues; public investment remains low by cross-country and historical standards.
- Recommendation to front-load fiscal consolidation:
  - Stability Program envisages a 1.5 percent of GDP adjustment in the primary balance (minus one-offs) over 2018–22.
  - Structural primary balance loosening by cumulative 0.5 percent of GDP in 2018–19 implies most adjustment occurs in 2020–2021 when growth may be weaker — risk of pro-cyclical stance.
  - Authorities could consider a one percent of GDP tightening of the structural primary balance cumulatively over 2018–2019, including aiming to over-perform on the official overall balance target for 2018.
  - Frontloading would build policy space, help accommodate contingent liabilities (e.g., Novo Banco support), and shorten time to reduce public indebtedness.
- Debt context:
  - Portugal’s debt to GDP ratio is 40 percentage points above the euro area average of 86.7 percent of GDP in 2017.
  - Faster, sustained strengthening in structural primary balance starting now could shorten time to reach 85 percent of GDP by three or more years, depending on growth and interest rate assumptions.
- Expenditure and structural reforms:
  - Continued structural fiscal consolidation should be based on durable expenditure reform and concentrate on current balance to preserve public capital.
  - Expenditure review is valuable but should be complemented with structural reforms to public employment and pensions.
    - Need for well-designed reform of the civil service to improve level and composition of public employment; demographic trends should guide reform.
    - On pensions: measures under consideration to reduce penalties for early retirement of employees with more than 40 years of contributions could increase social security cash-flow needs moderately in near term and should be accompanied by measures generating savings.
    - Medium-term recommendation: revisit ‘grandfathering’ of existing pensioners from recent reforms, focusing on highest pensions.

### Budget monitoring, health sector arrears, and public accounting
- Budget monitoring and control need improvement.
- Health sector:
  - Injecting public funds (about €1.4 billion in 2017–18) to clear arrears unlikely to provide durable results without addressing root causes such as under-budgeting and weaknesses in monitoring and enforcement.
  - Recent initiatives (e.g., joint unit by health and finance ministries) are positive steps; effectiveness should be monitored and additional interventions directed at preventing accumulation of new arrears if needed.
- Local governments should not delay transition to integrated accrual-based public accounting system.

_International Monetary Fund staff summary based on the provided chapter content._

### 26.      The authorities believe that the targets set out in the Stability Program 2018–2022 are

### cr18273 - 26.      The authorities believe that the targets set out in the Stability Program 2018–2022 are

### Fiscal strategy and targets
- Authorities view the Stability Program 2018–2022 targets as realistic and appropriately paced.
- Deficit reduction strategy focused on:
  - continued restraint on public sector wages and employment;
  - efficiency savings from the ongoing spending review;
  - falling interest payments, expected to lead to a sustained decline of current expenditure of 2.4 percent of GDP by 2022.
- Economic assessment: economy still in the recovery phase and growth will remain strong over the medium term.
- Projections in the Stability Program:
  - fiscal deficit to decline to 0.7 percent of GDP in 2018;
  - fiscal balance to turn to a surplus in 2020;
  - public debt to be reduced to 102 percent of GDP by 2022.
- Authorities consider this downward debt trajectory robust to macroeconomic and financial shocks.

### Expenditure reforms and social protection
- Authorities committed to advancing expenditure reforms to enhance efficiency and improve inclusion of vulnerable groups.
- Pension financing and transparency measures:
  - phasing in the earmarking of a fraction of corporate income tax, reaching two percentage points by 2021;
  - launched an online pension benefit calculator.
- Pension fairness measures:
  - raising the value of the lowest pensions;
  - analyzing the possibility of further reducing excessive penalties for early retirement;
  - keeping the legal retirement age indexed to life expectancy.
- Health sector measures:
  - transferring additional resources to hospitals (about €500 million by end-2018) to contain arrears accumulation;
  - strengthening budget planning and controls, expected to result in better services;
  - centralizing procurement of drugs and medical devices, renegotiating contracts with suppliers, and tackling fraud as part of the spending review;
  - formation in March 2018 of a task force of health experts to collaborate with the Ministries of Health and Finance to identify additional sustainability and efficiency measures.

### Potential growth, medium-term prospects, and convergence
- Need to improve medium-term growth prospects to converge to euro area standards of living and reduce vulnerabilities.
- Staff estimate of potential growth: around 1.4 percent over the medium-term, considering remaining structural bottlenecks and unchanged policies.
- Near-term demographics and labor market:
  - decline in working age population about 1 percent over five years expected to be offset by recovering labor force participation and moderating structural unemployment;
  - over the medium term a contracting labor force will weigh on growth.
- Uncertainty: these estimates are subject to a large degree of uncertainty.
- Staff note faster output growth would facilitate income convergence and further deleveraging.

### Investment, saving, and financing needs
- Increasing medium-term growth requires stronger domestic saving to finance additional private investment.
- Investment remains relatively low as a ratio to GDP despite the recovery.
- Public gross fixed capital formation likely to remain constrained given need to reduce fiscal deficits, though public investment efficiency can continue to improve.
- Private investment must be the driving force; requires larger saving—especially private saving.
- Corporate saving and policy options:
  - Gross corporate saving rose significantly during the adjustment period, but has remained broadly unchanged at 10 percent of GDP since 2015;
  - risk of erosion of corporate saving if there were significant additional increases in labor costs;
  - authorities could build on recent tax changes to support firms that retain and reinvest earnings and owners who inject new equity into their companies.
- Household saving:
  - household saving rate averaged 3.8 percent of GDP over the last three years, one of the lowest among advanced countries;
  - authorities should develop a medium-term strategy to strengthen saving, including by enacting regulations needed for the complementary professional pension regime as mandated in the pension law.

### Structural challenges to investment and productivity
- Key structural obstacles identified:
  - Uncertainty and regulation: need to ensure a stable regulatory and tax environment to limit uncertainty and determent to investment.
  - Energy prices: network industries such as energy and transport have relatively high prices, affecting tradable-sector competitiveness; energy prices remain above the EU average despite declines in recent years.
  - Wage growth and productivity: wage growth has continued to exceed productivity growth; minimum wage increased to €580 per month in 2018 from €557 in 2017 and €530 in 2016; minimum wage coverage increased to 22 percent in 2017 (from 20.6 percent in 2016); maintaining a similar trajectory could increase rigidities and reduce competitiveness.
  - Human capital development: share of low-skilled workers is 47 percent in 2017, much higher than the EU average of 18 percent; recommendation to support on- and off-the-job training and strengthen linkages between public education institutions and industry within budget constraints.
  - Legal and institutional framework for debt enforcement and insolvency: reforms have yielded positive results on resolution efficiency, debt recovery, and NPL resolution (examples include a new out-of-court collateral enforcement procedure and a debt-to-equity procedure); staff recommendations:
    - enable public creditors to participate more fully in debt restructuring, preferably on the same footing as other creditors, subject to clear and transparent guidelines;
    - prioritize addressing conditions allowing non-viable insolvent businesses to delay liquidation.

### Labor market flexibility and reforms
- Preserving labor market flexibility is important for adapting to shocks and supporting productivity growth.
- Employment dynamics:
  - most jobs created in 2017 were permanent, but temporary jobs remain a large fraction of employment by European standards.
- Government tri-partite negotiations aimed at increasing job security and reducing segmentation produced agreed reforms that:
  - include measures reducing firms’ ability to flexibly manage labor (new constraints in the use of “banks of hours” and a reduction in the maximum duration of temporary contracts);
  - permit an increase in the duration of probation periods in permanent contracts and account for industry-specific practices in some regulations.
- Net effect of the agreement on economic flexibility is ambiguous as it both constrains temporary contracts and makes permanent contracts more flexible in some dimensions; agreements are now in parliament.
- Warning: competing initiatives that would more markedly increase the restrictiveness of labor regulations would be counterproductive for Portugal’s need to process adverse shocks as a member of a common currency area.

### Authorities’ views on growth and policies
- Authorities’ Stability Program 2018–2022 estimate stronger potential growth of around two percent over the medium-term, grounded in structural improvements in skills, investment allocation, and export-orientation.
- Authorities emphasize:
  - ongoing improvement in education (attainment and quality) and revitalization of the financial system to support long-term potential growth and productivity;
  - need to boost investment and savings and to continue to improve the business environment;
  - recent tax changes aimed to encourage firms to build equity;
  - need for better management skills and to foster innovation in small businesses, supported by education strategy and return of skilled migrants.
- On labor market changes: authorities view proposed changes as intended to address long-standing segmentation issues; tripartite process ensured a balanced set of measures.
- Authorities stress tackling remaining structural challenges and building social capital will require both supply- and demand-side support and patience as reforms take time to materialize.
- Investment and innovation support measures highlighted:
  - improvement of legal, judicial, and tax framework;
  - new public post-restructuring financing instrument;
  - co-investment initiatives with venture capital funds and business angels;
  - renewed credit facilities with mutual guarantee;
  - creation of a new type of listed companies (SIMFE) holding shares in unlisted Portuguese firms.

### Staff appraisal and policy recommendations
- Recent performance and drivers:
  - 2017: economy performed well; investment and exports were key drivers of growth;
  - underlying fiscal balance posted a strong outturn allowing for ‘one-off’ payments;
  - improvement attributed to buoyant growth, disciplined budget execution, and falling interest costs;
  - increased stability and confidence in the banking system following capital raising by banks and the sale of Novo Banco in 2017.
- Risks and recommended policy stance:
  - Prospects positive but downside risks have increased; policies need to remain strong against heightened external risks and pressures to erode past reforms.
  - Staff recommends frontloading fiscal adjustment envisaged in the Stability Program 2018–2022 to:
    - take advantage of current favorable cyclical conditions;
    - avoid postponing fiscal effort until activity moderates;
    - create space to absorb contingent spending pressures;
    - help differentiate Portugal amid potential bond market volatility.
- Financial sector and macroprudential advice:
  - systemic risks appear contained, but elevated NPL stock and low bank profitability remain concerns;
  - continue implementing NPL-resolution strategy and press banks to strengthen risk management and corporate governance;
  - monitor credit standards closely in the low-interest rate environment and be ready to adjust macroprudential measures if needed.
- External position and saving:
  - Portugal’s external position remains weaker than consistent with medium-term fundamentals and desirable policy settings;
  - improving external position requires larger-than-forecast current account surpluses over the medium term, calling for policies to boost domestic saving.
- Longer-term growth strategy:
  - stronger medium-term growth essential to reduce vulnerabilities and converge toward EU productivity and income levels;
  - policies to foster growth include soundly financed investment, continued productivity and skills improvements, enhancing business conditions, streamlining regulations, and increasing flexibility and responsiveness of institutions and markets;
  - sustainable financing of investment requires strengthening domestic saving and the financial intermediation system.

*International Monetary Fund staff report excerpt.*

### 41.      Staff recommends that the next Article IV consultation be held on the standard

### cr18273 - 41.      Staff recommends that the next Article IV consultation be held on the standard

### Recommendation
- Staff recommends that the next Article IV consultation be held on the standard 12- month cycle.

### Real sector indicators (Figure 2; key observations)
- Consumer confidence, Industrial confidence, and Economic sentiment tracked from Jan-08 to Jan-18 (Last obs. Jun. 2018).
- Real GDP (Year-on-year percentage change): series through 2018Q1 (Last obs.2018Q1).
- Contributions to GFCF change (Year-on-year; percentage points) broken down by Machinery and Equipment, Construction, Other (Last obs.2018Q1).
- Tourism developments (Sum of last 4 quarters): Hotel revenues (billion euros) and Overnight stays (millions, rhs) — series through 2017Q3 and Last obs.2018Q1.
- Employment and Unemployment: Unemployment rate (percent) and Employment (y-o-y percent change; rhs) — Last obs.2018Q1.
- Harmonized CPI: Portugal vs Euro Area (Year on year percent change) — Last obs. Jun. 2018.

### Fiscal sector indicators (Figure 3; key observations)
- Monthly PSPP Purchases of Portugal Sovereign Debt: Monthly purchases (million euros) and ECB holdings as share of total PRT bonds outstanding (percent, rhs) — Last obs. May 2018.
- Fiscal Balance (Percent of GDP): Overall Balance and Primary balance series 1999–2017.
- Projected Public Debt at end-2018 (Percent of GDP): cross-country comparisons with PRT positioned relative to peers.
- 10 Year Government Bond Yield and Credit Rating: yields and credit rating notches; note "PRT before S&P upgrade to BBB-".
- 10 Year Government Bond Yields (Percent): Portugal, Spain, Italy, Ireland — Last obs. Jul.16, 2018.
- Public Gross Fixed Capital Formation (Percent of GDP): Portugal vs EU.

### External sector indicators (Figure 4; key observations)
- Current Account (Percent of GDP; 12-month rolling sum): Goods, Services, Income, Transfers — Last obs. Apr. 2018.
- Trade in Goods and Services (Percent of GDP; 12-month rolling sum): Exports, Imports, Balance — Last obs. Apr. 2018.
- Income Account components (Percent of GDP; 12-month rolling sum): Direct investment, Portfolio investment, Other investment — Last obs. Apr. 2018.
- Financial Account (Billions of euros; 12-month rolling sum): FDI (net), Portfolio (net), Other investment (net), Balance — Last obs. Apr. 2018.
- Real Effective Exchange Rate (Index: 2005Q1=100): ULC-based and CPI-based — Last obs. 2018Q2.
- Contribution to Growth in Exports of Goods, by Destination (Percentage points; y-o-y) — Last obs. 2018Q1.

### Financial stability indicators (Figure 5; key observations)
- Price-to-Income and Price-to-Rent Ratios (2010=100) — Last obs. 2017Q4.
- Non-financial Corporate Debt, 2017 (Percent of GDP) — country cross-section including PRT.
- Household Debt, 2017 (Percent of GDP) — country cross-section including PRT.
- Interest Rates on New Loans (Percent): Loans to NFCs (up to 1 million and over 1 million), Loans for house purchase, Consumer loans — Last obs. Apr. 2018.
- Real House Prices (2010=100): Portugal vs France, Spain, Italy, Euro area — Last obs. 2017Q4.
- Banks' Profitability (Percent of total assets): Net interest income, Net commissions, Financial operations results, Impair and provision, Other income, Operational costs — 2017Q1–2018Q1 movements shown.

### Selected economic indicators (Table 1; projections and historical)
- Real GDP: 2015 0.9; 2016 1.8; 2017 1.6; 2018 2.7; 2019 2.3; 2020 1.8; 2021 1.5; 2022 1.4; 2023 1.4; (Year-on-year percent change).
- Total domestic demand: 2015 2.2; 2016 2.7; 2017 1.6; 2018 2.8; 2019 2.8; 2020 2.3; 2021 2.0; 2022 1.7; 2023 1.6.
- Private consumption: 2015 2.3; 2016 2.3; 2017 2.1; 2018 2.3; 2019 1.9; 2020 1.6; 2021 1.3; 2022 1.2; 2023 1.2.
- Gross fixed investment: 2015 2.3; 2016 5.8; 2017 1.5; 2018 9.2; 2019 7.6; 2020 6.3; 2021 5.0; 2022 4.2; 2023 3.4.
- Exports: 2015 4.3; 2016 6.1; 2017 4.4; 2018 7.9; 2019 6.2; 2020 4.7; 2021 4.2; 2022 4.1; 2023 4.1.
- Unemployment rate (Percent; average): 2015 13.9; 2016 12.4; 2017 11.1; 2018 8.9; 2019 7.3; 2020 6.7; 2021 6.5; 2022 6.3; 2023 6.1; 2024 6.0 (table extends through 2023).
- Consumer prices (Harmonized index): 2015 -0.2; 2016 0.5; 2017 0.6; 2018 1.6; 2019 1.7; 2020 1.6; 2021 1.8; 2022 1.9; 2023 2.1.
- General government balance (Percent of GDP): 2015 -7.1; 2016 -4.3; 2017 -2.0; 2018 -3.0; 2019 -0.7; 2020 -0.3; 2021 -0.2; 2022 0.0; 2023 0.2.
- General government debt: 2015 130.6; 2016 128.8; 2017 129.9; 2018 125.7; 2019 120.8; 2020 117.2; 2021 115.1; 2022 109.6; 2023 105.8; 2024 102.8.
- Nominal GDP (Billions of euros): 2014 173.1; 2015 179.8; 2016 185.5; 2017 193.1; 2018 200.6; 2019 207.5; 2020 214.2; 2021 221.0; 2022 228.0; 2023 234.9.
- Private sector credit (end of period, percent change): 2015 -8.0; 2016 -4.1; 2017 -3.7; 2018 -3.1; 2019 0.1; 2020 0.8; 2021 1.6; 2022 1.6; 2023 1.6.

### General government accounts (Tables 2a & 2b; selected levels and ratios)
- Revenue (Billions of euros): 2014 77.2; 2015 78.8; 2016 79.7; 2017 82.8; 2018 86.7; 2019 89.8; 2020 92.8; 2021 95.6; 2022 98.6; 2023 101.5.
- Expenditure (Billions of euros): 2014 89.5; 2015 86.5; 2016 83.4; 2017 88.6; 2018 88.1; 2019 90.5; 2020 93.1; 2021 95.7; 2022 98.1; 2023 101.1.
- Net lending (+)/borrowing (–) (Billions of euros): 2014 -12.3; 2015 -7.7; 2016 -3.7; 2017 -5.7; 2018 -1.4; 2019 -0.6; 2020 -0.3; 2021 -0.1; 2022 0.5; 2023 0.4.
- Primary balance (Percent of GDP): 2014 -3.8; 2015 0.5; 2016 4.1; 2017 1.8; 2018 5.6; 2019 6.4; 2020 6.4; 2021 6.8; 2022 7.1; 2023 7.3.
- Debt at face value (EDP notification) (Billions of euros): 2014 226.0; 2015 231.5; 2016 241.0; 2017 242.7; 2018 242.4; 2019 243.3; 2020 246.7; 2021 242.3; 2022 241.3; 2023 241.4.

### Monetary survey (Table 3; aggregated MFI balance sheet and money)
- Assets of MFIs (Millions of euros): 2014 404,575; 2015 386,337; 2016 368,146; 2017 366,438; 2018 371,536; 2019 374,623; 2020 380,813; 2021 386,035; 2022 391,786; 2023 395,359.
- Broad money (M3, Millions of euros): 2014 147,174; 2015 153,193; 2016 167,000; 2017 179,603; 2018 185,694; 2019 191,121; 2020 196,377; 2021 201,588; 2022 206,924; 2023 212,159.
- Private sector credit (Millions of euros): 2014 224,396; 2015 215,174; 2016 207,316; 2017 200,789; 2018 200,990; 2019 202,598; 2020 205,839; 2021 209,133; 2022 212,479; 2023 215,878.
- Broad money (Percent of GDP): 2014 85.0; 2015 85.2; 2016 90.0; 2017 93.0; 2018 92.6; 2019 92.1; 2020 91.7; 2021 91.2; 2022 90.8; 2023 90.3.
- Private sector credit (Percent of GDP): 2014 129.6; 2015 119.7; 2016 111.8; 2017 104.0; 2018 100.2; 2019 97.6; 2020 96.1; 2021 94.6; 2022 93.2; 2023 91.9.

### Balance of payments (Table 4; key balances and projections)
- Current and Capital account (Billions of euros): 2014 2.5; 2015 2.3; 2016 3.0; 2017 2.7; 2018 3.8; 2019 3.9; 2020 3.5; 2021 1.7; 2022 0.0; 2023 -0.9.
- Current account (Billions of euros): 2014 0.1; 2015 0.2; 2016 1.1; 2017 0.9; 2018 0.5; 2019 -0.1; 2020 -1.0; 2021 -1.9; 2022 -3.0; 2023 -3.4.
- Trade balance (Billions of euros): 2014 -9.5; 2015 -9.5; 2016 -9.6; 2017 -12.1; 2018 -14.5; 2019 -16.0; 2020 -17.3; 2021 -18.7; 2022 -20.4; 2023 -21.7.
- Services, net (Billions of euros): 2014 11.4; 2015 12.5; 2016 13.5; 2017 15.6; 2018 17.3; 2019 18.4; 2020 19.5; 2021 20.6; 2022 21.7; 2023 22.8.
- Net international investment position (Percent of GDP): 2014 -118.6; 2015 -113.2; 2016 -106.1; 2017 -105.7; 2018 -99.8; 2019 -94.6; 2020 -90.0; 2021 -86.5; 2022 -83.9; 2023 -81.8.

### Banking system indicators (Table 5; selected)
- Regulatory capital to risk-weighted assets: series with values around 11.3–15.2 across 2014–2017 quarters.
- Non-performing loans to total gross loans: 2014 series around 17.5–13.3 by 2017.
- Return on assets and return on equity: quarterly volatility with negative and modest positive values across 2014–2017.
- Loans to deposits: 2014Q1 119.0 and trending down into 2017 quarters to ~92.6 (series shown).

### External debt sustainability (Table 6; baseline projections)
- Baseline: External debt (Percent of GDP): 2015 222.0; 2016 215.3; 2017 211.1; 2018 203.2; 2019 197.5; 2020 192.6; 2021 188.8; 2022 185.4; 2023 181.8.
- Change in external debt: 2015 -13.9; 2016 -6.7; 2017 -4.2; 2018 -7.9; 2019 -5.7; 2020 -4.8; 2021 -3.8; 2022 -3.4; 2023 -3.6.
- Current account deficit, excluding interest payments (Percent of GDP): 2015 -5.0; 2016 -4.9; 2017 -4.4; 2018 -3.9; 2019 -3.5; 2020 -2.9; 2021 -2.9; 2022 -2.4; 2023 -2.3.
- Gross external financing need (Billions of Euros): projections include values up to 200.3 and memorandum percent of GDP series in the 80s–90s.

### Indicators of Fund credit (Table 7; selected)
- Disbursements: 2014 1,563 (Millions of SDR).
- Outstanding stock (Millions of SDR): 2014 22,942; 2015 16,363; 2016 12,803; 2017 4,571; 2018 3,863; 2019 3,863; 2020 3,863; 2021 2,315; 2022 779; 2023 130.
- Total debt service, in percent of Exports of goods and services: 2014 1.2; 2015 2.4; 2016 6.7; 2017 12.5; 2018 1.1; 2019 0.1; 2020 0.1; 2021 1.9; 2022 1.7; 2023 0.7.
- Percent of quota (Outstanding stock): 2014 2,228.0; 2015 1,589.1; 2016 621.5; 2017 221.9; 2018 187.5; 2019 187.5; 2020 187.5; 2021 112.4; 2022 37.8; 2023 6.3.

### General government financing requirements and sources (Table 8; selected)
- Gross borrowing need (Billions of euros): 2015 58.9; 2016 40.0; 2017 39.5; 2018 27.0; 2019 29.7; 2020 28.8; 2021 37.5; 2022 32.3; 2023 29.0.
- Amortization (Billions of euros): 2015 49.4; 2016 35.8; 2017 35.2; 2018 25.1; 2019 28.6; 2020 28.0; 2021 36.9; 2022 32.3; 2023 28.9.
- Gross financing sources: market access dominates (e.g., Market access 2015 55.8; 2016 44.4; 2017 37.1; 2018 24.9).

### External financing requirements and sources (Table 9; selected)
- Gross financing requirements (Billions of euros): 2014 174.4; 2015 168.0; 2016 169.1; 2017 192.7; 2018 188.7; 2019 188.9; 2020 191.7; 2021 197.7; 2022 200.2; 2023 186.3.
- Gross financing requirements composition: Current account deficit, Medium- and long-term debt amortization, Short-term debt amortization (public sector, central bank, banks, other private).
- New borrowing and debt rollover (Billions of euros): 2014 168.4; 2015 173.2; 2016 183.4; 2017 187.9; 2018 189.4; 2019 190.9; 2020 193.7; 2021 200.2; 2022 202.6; 2023 192.1.
- Rollover rates: General government and private sector high rollover rates across years (detailed series provided).

*Italic: International Monetary Fund staff compilation from the Portugal country chapter tables and figures in the provided content.*

### Annex I. Public Debt Sustainability Analysis (DSA)

### Annex I. Public Debt Sustainability Analysis (DSA)

### Baseline Scenario
- Debt level and recent trajectory:
  - Public debt in 2017: 126 percent of GDP.
  - Debt fell by 4.2 percentage points of GDP in 2017.
  - Real GDP growth in 2017: 2.7 percent (highest level since 2000).
  - Primary balance in 2017: 0.9 percent of GDP (smaller than previous year due to recapitalization of CGD masking underlying improvement).
  - Interest bill in 2017: 3.9 percent of GDP.
  - Debt remains above the 85 percent of GDP high-risk threshold for the market access (MAC) DSA and above the 60 percent of GDP Stability and Growth Pact target.

- Projected trajectory (baseline):
  - Public debt projected to decline from 126 percent of GDP in 2017 to 103 percent of GDP in 2023 (a decline of 22 percent of GDP over six years).
  - Contributions to the projected reduction:
    - Cumulative reduction from primary balance: 19 percentage points of GDP (assuming structural primary balance remains broadly constant at its 2018 level).
    - Cumulative reduction from real GDP growth: 11 percentage points of GDP.
    - Interest bill effect: expected to decline from 3.9 percent of GDP in 2017 to 2.9 percent of GDP in 2023.
  - Drivers and assumptions:
    - Structural drivers (falling spreads, pass-through in new debt issuance, declining debt stock) dominate the decline in interest payments.
    - Marginal/risk-free rate expected to rise as monetary conditions normalize, but falling spread and declining debt stock dominate, leading to overall decline in interest payments.

### Risk Assessment
- Overall vulnerability:
  - Elevated debt leaves Portugal highly vulnerable to macroeconomic and financial shocks.
  - Debt will exceed the high-risk threshold for market access countries (85 percent of GDP) throughout the forecast horizon.
  - Government gross financing needs (GFN) expected to remain below the 20 percent of GDP high-risk threshold; however, 2021 amortization profile implies a spike to 17 percent.
  - Market perception of debt vulnerabilities: favorable.
  - Risks from short-term debt and debt held by non-residents: assessed to be low.
  - Total economy external financing requirement: 50 percent of GDP, indicating vulnerability to external conditions.

- Skew of risks:
  - Risks are skewed to higher debt; asymmetric fan-chart indicates downside risk to the baseline.
  - Recommendation: further effort to gradually raise the structural primary balance to build resilience and policy space if adverse shocks materialize.

### Realism of Baseline Assumptions and Alternative Scenarios
- Fiscal stance and growth assumptions:
  - Baseline assumes largely unchanged fiscal stance after 2018; structural primary balance expected to remain around three percent of GDP for the forecast period.
  - Level needed to stabilize debt: -0.2 percent of GDP.
  - Staff baseline assumes potential real GDP growth converging to 1.4 percent; continued growth converging to potential is an important driver of debt decline.
  - If growth disappoints (e.g., reversal of structural reforms or weaker external conditions), debt reduction could stall.

- Authorities’ medium-term strategy vs. staff baseline:
  - Authorities’ Stability Program 2018–2022 envisages public debt of 102 percent of GDP by 2022.
  - Staff baseline for 2022: 107 percent of GDP.
  - Differences reflect authorities’ assumption of average real GDP growth of 2.2 percent in 2018–22 versus staff projection of 1.6 percent, and an ambitious fiscal adjustment in the Stability Program not yet linked to specific measures.

### Stress Tests (2018–2023)
- Baseline sensitivity: highly sensitive to macro-fiscal and contingent liability shocks.

- Individual stress scenarios and impacts:
  - Growth shock:
    - Shock size: -2.3 percent (one-standard deviation of historical growth) applied in 2019 and 2020.
    - Impact: debt increases to 124 percent of GDP, 11 percent of GDP above the baseline.
  - Primary balance shock:
    - Shock size: -1.7 percent of GDP (1/2 standard deviation of historical changes) applied in 2019 and 2020.
    - Impact: debt increases to 117 percent of GDP in 2020, 4 percent of GDP above the baseline.
  - Interest rate shock:
    - Shock size: 350bps over 2018–23.
    - Impact: gradual deterioration leaving debt 3 percent of GDP higher than baseline by 2023.
  - Standard contingent liability shock:
    - Shock size: equal to 10 percent of GDP.
    - Impact: raises debt by an equivalent amount across the forecast period; potential to destabilize interest rates and generate second-round effects (not modelled).
  - Severe combined shock:
    - Incorporates macro-fiscal and contingent liability adverse scenarios.
    - Impact: raises debt above 130 percent of GDP, where it remains largely unchanged.
  - Upside scenario (authorities achieve overall balance in Stability Program with other assumptions unchanged):
    - Impact: debt of 99 percent of GDP by 2023, 4 percent of GDP below the baseline.

- Stress-test summary indicators:
  - Public gross financing needs (GFN) and gross nominal public debt rise materially under adverse scenarios (figures presented in main text and figures 4–5).

### Contingent Liabilities: Novo Banco Sale (Box A2)
- Sale terms and contingent capital agreement:
  - Novo Banco sold to Lone Star in October 2017; sale included a Contingent Capital Agreement expected to impact public finances.
  - Portuguese Resolution Fund retained control of 25 percent of Novo Banco’s shares and remained exposed to a large portfolio of troubled assets.
  - Resolution Fund obliged to compensate Novo Banco for recognized losses in the covered portfolio if capital ratios fell below predefined thresholds.
  - Cumulative limit to such compensation payments: €3.89 billion (2 percent of 2017 GDP) over eight years.
  - Government agreed to give the Resolution Fund access to loans from the Portuguese Treasury to help finance such payments; payments (not the loans) are classified as government spending due to sectorization of the Resolution Fund.

- Initial developments and fiscal impact:
  - Novo Banco reported results for 2017 showing a loss of nearly €1.4 billion, driven by impairments of €2 billion, mostly related to assets covered by the contingent capital agreement.
  - Resolution Fund payment to Novo Banco: €792 million (0.4 percent of GDP) to restore capital ratios.
  - Resolution Fund borrowed about €430 million from the government to finance part of this payment.
  - Market expectation: further payments due to additional impairments are expected in the future.

### Key Projections and Underlying Assumptions (Selected Figures)
- Selected projections and indicators (as presented):
  - Nominal gross public debt: 2016: 104.5; 2017: 129.9; 2018: 125.7; 2019: 120.9; 2020: 117.3; 2021: 115.2; 2022: 109.6; 2023: 105.9.
  - Public gross financing needs: 2016: 25.1; 2017: 21.3; 2018: 21.2; 2019: 13.0; 2020: 13.9; 2021: 13.0; 2022: 16.6; 2023: 13.8; 2018–23 cumulative implied changes shown in tables and figures.
  - Real GDP growth (baseline): 2018: 2.3; 2019: 1.8; 2020: 1.5; 2021: 1.4; 2022: 1.4; 2023: 1.4 (percent).
  - Inflation (GDP deflator): 2018: 1.6; 2019: 1.6; 2020: 1.7; 2021: 1.7; 2022: 1.7; 2023: 1.6 (percent).
  - Primary balance (baseline): 2018: 2.8; 2019–2023: 3.1 (percent of GDP).
  - Effective interest rate (defined as interest payments divided by debt stock): 2018: 2.9; 2019: 2.9; 2020: 2.8; 2021: 2.8; 2022: 2.7; 2023: 2.8 (percent).
  - Change in gross public sector debt (cumulative 2018–23): -22.8 (percent of GDP).
  - Identified debt-creating flows (cumulative 2018–23): -24.2 (percent of GDP).
  - Primary deficit (2016–23 line items): 2016: 2.4; 2017: -2.2; 2018: -0.9; 2019: -2.8; 2020: -3.1; 2021: -3.1; 2022: -3.1; 2023: -3.1; cumulative -18.2 (percent of GDP).
  - Privatization revenue (negative): 0.0 for projection years (percent of GDP).
  - Resolution Fund related payments in 2017: €792 million (0.4 percent of GDP); Resolution Fund borrowing from government: about €430 million.

*Source: IMF staff — Annex I. Public Debt Sustainability Analysis (DSA).*

### Annex II. Risk Assessment Matrix

### Annex II. Risk Assessment Matrix

### Key risks, likelihoods, impacts, and policy responses
- Loss of investor confidence.
  - Relative Likelihood: Low
  - Impact: High
  - Effects: Increase in sovereign bonds yields and reduction in foreign direct investment. Significant funding distress, higher public and private borrowing costs.
  - Policy response: Strengthen policy buffers and avoid backtracking on reforms. Continue to implement policies that support growth, lasting fiscal adjustment, and a strong banking system, to foster investor confidence, and favorable financing conditions.

- Rising protectionism and retreat from multilateralism.
  - Relative Likelihood: High
  - Impact: High
  - Effects: Weaker economic environment and expectations would have broad negative effects for a small open economy like Portugal, both for the near-term upswing, and for medium-term growth prospects.
  - Policy response: Stronger macro-financial and structural policies to support investment, sentiment, growth, and resilience of the economy.

- Weaker-than-expected global growth / Euro Area: slowing or reversal of progress on fiscal adjustment and structural reforms.
  - Relative Likelihood: Medium
  - Impact: High
  - Effects: Lower growth and investment would imperil debt dynamics in all sectors. With the euro area accounting for 60 percent of total exports, the current account balance and IIP would be at risk.
  - Policy response: Step up structural reforms to improve competitiveness and reduce indebtedness. Step up efforts to clean up corporate and bank balance sheets, to minimize drag on investment and growth.

- Policy and geopolitical uncertainties (fragmentation/security dislocation).
  - Relative Likelihood: Medium
  - Impact: High
  - Effects: Escalation of euro skepticism, leading to less cooperation and a reversal of integration.
  - Policy response: Accelerate structural reforms to support investment and growth.

- Unsustainable macroeconomic policies in systemically important countries (spillovers).
  - Relative Likelihood: Medium
  - Impact: High
  - Effects: As a result of spillovers from developments abroad, an abrupt rise in sovereign yields in Portugal could jeopardize growth prospects and impact the fiscal accounts and the banking system negatively.
  - Policy response: Step up efforts to clean up corporate and bank balance sheets. Strengthen policy buffers and avoid backtracking on reforms to prevent contagion and decouple Portuguese yields from movements in other European yields.

- Sharp tightening of global financial conditions.
  - Relative Likelihood: High
  - Impact: High
  - Effects: Less favorable financial conditions and potentially wider spreads as global conditions tighten would affect highly leveraged firms and households as short-term and variable-rate loans are repriced, and could weaken banks’ balance sheets.
  - Policy response: Step up efforts to implement policies that support growth, lasting fiscal adjustment, continued balance sheet clean-up, and a strong banking system, which would contribute to shoring up investor confidence, and ease financing conditions and restraints.

- Note on likelihood coding (staff’s subjective assessment):
  - "low" is meant to indicate a probability below 10 percent.
  - "medium" a probability between 10 and 30 percent.
  - "high" a probability of 30 percent or more.

*Source: Annex II. Risk Assessment Matrix, cr18273 - Annex II. Risk Assessment Matrix*

---

### Annex III. External Sector Assessment

### Overall assessment and trajectory
- NIIP and external debt:
  - NIIP: declined from its peak in 2014 of 118 percent of GDP to about 106 percent of GDP at the end of 2017.
  - Gross external debt: 211 percent of GDP.
  - Projection: Both are expected to continue to decline, but at a decelerating rate over the medium-term as the current account moves to deficit.
  - Assessment: The large negative NIIP comes with external vulnerabilities, including from valuation changes and the large gross financing needs from external debt. Portugal remains exposed to a loss in confidence by external investors despite past debt management efforts to smooth redemptions and lengthen average maturity.

- Overall Assessment statement:
  - "The external position in Portugal in 2017 was weaker than that consistent with medium-term fundamentals and desirable policy settings. Despite the large adjustment in the current account since the crisis, a strong improvement to a more sustainable NIIP position would require sustained current account surpluses for a long period. In 2018 the CA is projected to deteriorate somewhat with rising import demand."

- Potential policy responses:
  - Sustained fiscal consolidation and structural reforms to improve Portugal’s competitiveness and potential growth.
  - Spur investment by enhancing business conditions, streamlining regulations, and increasing the flexibility and responsiveness of institutions and markets.
  - Continued fast reduction of NPLs while keeping adequate capital buffers.

### Current account
- Background and recent history:
  - The Portuguese current account has been in a surplus since 2013 after an extended period of deficits in the range of 10 percent of GDP.
  - The current account registered a surplus of 0.5 percent of GDP in 2017, which is expected to moderate and shift to a deficit as import growth outstrips export growth.

- Assessment and model estimates:
  - EBA model-based estimates: cyclically adjusted current account balance at 0.0 percent of GDP, compared to a norm of -0.1 percent of GDP (implying no current account gap).
  - Staff’s assessment: the small actual current account surplus of 0.5 percent is insufficient given the large negative NIIP. Assuming continued capital account surpluses, staff assesses a current account short-fall of about 2–4 percent of GDP is needed to bring about a strong medium-term improvement in the NIIP.
  - Key policy to strengthen external position: sustained fiscal adjustment paired with structural reforms to support growth and investment, and continued efforts to address remaining financial sector challenges.

### Real exchange rate (REER)
- Background:
  - CPI-based REER: 4½ percent below pre-crisis peak.
  - ULC-based REER: 7½ percent below pre-crisis peak.
  - Both measures have been on an appreciating trend since early 2015; the appreciation is limited but trade balance has started to deteriorate.

- Assessment:
  - EBA index regression model: suggests an overvaluation of 4.9 percent for 2017.
  - Level REER model: suggests the REER is fairly valued with a marginal estimated 0.4 percent undervaluation.
  - Applying model elasticity and the current account gap suggests an overvaluation of the REER in the range of 5 to 10 percent.
  - Note: adjustment could be less through price competitiveness and more through sustained quality upgrades and innovation to improve non-price competitiveness.

### Capital and financial accounts; FX intervention and reserves
- Financing conditions:
  - Financing conditions have eased dramatically since resumption of sovereign market access in 2014.
  - Sovereign spreads: now down to a little above 100 basis points, after being above 300 as recently as early 2017.
  - Credit ratings: have been upgraded.
  - Assessment: A current account surplus and improved macro conditions have helped support external financing rollover needs for the near-term. Further policy action will be needed over the medium term to secure investor confidence and rule out negative equilibria.

- FX and reserves:
  - Background: The euro has the status of a global reserve currency.
  - Assessment: Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

*Source: Annex III. External Sector Assessment, cr18273 - Annex II. Risk Assessment Matrix*

---

### Annex IV. Labor Market Developments and Productivity

### Summary findings and projections
- Potential growth and labor factor:
  - Labor factor growth is expected to support potential growth in the short term.
  - Long-term potential growth: estimated to be around 1¼ percent, or 1.5 percent in per capita terms.

- Productivity and skills:
  - Continuing improvements in educational attainment and a reduction of self-employment underpin medium-term projections for labor productivity and total factor productivity.
  - Labor productivity outperformed the EU average in the late 2000s-early 2010s owing to rapid skill improvements and labor shedding during the crisis.

- Labor force participation and employment composition:
  - Labor force participation increased by 0.8 percent in 2017.
  - Activity rate: 66.2 percent (above EU and EA averages of 64.7 and 64.2, respectively).
  - Projected participation trend: recover further towards pre-crisis levels, increasing on average by about 0.2 percent per year.
  - Increasing share of full-time employment and reduction of involuntary part-time work would positively affect labor’s contribution to growth.

### Skill composition and self-employment
- Low-skilled share:
  - Low-skilled workers in Portugal: 47 percent in 2017.
  - EU average low-skilled share: 18 percent.
  - Trend: decline markedly since the mid-2000s; decline is broad-based and more pronounced for employees and the unemployed.

- Self-employment:
  - Self-employment declined from 24 percent in the late 1990s to 14.3 percent in 2017.
  - EU average self-employment in 2017: 13.4 percent.
  - Drivers: connected to improvements in educational attainment and demographic cohort replacement; as elder cohorts age and educational attainment rises, self-employment is expected to continue to fall.

### Policy implications
- Labor market reforms and human capital development would help address demographic pressures going forward.
  - The declining ratio of workers to the population will intensify pressures on social programs, pensions, and health care.
  - Addressing labor market segmentation and fostering skill formation will promote more inclusive growth.

*Source: Annex IV. Labor Market Developments and Productivity, cr18273 - Annex II. Risk Assessment Matrix*

### Annex V. Past Recommendations

### Annex V. Past Recommendations

### Labor markets
- Recommendation: Safeguard program-era policy changes to make: (i) hiring and collective bargaining more flexible; and (ii) permanent contracts more flexible rather than restricting temporary contracts.
- Progress: Partially implemented.
  - Measures under consideration emerged from a tripartite negotiation, preventing significant reversals.
  - Agreed measures would mostly discourage temporary contracts, and constrain flexibility afforded by "banks of hours;" however, allowances would be made for sectoral differences, and longer probation periods would improve permanent contracts.
- Related macro indicators and labor outcomes:
  - GDP growth: 0.5 percent in Q2 2018 (2.3 percent year-on-year).
  - Investment growth: 6.4 percent.
  - Exports growth: 6.8 percent.
  - Unemployment rate: 6.7 percent in Q2 2018, down 1.2 percentage points from the previous quarter and 2.1 percentage points from the previous year.
  - Employment: increased by 2.1 percent year-on-year in Q2 2018.
  - Salaried employment: grew by 2.9 percent in Q2 2018.
  - Employment rate: 55.1 percent — the highest since Q1 2011.
  - Tripartite Agreement (May): foresees a comprehensive set of policies aimed at reducing labor market segmentation.

### Financial sector
- Recommendations and implementation status:
  - Boosting internal capital generation.
    - Progress: Partially Implemented.
      - Progress in cutting costs: continued reduction in the number of branches and employees per habitant, sale of BPI’s holding in Angola, and various restructurings.
      - Earnings: no tangible progress; income from services and commissions remaining practically unchanged.
  - Removing the impediments to NPL resolution.
    - Progress: Implemented.
      - 2017 initiatives: platform by three banks with common exposures to large nonfinancial corporates to expedite NPL sales; development of a simplified regime to facilitate the transfer of NPL portfolios; establishment of a legal regime for debt-equity swaps; creation of a new legal framework for voluntary out-of-court debt restructurings.
  - Addressing the forthcoming regulatory challenges.
    - Progress: Implemented.
      - Introduction of IFRS9 and implementation of MREL impact appears manageable due to: positive macroeconomic outlook; increase in impairment recognition over the last years following asset quality review exercises; improvement in market perception about Portuguese banks; envisaged four-year transition period for MREL.
- Financial sector developments and indicators:
  - NPL reduction: from June 2016 to March 2018, NPLs declined by 15.8 billion euros (approximately 30 percent), representing a decrease of 5.2 percentage points in the NPL ratio, alongside an increase in the impairment coverage ratio.
  - Bank profitability and resilience:
    - Drivers of increased robustness: (i) stabilization of the shareholder base of the major banking groups; (ii) increase of banks’ capital ratios; (iii) increase in operational efficiency; (iv) increased capacity to significantly reduce NPLs.
    - Profitability: operating income has somewhat increased and efficiency has improved, but profitability remains under pressure due to competitive pressures from FinTech and increasing regulatory demands, notably MREL.
  - Macroprudential action: Banco de Portugal issued a Recommendation to mitigate excessive risk-taking in granting new credit to households.
  - Real estate and credit:
    - Consumer credit accelerating; new loans for house purchases increasing at robust growth rates.
    - Real estate upward pressures since second half of 2017, particularly in the residential segment driven by non-resident demand and tourism.

### Fiscal sector
- Recommendations and implementation status:
  - Public sector payments discipline.
    - Advice: Implement a more forceful strategy to prevent new arrears in the hospital sector by reviewing budgeting policy, addressing inefficiencies, and further strengthening commitment controls.
    - Progress: Partially implemented.
      - Initiatives: increased central control of budgetary execution in healthcare, decreased arrears, strengthened joint performance monitoring and control from the MoF and MoH — but insufficient to prevent hospitals from accumulating new arrears.
      - Reported arrears increase: EC (2018 European Semester) reports arrears increased by €300 million in 2017.
  - Structural primary adjustment.
    - Advice: For 2018, implement a structural primary adjustment of 0.5 percent of GDP, in line with Portugal’s commitments under the Stability and Growth Pact.
    - Progress: Not implemented.
      - Staff estimates: slight loosening of 0.2 percent of GDP implicit in the 2018 target for the overall balance under the April 2018 Stability Program.
  - Wage bill.
    - Advice: Implement a stronger wage bill planning and a public sector restructuring to adjust the level and composition of public employment to generate the planned fiscal savings while improving service delivery.
    - Progress: Partially implemented.
      - Wage bill: grew only by 0.3 percent in real terms, and declined as a share of GDP, generating a saving of around 0.3 percent of GDP.
      - Risks: savings might be eroded by unfreezing of career progressions and gradual restoration of the 35 hour week. No meaningful adjustment to the level and composition of public employment.
  - Pension reforms.
    - Advice: Revisit recent pension reforms to reduce grandfathering.
    - Progress: Not implemented. No major reforms of the pension system have been implemented.
  - Corporate debt overhang.
    - Advice: Reduce the tax debt bias to offset the distortion of the deductibility of debt interest.
    - Progress: Implemented. The 2018 budget contains provisions to extend the deductibility of equity to SMEs.
- Fiscal outcomes and indicators:
  - 2017 fiscal deficit: 0.9 percent of GDP, excluding the one-off factor of the recapitalization of Caixa Geral de Depósitos (lower than the 2017 State Budget forecast of 1.6 percent).
  - 2018 target and execution:
    - 2018 deficit target: 0.7 percent of GDP — budget execution through July indicates target is well within reach.
    - Revenue: up by 5.3 percent (year-on-year through July).
    - Expenditure: down by 2.5 percent (year-on-year through July).
    - Cash-basis deficit: improved by 1,109.7 million euros compared to the same period in 2017.
    - Primary surplus: increased by 1,417.1 million euros.
  - Public debt:
    - Expected public debt: 122.2 percent of GDP in 2018, down from 125.7 percent in 2017.
    - Debt management: amortization profile smoothed; financing costs of outstanding debt declined.
  - IMF loan:
    - Drawn: from a total amount of 26 billion euros (23 billion SDR) drawn, Portugal has already repaid 23.79 billion euros corresponding to over 80 percent of the total loan.

### Fund relations, statistics, and institutional points
- Fund membership and resources (As of June 30, 2018):
  - Quota: 2,060.10 SDR Million (100.00 percent).
  - Fund holdings of currency: 5,457.02 SDR Million (264.89 percent).
  - Reserve position in Fund: 465.77 SDR Million (22.61 percent).
  - Net cumulative allocation (SDR Department): 806.48 SDR Million (100.00 percent).
  - Holdings (SDR Department): 536.74 SDR Million (66.55 percent).
- Outstanding purchase and loans:
  - Extended Arrangements: 3,862.69 SDR Million (187.50 percent).
- Financial arrangements history:
  - EFF: Approval May 20, 2011 — Expiration June 30, 2014 — Amount Approved 23,742.00 SDR Million — Amount Drawn 22,942.00 SDR Million.
  - Stand-By: Oct 07, 1983 – Feb 28, 1985 — Amount Approved 445.00 SDR Million — Amount Drawn 259.30 SDR Million.
  - Stand-By: Jun 05, 1978 – Jun 04, 1979 — Amount Approved 57.35 SDR Million — Amount Drawn 0.00 SDR Million.
- Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs) — Forthcoming:
  - 2018: Principal 0; Charges/Interest 39.71; Total 39.71.
  - 2019: Principal 0; Charges/Interest 79.33; Total 79.33.
  - 2020: Principal 0; Charges/Interest 79.37; Total 79.37.
  - 2021: Principal 1,547.69; Charges/Interest 76.26; Total 1,623.94.
  - 2022: Principal 1,536.25; Charges/Interest 37.55; Total 1,573.80.
- Exchange rate arrangement:
  - Portugal’s currency is the euro, which floats freely and independently against other currencies. Portugal has accepted the obligations of Article VIII, Section 2, 3, and 4, and maintains an exchange system free of restrictions on payments and transfers for current international transactions, other than restrictions notified to the Fund under Decision No. 144 (52/51).
- Data adequacy and reporting:
  - General: Data provision to the Fund is adequate for surveillance purposes.
  - National accounts: Since September 2014, INE publishes a full set of national accounts based on ESA 2010, including quarterly GDP from Q1 1995; quarterly and annual data are consistent.
  - Prices: INE publishes CPI and HICP per EU methodology; quality supervised by Eurostat.
  - Fiscal data: Revisions during transition to ESA 2010 sizably altered revenue and expenditure; quarterly general government statistics on an accrual basis are available.
  - Balance of payments: Data provided according to IMF’s sixth edition of the Balance of Payments Manual; portfolio investment data collection system described.
  - Monetary and financial: Central bank and other monetary financial institutions' balance sheets available via Bank of Portugal’s BPStat; monthly monetary statistics provided to the IMF through the ECB; data for other financial corporations not reported.
  - Financial sector surveillance: Portugal reports eleven core FSIs (excluding the net open position in foreign exchange capital), twelve encouraged FSIs for deposit takers, and ten encouraged FSIs for other sectors on a quarterly basis.
  - Standards: Portugal adheres to SDDS+; relevant metadata posted on the Dissemination Standards Bulletin Board.
- Table of Common Indicators Required for Surveillance (As of June 30, 2018) — selected latest observation dates and frequencies:
  - Exchange Rates: Date of Latest Observation 06/30/18; Date Received 06/30/18; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
  - GDP/GNP: Latest Observation 2018:Q1; Date Received 6/18; Frequency Q/Q/Q.
  - Gross External Debt: Latest Observation 2018:Q1; Date Received 5/18; Frequency Q/Q/Q.
  - International Investment Position: Latest Observation 2018:Q1; Date Received 5/18; Frequency Q/Q/Q.

### Structural reforms and sectoral initiatives
- Structural reform priorities and outcomes:
  - National Reform Programme and Stability Programme 2018–2022: reaffirm predictable and sustainable economic path to promote confidence and investment.
  - Education and skills: addressing school failure and early departure from education; revising National Catalogue of Qualifications; establishing Anticipation of Labor Market Needs; implementing European Quality Assurance Reference Framework; improving average digital skills.
  - Judicial system and corporate restructuring:
    - Insolvency and Companies’ Recovery Code revised to improve special revitalization proceedings.
    - New regime for out-of-court restructuring of companies with specialized support in company recovery.
    - Early Warning Mechanism developed to inform companies annually on global financial situations and provide recommendations.
    - Capitalizar program: new credit lines for SMEs and start-ups.
    - Result: evidence of improved resolution efficiency, debt recovery, and NPL resolution.
  - Energy sector:
    - Tariff debt: declined by seven percent in both 2016 and 2017 and is projected to decline by a further 17 percent in 2018.
    - Baseline: current debt expected to be fully repaid by the end of 2021.
    - Policy: fostering investment in new renewable capacity without feed-in tariffs that could impact demand side.

### Conclusion and authorities' stance
- Authorities’ assessment and commitments:
  - Commendation of IMF staff for constructive overview and commitment to sound economic and fiscal policies focused on competitiveness, growth, social cohesion, and sustainable public finances.
  - Acknowledgement of strong 2017 performance and positive 2018 outlook, noting downside risks from global and euro area developments.
  - Continued engagement in structural fiscal consolidation and implementation of structural reforms to improve productivity and resilience.
  - Commitment to use revenue windfalls to continue reducing public debt.
  - Reiteration of enduring commitment to meeting obligations towards the Fund and to the ambitious structural reform agenda.
  - Look forward to the next Article IV Consultation in 2019.

*Source: Annex V. Past Recommendations — Country Report material (Portugal), August 21, 2018.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18273.pdf_