## EXECUTIVE SUMMARY (cr1852)

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**Canonical URL:** [EXECUTIVE SUMMARY (cr1852)](https://www.imf.org/-/media/files/publications/cr/2018/cr1852.pdf)

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---

### Recent developments and outlook
- Economic momentum
  - Job-rich growth gathered momentum since late 2016.
  - Real GDP growth: 2.5 percent year-on-year (0.5 percent q/q) in 2017Q3; expected to have reached 2.6 percent in 2017.
  - Private investment bounced back to above 9 percent year-on-year in 2017Q3 from 1.6 percent in 2016.
  - Employment: unemployment down to 8.1 percent in 2017 Q4; employment growth broad-based across permanent and temporary jobs.
- Inflation and competitiveness
  - Headline inflation fell to 1.6 percent in December 2017; core inflation moderated to 1.2 percent.
  - Headline inflation peak was 2.4 percent year-on-year in April 2017.
  - Unit labor costs (ULCs) rose at a slower pace than in early 2016, but ULC-based REER appreciated by 1.9 percent from end-2016 through November 2017.
  - Goods and services trade balance deteriorated by about ½ percent of GDP compared to the prior year.
- Banking sector
  - Main banks finalized capital augmentations in 2017; CET1 ratio increased by 2.1 percentage points since end-2016 to 13.5 percent in September 2017.
  - Nonperforming loans (NPLs) fell 2.6 percentage points to 14.6 percent of total loans through September 2017; provision coverage ratio improved to 47 percent.
  - Banks reduced reliance on wholesale and ECB funding and returned to modest profitability after 2016 losses.
- Fiscal position
  - 2017 deficit target of 1.4 percent of GDP likely met with some margin.
  - Portugal exited the EU’s Excessive Deficit Procedure in June 2017 after closing 2016 with an overall deficit of 2 percent of GDP.
  - Primary structural terms show a modest loosening of the fiscal stance in 2017.
  - 2018 budget targets headline deficit of 1.1 percent of GDP, largely reflecting savings on interest payments.
  - Interest costs projected to fall to 3.7 percent of GDP in 2018, a decline of 1 percentage point since 2015.
- Outlook and projections
  - Growth projected at 2.2 percent in 2018, with moderation over the medium term.
  - Employment growth expected to remain strong and unemployment to decline further in 2018.
  - Staff projects consumer inflation of 1.5 percent in 2018 and about 2 percent over the medium term.
  - Near-term downside risks mostly external and appear moderate.

### Capacity to repay the Fund
- Fund exposure and repayments
  - Portugal made advanced repurchases totaling SDR 19.1 billion to the Fund since the end of the program.
  - Debt outstanding to the Fund as of January 2018: SDR 3.9 billion (187.5 percent of quota).
  - Next scheduled repurchase not due until 2021.
- Market financing and debt profile
  - Annual public gross financing needs projected at around 15 percent of GDP.
  - Average maturity of non-IMF/EU debt was 6.4 years at end-December 2017.
  - Implicit interest rate on new debt declined to 2.6 percent; 10-year yields fell to about 2 percent by early 2018, down from the most recent peak of almost 4.3 percent.
  - Authorities target a cash buffer of at least 40 percent of 2018 financing needs (excluding short-term debt rollover).
- Role of ECB Asset Purchase Program (APP)
  - Importance of APP in supporting Portuguese financing conditions declined in 2017 as market confidence recovered.
  - ECB’s October 2017 decision halved net asset purchases from January 2018 to September 2018; purchases of Portuguese sovereign bonds could remain close to recent levels given the 33 percent limit.
  - Despite a roughly one-half reduction in average monthly PSPP purchases in 2017, Portuguese spreads vis-à-vis Germany narrowed by about 200 basis points during the year to around 150 basis points at end-2017.
  - Yields remain sensitive to market sentiment, phasing out of APP, and possible repricing of risk.
- Repayment capacity assessment
  - Portugal’s capacity to repay the Fund is adequate in the baseline and robust to the DSA risk scenarios; repayment risks pushed to the medium term owing to advanced repurchases and longer maturities.

### Risks and policy discussions — summary
- General vulnerabilities
  - Large stocks of public and private debt remain important crisis legacies and sources of vulnerability.
  - Large stock of bad loans on banks’ books constrains their ability to provide new credit for investment.
  - Structural fiscal consolidation based on durable expenditure reform is essential to keep public debt on a firmly downward trajectory over the medium term.
  - Continued efforts to improve banks’ profitability and reduce NPLs are necessary so banks can generate new capital from profits and better support the economy.
  - Raising growth potential and resilience while maintaining competitiveness requires further structural reforms, higher investment, and productivity improvements.

- Key risk areas and policy recommendations (high-level)
  - Labor costs and competitiveness: monitor ULC divergence with key partners; consider labor-market measures that preserve competitiveness.
  - External environment: manage vulnerability from tourism reliance and trading partner slowdowns; guard against tighter global financial conditions.
  - Structural reform priorities: labor market flexibility, judicial efficiency, corporate debt restructuring; make permanent contracts more flexible rather than restricting temporary contracts.
  - Fiscal consolidation: pursue durable expenditure reforms, contain public wage bill, advance public financial management reforms, and strengthen tax collection.

*Source: EXECUTIVE SUMMARY (cr1852), IMF Staff Report, February 5, 2018.*

---

### Financial-sector developments, corporate and household balance sheets, and policy recommendations

### Labor market reforms and active policies
- Intentions
  - Continue reducing labor market segmentation.
- Active labor market policies
  - Focus on supporting permanent contracts for low-skilled workers and the long-term unemployed.
  - Financial incentives seek to discourage temporary contracts.
  - Broad range of training programs introduced to upgrade skills.

### NPLs and bank resilience
- Current situation
  - Portuguese banks continue to face significant challenges from the large stock of NPLs.
  - High NPLs constrain banks’ profits, capital generation, and lending capacity.
- NPL resolution strategy
  - Comprehensive NPL reduction strategy under execution.
  - Banks have developed time-bound NPL reduction plans with specific operational targets by asset class and time horizon, subject to supervisory monitoring.
  - Three banks with high NPLs and common exposures to non-financial corporates have launched a platform to expedite coordinated credit and corporate restructurings.
  - The Capitalizar program seeks to facilitate corporate restructuring and funding.
- Policy recommendations
  - Supervisors should continue to ensure banks’ plans are credible and stand ready to activate supervisory measures in case of deviations.
  - Given the size of legacy NPLs and available capital buffers, additional capital augmentations might be needed for further write-offs.
  - Strengthen banks’ corporate governance, including risk management and audit committees, to reduce uncertainty associated with valuation and treatment of NPLs and criteria for future lending.
- Example target
  - Caixa Geral de Depositos targets a reduction of nonperforming exposures from 16 percent in 2016 to 8 percent by 2020; this ratio stood at 10.1 percent in September 2017.

### Bank profitability and structural challenges
- Recent performance
  - Banks returned to profitability in 2017.
- Headwinds to sustained profitability
  - Net interest income stabilizing as households refinance mortgages while variable rates’ spreads have been declining in the last two years.
  - Deposit rates moving close to zero.
  - Commercial margins on new loans narrowing owing to heightened bank competition.
  - Introduction of IFRS 9 in 2018 and issuance of MREL instruments will pose additional challenges to profitability.
  - Emerging competition from Fintech with the entry into force in 2018 of the EU Directive on payment systems.
- Recommendation
  - Deepen efforts to transform banks’ business models to ensure sustainable profitability by:
    - Developing digital banking platforms to rationalize branch networks and reduce costs.
    - Redirecting lending activities towards the dynamic tradable sector.
    - Taking advantage of recent capital increases and improved macroeconomic conditions to adapt to the post-crisis environment.

### Corporate deleveraging and policy reform
- Debt levels and trends
  - Non-financial corporate debt stock fell from its 2012 peak of 127.9 percent of GDP to 102.4 percent of GDP as of September 2017.
  - Deleveraging appears to be moderating, particularly in construction and utility sectors and among non-financial holdings.
- Composition shifts
  - Small decline in bank lending coinciding with an increase in loans granted by non-residents.
  - Gradual shift in non-financial corporate funding from debt towards equity, particularly for SMEs.
- Policy measures to accelerate deleveraging
  - Strengthen debt enforcement and insolvency framework under Capitalizar to help distressed but viable businesses seek debt restructuring early.
  - Consider enabling debt-equity swaps and transfer of whole NPL portfolios.
  - Establish business recovery mediators and an additional legal framework for out-of-court debt restructurings.
  - Commission an in-depth survey of stakeholders on judicial system efficiency in insolvency and debt enforcement.

### Household balance sheet repair and housing market
- Household debt and credit
  - Household debt-to-disposable income ratio declined another 3 percentage points to 107 percent through September 2017 after falling over 20 percentage points between 2011 and 2016; remains above the EU average.
  - Outstanding stock of mortgage loans declined 1.6 percent in 2017, while outstanding loans to individuals for consumption and other purposes increased 6.4 percent.
  - Flow of new loans for house purchases has been growing.
- Residential real estate prices
  - Residential real estate prices have risen by about 20 percent in real terms since 2013 compared with 7 percent in the euro area, reaching the 2009 level.
  - A growing share of housing transactions is financed by bank loans (45 percent in 2017Q2).
- Macroprudential response
  - Banco de Portugal announced on February 1, 2018 new limits on maturities, loan-to-value ratios, and debt service-to-income ratios for new mortgage and consumer loans to households granted starting on July 1, 2018; adopted as a recommendation on a “comply or explain” basis.
- Recommendation
  - Closely monitor rising housing market risks.
  - Macroprudential authorities should remain vigilant and stand ready to take additional measures if needed.
  - Step up efforts to broaden coverage and enhance quality of real estate data and strengthen analytical tools.
  - Continue attention to credit standards.

---

### Fiscal policy, public debt sustainability, and DSA findings

### Public debt trajectory and vulnerabilities
- Debt levels and projections
  - Public debt declined from 130.1 percent of GDP at end-2016 to around 126 percent at end-2017, and projected to around 108 percent of GDP by 2023.
  - Public Sector DSA suggests debt trajectory remains subject to significant risks.
- Vulnerabilities
  - Debt dynamics vulnerable to macro-fiscal and contingent liabilities shocks, including possible need for further fiscal support for the financial sector.
  - High debt and substantial financing needs limit fiscal space to address banking vulnerabilities aggressively.

### Fiscal policy recommendations
- Durable structural fiscal consolidation remains critical to anchor debt on a downward-sloping path and boost policy credibility.
- Consolidation should aim to generate net savings while ringfencing growth-enhancing expenditures.
- Be cautious about permanent increases in spending that reduce flexibility when cyclical conditions change, especially decisions affecting the government wage bill trajectory.
- Contain the public wage bill through comprehensive public-sector reform to adjust level and composition of public employment and revisit compensation to streamline allowances and improve equity among civil servants.
- Advance public financial management reforms, including implementing the new budget framework law and enforcing full compliance with commitment control legislation.
- Design and implement the current spending review more in line with best practices to identify high-quality saving options.
- Strengthen tax collection by simplifying procedures and limiting recourse to reduced VAT rates.

### Authorities’ fiscal intentions
- Spending review should generate savings of about 0.1 percent of GDP in 2018 to help offset budgetary costs of gradual unfreezing of career progressions and an increase in retirement benefits.
- Revenue-side reforms focus on enhancing progressivity of personal and corporate income taxes by reducing tax burden on low- and middle-income households and increasing taxes on companies with profits above €35 million.
- Government considering additional tax measures for 2018 to incentivize investment by SMEs.

### Staff appraisal — priorities
- Use favorable borrowing conditions and economic upswing to pursue faster public debt reduction through structural consolidation focused on durable expenditure reform.
- Continue strengthening banks’ business models and cleaning NPLs so banks can generate new capital from profits and better support the economy.
- Implement legal and institutional improvements to support debt restructuring of viable but distressed debtors and recovery of collateral, including out-of-court mechanisms.
- Monitor housing market developments carefully and have macroprudential authorities stand ready to act.

*Source: IMF staff report text provided in content unit.*

---

### Growth, macro projections, external sector, and DSA stress tests

### Growth potential, investment, and savings
- Structural requirements to raise growth potential
  - Further structural reforms, higher investment and productivity, and a flexible labor market that preserves flexibility even as more stable jobs are sought.
  - Improve the business environment alongside human capital initiatives.
- Investment and savings indicators (selected Table 1 and projections)
  - Real GDP (Year-on-year percent change): 2017 = 2.6; 2018 = 2.2; 2019 = 1.8; 2020 = 1.5; 2021 = 1.2; 2022 = 1.2; 2023 = 1.2.
  - Gross fixed investment (Year-on-year percent change): 2017 = 1.6; 2018 = 8.7; 2019 = 8.1; 2020 = 5.1; 2021 = 4.4; 2022 = 3.5; 2023 = 3.8.
  - Gross national savings (Percent of GDP): 2015 = 15.4; 2016 = 15.9; 2017 = 16.2; 2018 = 17.5; 2019 = 18.3; 2020 = 18.8; 2021 = 18.9; 2022 = 19.0; 2023 = 19.3.
  - Gross domestic investment (Percent of GDP): 2015 = 15.3; 2016 = 15.8; 2017 = 15.5; 2018 = 17.0; 2019 = 18.1; 2020 = 18.8; 2021 = 19.4; 2022 = 19.8; 2023 = 20.2.

### Labor market and employment indicators (Table 1)
- Employment (Year-on-year percent change): 2015 = 1.5; 2016 = 1.2; 2017 = 1.5; 2018 = 3.1; 2019 = 1.3; 2020 = 1.1; 2021 = 0.5; 2022 = 0.5; 2023 = 0.5.
- Unemployment rate (Percent): 2015 = 13.9; 2016 = 12.4; 2017 = 11.1; 2018 = 9.0; 2019 = 7.8; 2020 = 7.2; 2021 = 6.7; 2022 = 6.2; 2023 = 5.7; 2024 = 5.2.

### Fiscal context (Table 2a and 2b, selected figures)
- General government revenue (Percent of GDP): 2014 = 44.6; 2015 = 43.8; 2016 = 43.0; 2017 = 43.2; 2018 = 43.2; 2019 = 43.0; 2020 = 42.9; 2021 = 42.8; 2022 = 42.7; 2023 = 42.6.
- Expenditure (Percent of GDP): 2014 = 51.8; 2015 = 48.2; 2016 = 45.0; 2017 = 44.3; 2018 = 44.2; 2019 = 43.9; 2020 = 43.7; 2021 = 43.5; 2022 = 43.4; 2023 = 43.1.
- Net lending (+)/borrowing (–) (Percent of GDP): 2014 = -7.2; 2015 = -4.4; 2016 = -2.0; 2017 = -1.2; 2018 = -1.1; 2019 = -0.9; 2020 = -0.8; 2021 = -0.7; 2022 = -0.7; 2023 = -0.5.
- Debt at face value (EDP notification, Percent of GDP): 2014 = 130.6; 2015 = 128.8; 2016 = 130.1; 2017 = 125.7; 2018 = 121.7; 2019 = 118.4; 2020 = 115.4; 2021 = 112.7; 2022 = 110.4; 2023 = 108.0.
- Selected nominal projections (Billions of euros, Table 2a): Revenue: 2017 = 83.3; 2018 = 86.4; 2019 = 88.9; 2020 = 91.5; 2021 = 94.1; 2022 = 96.6; 2023 = 99.1. Expenditure (Expense): 2017 = 85.8; 2018 = 90.3; 2019 = 92.7; 2020 = 95.1; 2021 = 97.5; 2022 = 100.1; 2023 = 102.4. Net lending (+)/borrowing (–): 2017 = -3.7; 2018 = -2.3; 2019 = -2.1; 2020 = -1.9; 2021 = -1.7; 2022 = -1.5; 2023 = -1.3.

### External sector and financing (Table 4 and Table 6 highlights)
- Current account (Percent of GDP): 2014 = 0.2; 2015 = 0.2; 2016 = 1.3; 2017 = 0.8; 2018 = 0.3; 2019 = -0.1; 2020 = -1.0; 2021 = -2.1; 2022 = -2.7; 2023 = -3.4.
- Trade balance (Goods, Billions of euros): 2014 = -9.5; 2015 = -9.4; 2016 = -9.3; 2017 = -12.0; 2018 = -14.2; 2019 = -15.3; 2020 = -16.6; 2021 = -18.1; 2022 = -20.0; 2023 = -22.0.
- Net international investment position (Percent of GDP): 2014 = -117.5; 2015 = -112.0; 2016 = -104.7; 2017 = -99.0; 2018 = -94.0; 2019 = -89.7; 2020 = -86.2; 2021 = -83.5; 2022 = -81.2; 2023 = -79.2.
- Baseline external debt (Percent of GDP): 2015 = 222.3; 2016 = 215.8; 2017 = 202.4; 2018 = 195.4; 2019 = 189.2; 2020 = 183.5; 2021 = 178.7; 2022 = 176.3; 2023 = 173.4.
- Debt-stabilizing non-interest current account: 1.6.

### Financial sector indicators (selected)
- Non-performing loans to total gross loans (quarterly observations, Table 5): series includes 17.5, 17.9, 17.9, 17.6, 17.2, 16.4, 15.5, 14.6.
- Common Equity Tier 1 capital to risk-weighted assets (Table 5 quarterly values): 11.1, 10.6, 12.0, 11.3, 11.1, 11.7, 11.6, 12.4, 12.1, 12.1, 12.3, 11.4, 12.6, 13.2, 13.5.
- Private sector credit (end-period, Millions of euros): 2014 = 224,396; 2015 = 215,174; 2016 = 207,317; 2017 = 204,207; projections to 2023 show 219,554.
- Broad money (M3, end-period, Millions of euros): 2014 = 147,174; 2015 = 153,193; 2016 = 152,601; 2017 = 158,298; projections to 2023 show 185,316.

### Key macro assumptions underlying external-debt baseline (Table 6)
- Real GDP growth (Percent): 2017 = 2.6; 2018 = 2.2; 2019 = 1.8; 2020 = 1.5; 2021 = 1.2; 2022 = 1.2; 2023 = 1.2.
- GDP deflator in Euros (Percent): 2017 = 1.4; 2018 = 1.6; 2019 = 1.5; 2020 = 1.5; 2021 = 1.7; 2022 = 1.7; 2023 = 1.7.
- Nominal external interest rate (Percent): 2017 = 1.8; 2018 = 1.9; 2019 = 1.6; 2020 = 2.1; 2021 = 0.9; 2022 = 1.7; 2023 = 1.8.
- Current account balance, excluding interest payments (Percent of GDP): 2017 = 4.2; 2018 = 3.8; 2019 = 3.0; 2020 = 3.4; 2021 = 0.7; 2022 = 1.8; 2023 = 1.6.

### Public DSA — baseline, risks, and stress tests (Annex I)
- Baseline key outcomes
  - Public debt falls from 126 percent in 2017 to 108 percent of GDP in 2023.
  - Primary surplus projected to have risen to 2.7 percent of GDP in 2017 and expected to stabilize around 2½ percent of GDP over the medium term.
  - Effective nominal interest rate on public debt projected to decline from 3.4 to 3.1 percent in 2017.
- Risk assessment
  - Portugal’s debt ratio exceeds the advanced-economy debt burden benchmark of 85 percent of GDP.
  - Public gross financing needs fall below the 20 percent of GDP benchmark.
  - Debt profile subject to medium-to-low risks in market perception and short-term debt change.
- Alternative scenarios and realism
  - Staff baseline assumes medium-term growth of 1.2 percent.
  - Authorities’ Stability Program assumes annual real GDP growth of 2.0 percent in 2017–21; staff baseline average 2017–21: 1.7 percent.
- Stress-test scenarios (selected impacts)
  - Growth shock: output lower by nearly 4.5 percentage points in 2019–20 (inflation down by cumulative 1 percentage point) → debt peaks at about 127 percent of GDP in 2020, 11 percentage points higher than baseline.
  - Interest rate shock: sustained 340 basis points throughout projection period → by 2023 debt-to-GDP ratio about 3 points higher than baseline.
  - Contingent liability shock (a): Novo Banco Resolution Fund commitment cumulative ceiling of €3.89 billion → debt-to-GDP increase about 2 percent of GDP above baseline by 2023.
  - Contingent liability shock (b): public sector costs amount to 10 percent of GDP → pushes 2019 debt ratio to 130 percent of GDP.
  - Combined severe shock: macro-fiscal and contingent liabilities adverse scenarios → debt rises to 136 percent of GDP in 2020 and remains close to that level over the medium term.

- Selected DSA statistics
  - Public debt: 2017 = 126 percent of GDP (projected 108 percent by 2023).
  - Primary surplus: 2017 = 2.7 percent of GDP.
  - Real GDP growth: 2017 = 2.6 percent; staff medium-term assumption = 1.2 percent.
  - Effective nominal interest rate on public debt: decline from 3.4 to 3.1 percent in 2017.
  - Public sector recapitalization of CGD: 2 percent of GDP in the first half of 2017.
  - Novo Banco contingent liability cumulative ceiling: €3.89 billion.
  - Interest rate shock examined: 340 basis points sustained.
  - Growth shock examined: output lowers by nearly 4.5 percentage points in 2019–20; inflation down by cumulative 1 percentage point.

*International Monetary Fund — Annex I. Public Debt Sustainability Analysis (DSA) — Portugal*

---

### Risk Assessment Matrix — selected risks, likelihoods, impacts, and policy responses (Annex II)

- Loss of investor confidence due to reform reversals or other negative surprises (including banking difficulties)
  - Relative Likelihood: Low
  - Impact: High
  - Findings: increase in sovereign bond yields; reduction in FDI; significant funding distress and higher public and private borrowing costs.
  - Policy response: strengthen policy buffers; avoid backtracking on reforms; implement policies that support growth, lasting fiscal adjustment, and a strong banking system.

- Financial distress in one or more banks, requiring intervention
  - Relative Likelihood: Low
  - Impact: High
  - Findings: loss of confidence in the banking system, potentially high fiscal costs.
  - Policy response: proactive bank supervision; balance sheet clean-up; build-up of capital and fiscal buffers; strengthen oversight of banks’ risk management practices; shore up banks using existing toolkit while protecting public debt dynamics.

- Policy and geopolitical uncertainties
  - Relative Likelihood: High
  - Impact: High
  - Findings: policy uncertainty, US/ECB/Fed policy shifts, Brexit negotiations, election-related uncertainty; increased investor uncertainty and lower investment; risk of trade barriers and euro skepticism.
  - Policy response: accelerate structural reforms; strengthen fiscal adjustment; clean up corporate and bank balance sheets.

- Financial conditions
  - Relative Likelihood: High
  - Impact: Medium overall; High for some items
  - Findings: tighter global financial conditions from Fed normalization and ECB tapering; potential European bank distress; loss of market confidence; Portugal highly susceptible to financial contagion given high corporate and private debt.
  - Policy response: implement policies that support growth and fiscal adjustment; proactive bank supervision; build-up of capital buffers and fiscal buffers; strengthen oversight of banks’ risk management.

- Weaker-than-expected global growth
  - Relative Likelihood: Medium (US, euro area, Japan); Medium (Emerging Markets)
  - Impact: High
  - Findings: structurally weak growth in key advanced economies would imperil debt dynamics; current account and IIP at risk.
  - Policy response: step up structural reforms; clean up corporate and bank balance sheets.

- Lower energy prices driven by stronger-than-expected U.S. shale and/or recovery of oil production in Africa
  - Relative Likelihood: Low
  - Impact: Medium
  - Findings: lower fuel import bill possibly offset by greater difficulties in Angola, a key partner.
  - Policy response: reduce exposures to Angola; shore up banks using existing toolkit; renew structural reform to expand exports to other markets.

*Note: Relative likelihood definitions: “low” = probability below 10 percent; “medium” = between 10 and 30 percent; “high” = 30 percent or more.*

*Source: Annex II. Risk Assessment Matrix*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### RECENT DEVELOPMENTS AND OUTLOOK
- Economic momentum:
  - Job-rich growth gathered momentum since late 2016.
  - Real GDP growth: 2.5 percent year-on-year (0.5 percent q/q) in 2017Q3; expected to have reached 2.6 percent in 2017.
  - Private investment bounced back to above 9 percent year-on-year in 2017Q3 from 1.6 percent in 2016.
  - Employment: unemployment down to 8.1 percent in 2017 Q4; employment growth broad-based across permanent and temporary jobs.
- Inflation and competitiveness:
  - Headline inflation fell to 1.6 percent in December 2017; core inflation moderated to 1.2 percent.
  - Headline inflation peak was 2.4 percent year-on-year in April 2017.
  - Unit labor costs (ULCs) rose at a slower pace than in early 2016, but ULC-based REER appreciated by 1.9 percent from end-2016 through November 2017.
  - Goods and services trade balance deteriorated by about ½ percent of GDP compared to the prior year.
- Banking sector:
  - Main banks finalized capital augmentations in 2017; CET1 ratio increased by 2.1 percentage points since end-2016 to 13.5 percent in September 2017.
  - Nonperforming loans (NPLs) fell 2.6 percentage points to 14.6 percent of total loans through September 2017; provision coverage ratio improved to 47 percent.
  - Banks reduced reliance on wholesale and ECB funding and returned to modest profitability after 2016 losses.
- Fiscal position:
  - 2017 deficit target of 1.4 percent of GDP likely met with some margin.
  - Portugal exited the EU’s Excessive Deficit Procedure in June 2017 after closing 2016 with an overall deficit of 2 percent of GDP.
  - Primary structural terms show a modest loosening of the fiscal stance in 2017.
  - 2018 budget targets headline deficit of 1.1 percent of GDP, largely reflecting savings on interest payments.
  - Interest costs projected to fall to 3.7 percent of GDP in 2018, a decline of 1 percentage point since 2015.
- Outlook and projections:
  - Growth projected at 2.2 percent in 2018, with moderation over the medium term.
  - Employment growth expected to remain strong and unemployment to decline further in 2018.
  - Staff projects consumer inflation of 1.5 percent in 2018 and about 2 percent over the medium term.
  - Near-term downside risks mostly external and appear moderate.

### CAPACITY TO REPAY THE FUND
- Fund exposure and repayments:
  - Portugal made advanced repurchases totaling SDR 19.1 billion to the Fund since the end of the program.
  - Debt outstanding to the Fund as of January 2018: SDR 3.9 billion (187.5 percent of quota).
  - Next scheduled repurchase not due until 2021.
- Market financing and debt profile:
  - Annual public gross financing needs projected at around 15 percent of GDP.
  - Average maturity of non-IMF/EU debt was 6.4 years at end-December 2017.
  - Implicit interest rate on new debt declined to 2.6 percent; 10-year yields fell to about 2 percent by early 2018, down from the most recent peak of almost 4.3 percent.
  - Authorities target a cash buffer of at least 40 percent of 2018 financing needs (excluding short-term debt rollover).
- Role of ECB Asset Purchase Program (APP):
  - Importance of APP in supporting Portuguese financing conditions declined in 2017 as market confidence recovered.
  - ECB’s October 2017 decision halved net asset purchases from January 2018 to September 2018; purchases of Portuguese sovereign bonds could remain close to recent levels given the 33 percent limit.
  - Despite a roughly one-half reduction in average monthly PSPP purchases in 2017, Portuguese spreads vis-à-vis Germany narrowed by about 200 basis points during the year to around 150 basis points at end-2017.
  - Yields remain sensitive to market sentiment, phasing out of APP, and possible repricing of risk.
- Repayment capacity assessment:
  - Portugal’s capacity to repay the Fund is adequate in the baseline and robust to the DSA risk scenarios; repayment risks pushed to the medium term owing to advanced repurchases and longer maturities.

### RISKS AND POLICY DISCUSSIONS
- General vulnerabilities:
  - Large stocks of public and private debt remain important crisis legacies and sources of vulnerability.
  - Large stock of bad loans on banks’ books constrains their ability to provide new credit for investment.
  - Structural fiscal consolidation based on durable expenditure reform is essential to keep public debt on a firmly downward trajectory over the medium term.
  - Continued efforts to improve banks’ profitability and reduce NPLs are necessary so banks can generate new capital from profits and better support the economy.
  - Raising growth potential and resilience while maintaining competitiveness requires further structural reforms, higher investment, and productivity improvements.

A. Risks to the Growth Outlook
- Labor costs and competitiveness:
  - Past declines in labor costs helped firms deleverage and finance investment; faster rises in labor costs could dampen corporate savings and constrain investment without creating external imbalances.
  - In recent quarters ULCs have risen faster than in key partners, particularly Spain where ULCs have recently fallen; persistent divergence could affect external competitiveness.
  - Minimum wage increase in 2018: EUR 580 (from EUR 557); minimum wage covers about a fifth of full-time employees and may contribute to higher labor costs.
- External environment risks:
  - Reliance on tourism increases vulnerability to external shocks; gains from geopolitical shifts could reverse.
  - Slowdown in trading partner growth (especially Spain) could affect Portugal.
  - Tighter global financial conditions—scaling down of the ECB’s APP and Fed normalization—could affect domestic and external demand; domestic effects amplified by high leverage across the economy.
- Structural reform importance:
  - Structural policy priorities: labor market flexibility, judicial efficiency, corporate debt restructuring.
  - Safeguard program-era reforms to hiring and collective bargaining flexibility.
  - Address gap between temporary and permanent contracts by making permanent contracts more flexible rather than restricting temporary contracts.
  - Wages that reflect productivity are important to absorb higher-skilled labor and safeguard competitiveness.
- Medium-term risks:
  - Possible rise in volatility in European bond markets as monetary accommodation is reduced.
  - Insufficient progress on (or yield from) reforms would pose downside risk.
- Authorities’ views on risks:
  - Authorities see growth likely more robust than staff’s baseline over the medium term, citing supply-side structural reforms as foundation for stronger export-oriented growth.
  - Authorities emphasize that potential output estimates should capture structural change from ongoing and past reforms.
  - Authorities acknowledge potential downside risks from a weakening external environment but stress Portugal’s competitive performance and reform record.
  - Authorities view global monetary conditions as likely to remain broadly accommodative and any turbulence manageable; they highlight maturity structure and large cash buffer as mitigating factors.
  - Authorities note advanced Fund repurchases reduced average debt cost while maintaining average maturity.

*Source: EXECUTIVE SUMMARY (cr1852), IMF Staff Report, February 5, 2018.*

### 16.      The authorities stated that program-era reforms are not at stake, while indicating their

### 16.      The authorities stated that program-era reforms are not at stake, while indicating their

### Labor market reforms and active policies
- Intentions:
  - Continue reducing labor market segmentation.
- Active labor market policies:
  - Focused on supporting permanent contracts for low-skilled workers and the long-term unemployed.
  - Financial incentives seek to discourage temporary contracts.
  - A broad range of training programs have been introduced to upgrade the skills of the labor force.

### Risks to balance sheets — Nonperforming loans (NPLs) and bank resilience
- Current situation:
  - Portuguese banks continue to face significant challenges from the large stock of NPLs.
  - High NPLs constrain banks’ profits, capital generation, and lending capacity.
- NPL resolution strategy:
  - A comprehensive NPL reduction strategy is under execution.
  - In line with ECB guidance, banks have developed time-bound NPL reduction plans with specific operational targets by asset class and time horizon, subject to monitoring by supervisors.
  - Three banks with high NPLs and common exposures to non-financial corporates have launched a platform to expedite coordinated credit and corporate restructurings.
  - The ongoing Capitalizar program seeks to facilitate corporate restructuring and funding.
- Policy recommendations:
  - Supervisors should continue to ensure that banks’ plans are credible and stand ready to activate supervisory measures in case of deviations.
  - Given the size of legacy NPLs and available capital buffers, additional capital augmentations might be needed for further write-offs.
  - Strengthen banks’ corporate governance, including the role of risk management and audit committees, to reduce uncertainty associated with valuation and treatment of NPLs and the criteria for future lending.
- Example target:
  - Caixa Geral de Depositos targets a reduction of nonperforming exposures from 16 percent in 2016 to 8 percent by 2020; this ratio stood at 10.1 percent in September 2017.

### Bank profitability and structural challenges
- Recent performance:
  - Banks returned to profitability in 2017.
- Headwinds to sustained profitability:
  - Net interest income stabilizing as households refinance mortgages while variable rates’ spreads have been declining in the last two years.
  - Deposit rates moving close to zero.
  - Commercial margins on new loans narrowing owing to heightened bank competition.
  - Introduction of IFRS 9 in 2018 and issuance of MREL instruments will pose additional challenges to profitability.
  - Emerging competition from firms specialized in digital financial services (Fintech) with the entry into force in 2018 of the EU Directive on payment systems.
- Recommendation:
  - Deepen efforts to transform banks’ business models to ensure sustainable profitability by:
    - Developing digital banking platforms to rationalize branch networks and reduce costs.
    - Redirecting lending activities towards the dynamic tradable sector.
    - Taking advantage of recent capital increases and improved macroeconomic conditions to adapt to the post-crisis environment.

### Corporate sector deleveraging and policy reform
- Debt levels and trends:
  - Non-financial corporate debt stock fell from its 2012 peak of 127.9 percent of GDP to 102.4 percent of GDP as of September 2017.
  - Deleveraging process appears to be moderating, particularly in the construction and utility sectors and among non-financial holdings.
- Composition shifts:
  - Small decline in bank lending coinciding with an increase in loans granted by non-residents.
  - Gradual shift in non-financial corporate funding from debt towards equity, particularly for SMEs.
- Policy measures to accelerate deleveraging:
  - Strengthen debt enforcement and insolvency framework under the Capitalizar initiative to help distressed but viable businesses seek debt restructuring early.
  - Consider enabling debt-equity swaps and transfer of whole NPL portfolios.
  - Establish business recovery mediators to assist debtors and an additional legal framework for out-of-court debt restructurings.
  - Commission an in-depth survey of stakeholders on the efficiency of the judicial system in insolvency and debt enforcement.

### Household balance sheet repair and housing market
- Household debt:
  - Household debt-to-disposable income ratio declined another 3 percentage points to 107 percent through September 2017 after falling over 20 percentage points between 2011 and 2016; remains above the EU average.
  - Outstanding stock of mortgage loans declined 1.6 percent in 2017, while outstanding loans to individuals for consumption and other purposes increased 6.4 percent.
  - Flow of new loans for house purchases has been growing.
- Residential real estate prices:
  - Residential real estate prices have risen by about 20 percent in real terms since 2013 compared with 7 percent in the euro area, reaching the 2009 level.
  - A growing share of housing transactions is financed by bank loans (45 percent in 2017Q2).
- Macroprudential response:
  - Banco de Portugal announced on February 1, 2018 new limits on maturities, loan-to-value ratios, and debt service-to-income ratios for new mortgage and consumer loans to households granted starting on July 1, 2018; adopted as a recommendation on a “comply or explain” basis.
- Recommendation:
  - Closely monitor rising housing market risks.
  - Macroprudential authorities should remain vigilant and stand ready to take additional measures if needed to prevent build-up of imbalances and to strengthen resilience of banks and borrowers.
  - Step up efforts to broaden coverage and enhance quality of real estate data and strengthen analytical tools.
  - Continue attention to credit standards.

### Public debt sustainability risks and fiscal policy
- Debt trajectory and vulnerabilities:
  - Public debt declined from 130.1 percent of GDP at end-2016 to around 126 percent at end-2017, and projected to around 108 percent of GDP by 2023.
  - Public Sector DSA suggests debt trajectory remains subject to significant risks.
  - Debt dynamics vulnerable to macro-fiscal and contingent liabilities shocks, including possible need for further fiscal support for the financial sector.
  - High debt and substantial financing needs limit fiscal space to address banking vulnerabilities aggressively.
- Fiscal policy recommendations:
  - Durable structural fiscal consolidation remains critical to anchor debt on a downward-sloping path and boost policy credibility.
  - Consolidation should aim to generate net savings while ringfencing growth-enhancing expenditures.
  - Be cautious about permanent increases in spending that reduce flexibility when cyclical conditions change, especially decisions affecting the government wage bill trajectory.
  - Contain the public wage bill through comprehensive public-sector reform to adjust level and composition of public employment and revisit compensation structure to streamline allowances and improve equity among civil servants.
  - Advance public financial management reforms, including implementing the new budget framework law and enforcing full compliance with commitment control legislation, to keep non-wage expenditures contained and prevent accumulation of new payment arrears.
  - Design and implement the current spending review more in line with best practices to identify a menu of high-quality saving options.
  - Strengthen tax collection by simplifying procedures to comply with tax obligations and limiting recourse to reduced VAT rates.
- Authorities’ fiscal intentions:
  - Spending review should generate savings of about 0.1 percent of GDP in 2018 to help offset budgetary costs of gradual unfreezing of career progressions and an increase in retirement benefits.
  - Revenue-side reforms focus on enhancing progressivity of personal and corporate income taxes by reducing tax burden on low- and middle-income households and increasing taxes on companies with profits above €35 million.
  - Government considering additional tax measures for 2018 to incentivize investment by SMEs.

### Authorities’ views on financial-sector measures
- Authorities’ position:
  - Acknowledge current challenges and point to ongoing efforts by stakeholders to address them.
  - Highlight that banks’ NPL reduction plans resulted from an iterative process with supervisors and showed good performance through September 2017.
  - Stress that asset disposal strategies must consider the EU regulatory framework (BRRD, State aid rules) and potential impact on public accounts; caution that a rush to dispose of assets could erode bank capital and have unwarranted economic impacts.
  - Note mitigating factors for profitability impacts from IFRS 9 and MREL: envisaged phasing-in periods, increased impairment recognition in recent years following asset quality reviews, improved market perceptions of Portuguese banks, and a favorable macroeconomic outlook.
  - Indicate stepped-up efforts to close data gaps and improve assessment tools, and readiness to deploy macroprudential tools focused on strengthening credit-risk assessments by banks.

### Staff appraisal — summary conclusions and priorities
- Economic outlook and risks:
  - Portuguese economy has continued to strengthen with job-rich and broad-based growth since late 2016, contributing to better than anticipated fiscal outcomes in 2017 and exit from the European Commission’s excessive deficit procedure.
  - Downside near-term risks are mostly external and appear moderate.
- Financial access and sovereign financing:
  - Portugal has improved access to financial markets; sovereign debt eligible for inclusion in several international bond indexes.
  - Capacity to repay the Fund is adequate in the baseline and robust to DSA risk scenarios; no repurchases due until 2021 owing to substantial early repurchases to date.
- Remaining legacies and vulnerabilities:
  - Important crisis legacies remain: large nonfinancial private sector debt, large stock of bad loans on banks’ books, high public debt at 126 percent of GDP (third largest in the euro area).
  - Even with projected decline to 108 percent of GDP by 2023, Portugal remains vulnerable to unexpected rises in interest rates, wind-down of monetary stimulus, and cyclical downturns.
- Policy priorities:
  - Use favorable borrowing conditions and economic upswing to pursue faster public debt reduction through structural consolidation focused on durable expenditure reform.
  - Continue strengthening banks’ business models and cleaning NPLs so banks can generate new capital from profits and better support the economy.
  - Implement legal and institutional improvements to support debt restructuring of viable but distressed debtors and recovery of collateral, including out-of-court mechanisms, and closely monitor these initiatives.
  - Monitor housing market developments carefully and have macroprudential authorities stand ready to act to prevent imbalances and strengthen resilience of banks and borrowers.

*Source: IMF staff report text provided in content unit.*

### 36.      Raising the economy’s growth potential and resilience to shocks will also require

### 36.      Raising the economy’s growth potential and resilience to shocks will also require

### Growth potential, resilience, and labor market
- Raising medium-term growth potential and resilience requires:
  - further structural reforms;
  - higher investment and productivity;
  - a flexible labor market that preserves flexibility even as an environment with more stable jobs is sought.
- Along with ongoing initiatives to develop human capital, structural reforms should include efforts to continue improving the business environment.

### Investment, savings, and external balance
- Investment needs to increase substantially to raise the economy’s medium-term growth potential.
- Preserving external balance while raising investment requires strengthening national saving rates as well.
- From Table 1 (selected indicators, projections):
  - Real GDP: 2017 = 2.6; 2018 = 2.2; 2019 = 1.8; 2020 = 1.5; 2021 = 1.2; 2022 = 1.2; 2023 = 1.2 (Year-on-year percent change).
  - Gross fixed investment: 2017 = 1.6; 2018 = 8.7; 2019 = 8.1; 2020 = 5.1; 2021 = 4.4; 2022 = 3.5; 2023 = 3.8 (Year-on-year percent change).
  - Gross national savings (Percent of GDP): 2015 = 15.4; 2016 = 15.9; 2017 = 16.2; 2018 = 17.5; 2019 = 18.3; 2020 = 18.8; 2021 = 18.9; 2022 = 19.0; 2023 = 19.3.
  - Gross domestic investment (Percent of GDP): 2015 = 15.3; 2016 = 15.8; 2017 = 15.5; 2018 = 17.0; 2019 = 18.1; 2020 = 18.8; 2021 = 19.4; 2022 = 19.8; 2023 = 20.2.

### Labor market and employment indicators
- Employment (Year-on-year percent change, Table 1): 2015 = 1.5; 2016 = 1.2; 2017 = 1.5; 2018 = 3.1; 2019 = 1.3; 2020 = 1.1; 2021 = 0.5; 2022 = 0.5; 2023 = 0.5.
- Unemployment rate (Percent): 2015 = 13.9; 2016 = 12.4; 2017 = 11.1; 2018 = 9.0; 2019 = 7.8; 2020 = 7.2; 2021 = 6.7; 2022 = 6.2; 2023 = 5.7; 2024 = 5.2 (last two values from table context).

### Fiscal context and public debt dynamics
- From Table 2b (Percent of GDP):
  - General government revenue: 2014 = 44.6; 2015 = 43.8; 2016 = 43.0; 2017 = 43.2; 2018 = 43.2; 2019 = 43.0; 2020 = 42.9; 2021 = 42.8; 2022 = 42.7; 2023 = 42.6.
  - Expenditure: 2014 = 51.8; 2015 = 48.2; 2016 = 45.0; 2017 = 44.3; 2018 = 44.2; 2019 = 43.9; 2020 = 43.7; 2021 = 43.5; 2022 = 43.4; 2023 = 43.1.
  - Net lending (+)/borrowing (–): 2014 = -7.2; 2015 = -4.4; 2016 = -2.0; 2017 = -1.2; 2018 = -1.1; 2019 = -0.9; 2020 = -0.8; 2021 = -0.7; 2022 = -0.7; 2023 = -0.5.
  - Debt at face value (EDP notification, percent of GDP): 2014 = 130.6; 2015 = 128.8; 2016 = 130.1; 2017 = 125.7; 2018 = 121.7; 2019 = 118.4; 2020 = 115.4; 2021 = 112.7; 2022 = 110.4; 2023 = 108.0.
- Table 2a (Billions of euros, selected items, projections):
  - Revenue: 2017 = 83.3; 2018 = 86.4; 2019 = 88.9; 2020 = 91.5; 2021 = 94.1; 2022 = 96.6; 2023 = 99.1.
  - Expenditure (Expense): 2017 = 85.8; 2018 = 90.3; 2019 = 92.7; 2020 = 95.1; 2021 = 97.5; 2022 = 100.1; 2023 = 102.4.
  - Net lending (+)/borrowing (–): 2017 = -3.7; 2018 = -2.3; 2019 = -2.1; 2020 = -1.9; 2021 = -1.7; 2022 = -1.5; 2023 = -1.3.

### External sector and external financing
- Current account (Percent of GDP, Table 4, projections):
  - 2014 = 0.2; 2015 = 0.2; 2016 = 1.3; 2017 = 0.8; 2018 = 0.3; 2019 = -0.1; 2020 = -1.0; 2021 = -2.1; 2022 = -2.7; 2023 = -3.4 (Billions of euros context also provided).
- Trade balance (Goods, Billions of euros, Table 4): 2014 = -9.5; 2015 = -9.4; 2016 = -9.3; 2017 = -12.0; 2018 = -14.2; 2019 = -15.3; 2020 = -16.6; 2021 = -18.1; 2022 = -20.0; 2023 = -22.0.
- Net international investment position (Percent of GDP, Table 4, projections): 2014 = -117.5; 2015 = -112.0; 2016 = -104.7; 2017 = -99.0; 2018 = -94.0; 2019 = -89.7; 2020 = -86.2; 2021 = -83.5; 2022 = -81.2; 2023 = -79.2.
- External debt dynamics (Table 6):
  - Baseline external debt (Percent of GDP): 2015 = 222.3; 2016 = 215.8; 2017 = 202.4; 2018 = 195.4; 2019 = 189.2; 2020 = 183.5; 2021 = 178.7; 2022 = 176.3; 2023 = 173.4.
  - Debt-stabilizing non-interest current account: 1.6 (long-run constant balance stabilizing the debt ratio at last projection year).

### Financial sector and banking indicators
- From Figure and Table data (selected highlights):
  - Return on equity (Percent, banking system): Last obs. Sep. 2017 (chart reference).
  - Non-performing loans ratio (percent, banking system): 2015Q4–2017Q2 series by sector shown in figures; Table 5 reports non-performing loans to total gross loans: 2013–2017 range includes 17.5, 17.9, 17.9, 17.6, 17.2, 16.4, 15.5, 14.6 (quarterly observations).
  - Common Equity Tier 1 capital to risk-weighted assets (Table 5): quarterly values include 11.1, 10.6, 12.0, 11.3, 11.1, 11.7, 11.6, 12.4, 12.1, 12.1, 12.3, 11.4, 12.6, 13.2, 13.5.
  - Private sector credit (Table 3, end-period, Millions of euros): 2014 = 224,396; 2015 = 215,174; 2016 = 207,317; 2017 = 204,207; projections to 2023 show 219,554.
  - Broad money (M3, Table 3, end-period, Millions of euros): 2014 = 147,174; 2015 = 153,193; 2016 = 152,601; 2017 = 158,298; projections to 2023 show 185,316.

### Key macro projections underlying external-debt baseline (Table 6)
- Real GDP growth (Percent): 2017 = 2.6; 2018 = 2.2; 2019 = 1.8; 2020 = 1.5; 2021 = 1.2; 2022 = 1.2; 2023 = 1.2.
- GDP deflator in Euros (Percent): 2017 = 1.4; 2018 = 1.6; 2019 = 1.5; 2020 = 1.5; 2021 = 1.7; 2022 = 1.7; 2023 = 1.7.
- Nominal external interest rate (Percent): 2017 = 1.8; 2018 = 1.9; 2019 = 1.6; 2020 = 2.1; 2021 = 0.9; 2022 = 1.7; 2023 = 1.8.
- Current account balance, excluding interest payments (Percent of GDP): 2017 = 4.2; 2018 = 3.8; 2019 = 3.0; 2020 = 3.4; 2021 = 0.7; 2022 = 1.8; 2023 = 1.6.

*Italicized source: IMF staff compilation from the provided chapter and tables.*

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

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

### Overview / Key Findings
- Staff’s analysis, applying the Public DSA framework for Market-Access Countries, suggests that Portugal’s gross debt trajectory remains subject to significant risks, in the context of the very high level of public debt.
- Market conditions improved in 2017, supported by the improved near-term growth outlook and successful efforts to meet headline fiscal targets and raise bank capital, which were reflected in the upgrade to an investment grade rating by S&P and Fitch.
- In the baseline, public debt falls from 126 percent in 2017 to 108 percent of GDP in 2023.
- Debt dynamics remain vulnerable to adverse yet plausible macro-fiscal and contingent liabilities shocks, including the possible need for further fiscal support for the financial sector.
- Staff’s baseline projections reflect the authorities’ current fiscal policies; durable structural fiscal consolidation remains critical to anchor debt safely on a downward-sloping path, boosting policy credibility and strengthening the country’s resilience to reversals in market sentiment.

### A. Baseline Scenario
- Public debt is projected to decline to 126 percent of GDP at end-2017, the lowest level since 2011.
- The primary surplus is projected to have risen to 2.7 percent of GDP in 2017.
- Real GDP growth accelerated to 2.6 percent in 2017.
- The effective nominal interest rate on public debt is projected to decline from 3.4 to 3.1 percent in 2017.
- Projected interest costs are lower than in the 2017 Article IV DSA, reflecting the fall in Portuguese bond yields in the second half of 2017 and additional Fund repurchases.
- Under the baseline, borrowing costs on new issuance are projected to gradually increase in line with German bund yields; the impact during the projection period is relatively muted because debt maturing over the next several years was originally issued at much higher yields.
- The impact of rising yields on the effective interest rate would only be felt after 2022 as lower-cost debt begins to be rolled over.
- The public sector contribution to the recapitalization of CGD in the first half of 2017 amounted to 2 percent of GDP, but will be accommodated through a decline in deposits that were accumulated in 2016.
- The further drawdown of cash deposits from 2018–2  3 is projected to be modest, reflecting the authorities’ intention to maintain cover for over 40 percent of the next 12 month’s financing needs.

### B. Risk Assessment
- Portugal’s sizable debt burden continues to pose significant risks to debt sustainability and leaves debt dynamics very sensitive to macro shocks.
- Portugal’s debt ratio already exceeds the debt burden benchmark for advanced economies of 85 percent of GDP under the baseline scenario.
- Portugal’s public gross financing needs fall below the relevant benchmark of 20 percent of GDP, as the combination of longer-term issuance and shorter-term debt buybacks (including advanced repurchases to the Fund) has helped to moderate near-term refinancing needs and smooth the redemption profile of public debt.
- The debt profile remains subject to medium to low risks in terms of market perception, projected change in short-term debt, and the share of public debt held by nonresidents.

### C. Realism of Baseline Assumptions and Alternative Scenarios
- Realizing the potential growth rate assumed in the current projection has important implications for the debt adjustment path.
- Portugal’s growth forecast track record shows a relatively large median error compared with other countries with Fund-supported programs, especially during the pre-crisis period.
- Staff’s updated projection assumes a growth rate of 1.2 percent over the medium term, consistent with moderate growth convergence.
- If growth were to turn out lower than currently projected—for instance as a result of reversal of structural reforms or shocks to external demand—the rate of debt decline would significantly slow down.
- Risks from a protracted period of negative inflation in Portugal could further impede the repair of already-weak private and public balance sheets.
- Given Portugal’s sizable debt burden, the primary balance is expected to exceed its debt-stabilizing threshold over the projection period.
- Under staff’s baseline scenario, the fiscal primary balance is expected to stabilize at around 2½ percent of GDP over the medium term.
- The authorities’ medium-term fiscal strategy under the Stability Program for 2017–2  1 envisages a reduction in public debt to 109.4 percent of GDP by 2021; this projection is based on an ambitious timetable for fiscal adjustment with largely unspecified cost savings and more optimistic assumptions on medium-term growth than staff’s.
- The Stability Program assumes annual real GDP growth of 2.0 percent in 2017–21, as opposed to staff’s baseline projection of average annual growth of 1.7 percent over the same period.

### D. Stress Tests and Alternative Shock Scenarios
- Baseline remains highly sensitive to macro-fiscal and contingent liabilities shocks:
  - Growth shock:
    - A growth shock that lowers output by nearly 4.5 percentage points in 2019–20 (and in turn inflation by a cumulative 1 percentage point) would cause debt to peak at about 127 percent of GDP in 2020, 11 percentage points higher than under the baseline.
  - Interest rate shock:
    - A sustained interest rate shock of 340 basis points throughout the projection period is not expected to have a large immediate effect, reflecting the relatively long-term maturity of public debt, but it would slow down the rate of debt decline in the medium term, so that by 2023 the debt-to-GDP ratio is about 3 points higher compared with the baseline.
  - Contingent liabilities:
    - Recent sale of Novo Banco included a commitment by the Resolution Fund contingent on the bank’s capital adequacy ratio breaching certain thresholds; the commitment can be called starting in 2018 and is subject to a cumulative ceiling of €3.89 billion.
    - If the cumulative ceiling of €3.89 billion is reached, debt-to-GDP would increase about 2 percent of GDP above the baseline by 2023 (contingent liability shock (a)).
    - A larger financial sector shock in which public sector costs amount to 10 percent of GDP (contingent liability shock (b), as in the DSA for the 2017 Article IV consultation) would push the 2019 debt ratio to 130 percent of GDP.
  - Combined shock:
    - A severe combined shock that incorporates the macro-fiscal and contingent liabilities adverse scenarios would raise debt to 136 percent of GDP in 2020 and then keep it close to this level over the medium term.

### Selected Key Statistics and Projection Highlights (as reported)
- Public debt:
  - 2017: 126 percent of GDP (projected decline to 108 percent of GDP in 2023 under baseline)
- Primary surplus:
  - 2017: 2.7 percent of GDP (projected stabilization around 2½ percent of GDP over medium term)
- Real GDP growth:
  - 2017: 2.6 percent
  - Staff baseline medium-term assumption: 1.2 percent
  - Stability Program assumption (2017–21): 2.0 percent
  - Staff baseline average (2017–21): 1.7 percent
- Effective nominal interest rate on public debt:
  - Decline from 3.4 to 3.1 percent in 2017
- Public sector recapitalization of CGD:
  - 2 percent of GDP in the first half of 2017
- Novo Banco contingent liability:
  - Cumulative ceiling of €3.89 billion (noted as 2 percent of 2017 GDP in explanatory footnote)
- Interest rate shock magnitude examined:
  - 340 basis points sustained throughout projection period
- Growth shock magnitude examined:
  - Output lowers by nearly 4.5 percentage points in 2019–20; inflation down by cumulative 1 percentage point

_International Monetary Fund — Annex I. Public Debt Sustainability Analysis (DSA) — Portugal_

### Annex II. Risk Assessment Matrix

### Annex II. Risk Assessment Matrix

### Loss of investor confidence due to reform reversals or other negative surprises potentially including difficulties in the banking system
- Relative Likelihood: Low
- Impact: High
- Findings:
  - 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 to prevent negative domestic shocks.
  - Step up efforts to implement policies that supports growth, lasting fiscal adjustment, and a strong banking system, which would contribute to shoring up investor confidence, and ease financing conditions and restraints.

### Financial distress in one or more banks, requiring intervention
- Relative Likelihood: Low
- Impact: High
- Findings:
  - Loss of confidence in the banking system, resulting in potentially high fiscal costs.
- Policy response:
  - Proactive bank supervision to ensure balance sheet clean-up, a build-up of capital buffers in banks and of fiscal buffers.
  - Strengthen oversight of banks’ risk management practices.
  - Shore up the banks using the existing toolkit, while ensuring public debt dynamics are not compromised.

### Policy and geopolitical uncertainties
- Relative Likelihood: High
- Impact: High
- Findings:
  - Policy uncertainty. Two-sided risks to U.S. growth with difficult-to -predict policies; uncertainty associated with negotiating post-Brexit arrangements; and evolving political processes, including elections in several large advanced and emerging market economies weigh on global growth.
  - Increased investor uncertainty and lower investment, undermining the cyclical recovery and medium-term growth prospects.
  - Lower growth due to trade barriers.
  - Escalation of euro skepticism, leading to less cooperation and a reversal of integration.
- Policy response:
  - Accelerate structural reforms to support investment and growth.
  - Strengthen fiscal policy adjustment to support investor confidence.
  - Step up efforts to clean up corporate and bank balance sheets.

### Financial conditions
- Relative Likelihood: High
- Impact: Medium (overall); High (for some items)
- Findings:
  - Tighter global financial conditions. Fed normalization and tapering by ECB increase global rates and term premia, strengthen the U.S. dollar and the euro vis-à-vis the other currencies, and correct market valuations. Adjustments could be disruptive if there are policy surprises. Higher debt service and refinancing risks could stress leveraged firms, households, and vulnerable sovereigns, including through capital account pressures in some cases.
  - European bank distress: Strained bank balance sheets amid a weak profitability outlook could lead to financial distress in one or more major banks with possible knock-on effects on the broader financial sector and for sovereign yields in vulnerable economies.
  - Loss of market confidence, leading to wider spreads.
  - Less favorable financial conditions as global conditions tighten.
  - Given its high corporate and private debt levels, Portugal would be highly susceptible to financial contagion. The result would be heightened financial stress in the Portuguese banking system, as balance sheet fragilities in both banking and corporate sectors are still significant.
- Policy response:
  - Step up efforts to implement policies that support growth, lasting fiscal adjustment, and a strong banking system, which would contribute to shoring up investor confidence, and ease financing conditions and restraints.
  - Proactive bank supervision to ensure balance sheet clean-up, a build-up of capital buffers in banks and of fiscal buffers. Strengthen oversight of banks’ risk management practices.
  - Shore up the banks using the existing toolkit, while ensuring public debt dynamics are not compromised.

### Weaker-than-expected global growth
- Relative Likelihood: Medium (US, euro area, and Japan); Medium (Emerging Markets)
- Impact: High
- Findings:
  - Structurally weak growth in key advanced economies: Low productivity growth (U.S., the Euro Area, and Japan), a failure to fully address crisis legacies and undertake structural reforms, and persistently low inflation (the Euro Area, and Japan) undermine medium-term growth in advanced economies.
  - Low growth 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.

### Lower energy prices driven by stronger-than-expected U.S. shale and/or recovery of oil production in the African continent
- Relative Likelihood: Low
- Impact: Medium
- Findings:
  - A low fuel import bill is potentially offset by greater difficulties in Angola, a key economic and financial partner.
- Policy response:
  - Step up efforts to clean up corporate balance sheets, including the reduction of exposures to Angola.
  - Shore up the banks using the existing toolkit, while ensuring public debt dynamics are not compromised.
  - Renewed structural reform effort to expand exports to other markets.

*Note: The Risk Assessment Matrix shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of the staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more).* 

*Source: Annex II. Risk Assessment Matrix*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1852.pdf_