## 1prtea2022002

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### HOW COULD THE COVID-19 PANDEMIC AFFECT FIRM PRODUCTIVITY AND THE SPEED OF THE RECOVERY?
- Firm demographics and pre-pandemic baseline (2019):
  - NFC sector consolidated equity-to-total-liabilities ratio rose from 40 percent in 2011 to 51 percent in 2019.
  - Combined loan and debt security liabilities decreased from 125 percent of GDP in 2012 to 85 percent of GDP in 2019.
  - In 2019:
    - About one-third of firms did not generate positive net income.
    - A quarter of firms had negative equity.
    - Almost one-sixth did not generate enough earnings to cover financing expenses.
  - Financial risk indicators weaker in accommodation and food services; Portuguese NFCs had relatively weaker financial ratios compared to EA peers, particularly in the share of negative equity firms.

- Actual 2020 firm-level impacts (Orbis reporting and panels):
  - Share of firms with negative equity rose marginally from 25.5 to 26.6 percent (aggregate Orbis reporting).
  - Among firms with data for both 2019 and 2020:
    - 6 percent of firms that had positive equity in 2019 became insolvent in 2020.
    - Transition into insolvency in the three most affected NACE sectors rose to about 14 percent from about 6–8 percent in the previous year.
  - Exit and entry dynamics:
    - Overall exit rate moved from 5.4 percent to 5.7 percent in 2020.
    - Aggregate firm birth rate fell sharply to the lowest level since 2009; for affected sectors birth rates fell even more sharply.
    - Share of insolvent firms that exited increased from 13.7 percent in 2019 to 19.6 percent in 2020.
    - Share of solvent firms that exited increased from 5.7 percent to 11.9 percent.
    - Share of insolvent firms among all firms that exited decreased from 44.4 percent in 2019 to 34.9 percent in 2020.
  - Aggregate balance-sheet changes (Orbis, reporting firms):
    - Aggregate equity-to-GDP rose from about 108 to 116 percent of GDP in 2020 (equivalent to about 6 billion euros).
    - Aggregate equity gap of insolvent firms deteriorated by about 1 percent of GDP in 2020.
    - Among firms reporting both 2019 and 2020, the aggregate equity gap widened by about 2.3 percent of GDP.
    - Widening in affected sectors (excluding transport) was about 0.8 percent of GDP; transport sector equity gaps accounted for about 3 percent of GDP.
    - Firms with negative equity of about 2½ percent of GDP in 2019 have not reported 2020 data to date.

- Leverage, interest coverage, and vulnerability comparisons:
  - GDP fall: Portugal GDP fall of 8.4 percent in 2020 vs. 6.5 percent in the EA.
  - Leverage:
    - Leverage ratio decreased (improved) in 43 percent of Portuguese firms, compared to 50 percent in the EA.
    - Leverage increased in about 1/3 of firms (both Portugal and EA).
    - Using EU “undertaking in difficulty” definition, share of Portuguese continuing firms with financial difficulty rose from 20 to 28 percent (EA: rose from 14 to 20 percent).
  - Interest coverage (ICR):
    - Share of Portuguese firms with ICR<1 jumped from 22 in 2019 to 33 percent in 2020.
    - Among continuing firms, about one-third with ICR<1 in 2020 also had ICR<1 in 2019.
    - In affected sectors (e.g., hotels and food services), 20 percent of continuing firms had ICR<1.
    - Only about half of nearly 400 thousand Portuguese firms represented in Orbis reported interest payments in 2019; among interest-paying firms the share with ICR<1 may have jumped to nearly two thirds in 2020.
  - Interest-rate risk:
    - Nearly 60 percent of NFC loans estimated to be contracted on variable rate with a fixation up to one year.
    - Simulation: a 100bps increase in borrowing rates would increase the share of firms with ICR<1 by 2 percentage points.

- Assessing impact of liquidity and solvency support (end-2020 estimates and simulations):
  - Definitions and methodology: illiquid = liquidity position negative at end-period; insolvent = equity position negative; methodology based on Ebeke et al. (2021) with adjustments; policy uptake distinguished by non-distressed and distressed firms; liquidity support carry-over into 2021 considered.
  - Policy coverage (end-2020):
    - Crisis-induced liquidity needs estimated at 8 percent of GDP.
    - Credit measures covered about 6½ percent of GDP of liquidity needs:
      - Moratoria: 3½ percentage points of GDP.
      - Credit guarantees: 3 percentage points of GDP.
    - Job retention programs covered another 2/3 percentage point of GDP.
    - Policies enhanced NFCs’ cash buffers:
      - Credit lines: 3 percent of GDP.
      - Other measures: 1 percent of GDP.
    - Support provided to liquid firms (on 2020 annual basis) estimated at 3/4 percent of GDP, primarily attributable to employment support schemes.
  - Effectiveness:
    - Credit support measures key to closing large liquidity shortfalls; share of illiquid firms smaller post-policies at end-2020 relative to no-policy scenario.
    - Policies restored solvency position of around 1½ percent of Portuguese NFCs by end-2020, reducing crisis-induced increase in the share of insolvent firms from 6½ to about 5 percent.
    - For accommodation and food sector, policies reduced increase in share of insolvent firms from 20 to about 14 percentage points.
    - Universal schemes effectively bridged systemic liquidity shortfalls but exhibited targeting inefficiencies.

- Aggregate caveats and survivorship:
  - Aggregate improvements in 2020 partly driven by survivorship bias (non-reporting by firms with solvency gaps).
  - Simulations for 2021 indicate possible further aggregate balance sheet improvement and further widening of corporate negative equity under assumptions of no firm exit and no new external equity support—these assumptions likely overstate solvency gap deterioration.
  - Banco de Portugal evidence:
    - Debt of vulnerable firms in most affected sectors doubled between 2019 and 2020.
    - Firms financially vulnerable in 2020 increased their debt by 30 percent.
    - Drop in investment sharper in firms with greater observed decrease in cash flow from operations.

### Corporate distress is expected to have remained stable in 2021; corporate distress and zombification
- Simulations and expectations:
  - Corporate distress expected to have remained stable in 2021 for firms that were solvent and liquid prior to the crisis and reported data in 2020.
  - Rise in share of illiquid firms relatively small, reflecting strong policy support.
  - Viability considerations played a limited role in lifeline programs, creating risks of an increased share of unviable firms.
  - Unwinding of liquidity support may have posed challenges for a small share of firms in 2021 that depleted cash buffers.
- Zombie firms:
  - Zombie definition: ICR<1 for 3 consecutive years and age over 10 year; ICR is based on EBIT.
  - The share of zombie companies is estimated to have risen since the start of the pandemic.
  - Note: EBIT vs. EBITDA choice affects ICR and incidence of zombie firms.
  - Banco de Portugal (BdP) evidence: BdP reports 6.9 percent in 2019, a decline of 4 percentage points from the sovereign debt crisis peak; asset-weighted decline from 7.7 percent to 2.9 percent in 2019 (BdP results cited).

- Risks to jobs, economy, and financial system:
  - Without policy support the crisis could have destroyed up to a third of NFC jobs and 20 percent of economic output.
  - In absence of lifelines:
    - Share of NFC employment by illiquid firms would have jumped from about 15 percent prior to the pandemic to 33 percent.
    - On a value-added weighted basis, share of economic activity of illiquid firms would have jumped from 10 to 28 percent.
  - As of 2020, lifeline policies significantly helped illiquid firms relative to pre-Covid-19.
  - Financial stability indicators and loan exposures:
    - Share of loans to firms with negative equity estimated to have fallen from 13.3 percent at end-2019 to 12.5 percent by end-2020.
    - Share of banking loans to zombie firms rose from 7 percent pre-Covid-19 to almost 9 percent by end-2020 and is likely to have risen to almost 13 percent by end-2021.
    - Share of stage 2 loans that benefitted from the moratoria rose from 17 percent in mid-2020 to 32 percent in December 2021.

- Vulnerability and labor-market impacts:
  - Medians of net liquidity position indicate weaker liquidity for insolvent and zombie firms.
  - Employment shares:
    - Pre-Covid insolvent firms employment share: 9.2 percent.
    - 2020 insolvent firms employment share: 10.4 percent.
    - Pre-Covid zombie firms employment share: 2.1 percent.
    - 2020 zombie firms employment share: 3.6 percent.
  - Sectoral employment adjustment largest in Hotels and Restaurants, Arts, Entertainment, Sports & Recreation, and Transportation and Storage.

- Dynamism, allocative efficiency, and role of zombies:
  - Historical effects:
    - Exit contributed to improving total firm productivity: gains of 0.33 percentage points and 0.15 percentage points per year in two episodes.
    - During 2008–12 aggregate productivity of micro and SME companies declined by 0.45 percentage points per year; during 2013–17 it accelerated to about 1.1 percent per year.
    - Continuing firms contributed almost 1 percentage point per year to TFP growth during 2013–17, with about two thirds from within-firm productivity growth.
    - Large firms: TFP nearly flat during 2008–13; grew by almost 3 percentage points per year during 2013–17.
  - Current episode:
    - Kozeniauskas and others (2022) find no rise in exit among lower-productivity firms, consistent with support policies offsetting the cleansing effect.
    - High-productivity firms have been less likely to take up government support.
  - Zombies:
    - Zombies less productive and employ more people: among SMEs average employment 29 people vs. 22 among non-zombie firms.
    - Zombies tend to be 20 to 40 percent less productive within their industries.
    - Rise in share of zombie firms estimated to have been nearly 3 percentage points.
    - Based on past productivity drag estimates from zombies, allocative efficiency and productivity losses could chip away at aggregate TFP growth 0.2–0.4 percentage points per year over the medium-term.

### The pandemic eroded equity positions of Portuguese firms with varying impacts
- Key balance-sheet and solvency findings:
  - Economy-wide share of negative equity firms has risen only marginally: "2 percentage points".
  - Share of pre-Covid-19 solvent firms that turned insolvent by end-2020 surged in affected sectors.
  - Over a third of companies in affected sectors (food and hospitality, arts and recreation) are technically insolvent.
  - Share of zombie firms rose from "about 1 percent" prior to the pandemic to "4 percent".
  - Among firms reporting both 2019 and 2020 data, the aggregate equity gap widened by "about 2.3 percent of GDP".
  - Insolvent or zombie firms saw doubling of ratio of their short-term to total loan liabilities, from "about a quarter" pre-Covid-19 to "almost a half".
  - Additional vulnerabilities: war in Ukraine, cost-push pressures, supply-chain disruptions, and higher interest rates.

- Liquidity vs. solvency support:
  - Authorities’ swift response largely addressed immediate liquidity shortages through moratoria and credit lines.
  - Support to solvency has been small thus far.
  - Solvency-support defined as non-refundable lifeline policy support limited to:
    - (i) job retention and wage subsidy schemes including corresponding social security contribution exemptions, and
    - (ii) SME grant provided under APOIAR.PT.
  - All other policies considered to only affect liquidity.

- Debt overhang, sectoral risk, and SOEs:
  - State capital injections into main transport SOE amounted to "1 percent of GDP" in both 2020 and 2021.
  - Support to the national airlines, including under the restructuring plan, is expected to be "close to 3 percent of GDP".
  - Targeted support to transport-related SOEs via debt-equity swaps and capital injections helped with large solvency gaps; enhanced governance and viability considerations are key.

- Banco Português de Fomento schemes:
  - Strategic Recapitalization and Consolidar programs promising but may need augmentation in size and instrument design; Consolidar offers venues for private expertise and capital but envelope may require augmentation.

- Recovery dynamics, productivity, and policy recommendations:
  - Broad-based economic recovery and structural reforms would spur firm dynamism, productivity growth, and strengthen financial health metrics.
  - Strong restructuring and insolvency regimes recommended to facilitate reorganization and exit and optimize resource reallocation.

- Data and simulation coverage (technical notes summary):
  - Liquidity simulated with multi-stage cash-flow dynamics; equity updated via equation (4) including solvency support.
  - 2021 forecast incorporates NACE1-level recovery from Phase 3 of Covid-19 WB Enterprise Surveys (February 2021).
    - Average recovery time across sectors equals "14 months" and implies economy-wide recovery to pre-pandemic activity level by the "first quarter of 2022".
  - Analysis uses Orbis data covering "about 250 thousand firms" in 2018, representing "about a third of registered companies" and "almost 80 percent of total operating revenue of corporates in Portugal".
  - Results upscaled using OECD Structural Demographics and Business Statistics by aggregate turnover at NACE2 and company size.

- Productivity decomposition:
  - Aggregate productivity measured via Levinsohn-Petrin (2003) and decomposed per Melitz and Polanec (2015) into within-firm, reallocation, entry and exit contributions.
  - Micro firms and SMEs comprise "99.9 percent" of firms, generate "55.8 percent" of value added and "64.1 percent" of employment.
  - Excluded NACE1 categories: Education, Financial and insurance activities, Administrative and support service, Public administration and defense, and Human health and social work activities.

### The wide range of measures to support the tourism sector alleviated some effects; outlook and policy recommendations
- Measures implemented and near-term effects:
  - VAT tax rebate for catering, accommodation and culture; job retention schemes; income tax and social security deferrals; direct support for small and micro businesses; moratorium on bank loan repayments extended until end-September 2021; state-guaranteed credit lines for hard-hit sectors.
  - Share of employment in illiquid tourism firms declined from 18 percent before the crisis to 16 percent in 2020.
  - Counterfactual: without measures unemployment could have risen to 62 percent during the crisis (Selected Issues Paper I).

- Baseline forecasts and outturns (2021:Q3 basis):
  - IMF staff baseline: gradual recovery of tourism to its 2019 GVA by end 2023.
  - 2021:Q3 outturns:
    - GVA in tourism is 7.1 percent below the 2019 level.
    - Total GDP is 2.4 percent below the 2019 level.
    - Employment (hours worked) in tourism is 2.5 percent below 2019 levels.
    - Employment (hours worked) total economy is 1.0 percent above 2019 levels.
    - Employment (hours worked) total economy is 2.4 percent below 2019 levels (both figures preserved as in source).
  - Scenario: if tourism recovery delayed by 3-4 quarters, this would shave off some 0.8 pp from staff’s baseline growth projections in 2022 and real GDP in 2023 could be about 1 percent lower than current projected path.

- Scarring risks and medium-term effects:
  - Share of tourism in GVA would have been nearly 2 percentage points higher by 2026 if pre-pandemic trends continued.
  - Under staff’s baseline recovery by end 2023, share of tourism in GVA would still remain below its 2019 level by about ½ percentage point in 2026.

- Labor reallocation and policy recommendations:
  - Multi-speed recovery implies substantial labor reallocation; tourism employment share may drop by almost 1 percentage point over the medium term.
  - Near-term: targeted and time-bound liquidity support for viable small and micro firms; efficient and timely bankruptcy proceedings for unviable firms; increased access to SME restructuring tools.
  - Protect vulnerable groups (women, young people, informal workers) via income replacement or wage subsidies while tourism under stress.
  - Medium-term priorities: environmental sustainability, digital transformation, productivity improvements, active labor market policies, and NGEU investment plans in skills, digitalization and climate sustainability.

### With per capita GHG emissions below EU average, Portugal’s contribution to global emissions; carbon pricing simulations and policy implications
- GHG and energy overview:
  - Peak emissions: 69 mil tCO2e (peak in 2005).
  - Per capita GHG emissions in 2019: 6.7 tCO2e (EU average 8.4 tCO2e).
  - Transport: almost 30 percent of total emissions; electricity generation: one fifth; renewable share in electricity generation in 2020: 34 percent.
  - Last coal-based power plant closed in 2021.
  - Forest carbon sink (excluding 2017 wildfires): about 10 Mt CO2 a year.

- Strategic targets and policy context:
  - Carbon neutrality by 2050; reduce GHG by 45-55 percent compared to 2005 by 2030; reduce primary energy consumption by 35 percent by 2030; increase share of energy from renewables to 47 percent by 2030.
  - NECP and RCN targets; ¾ of Portugal’s total GHG emissions already subject to some form of carbon pricing.
  - RRP allocations: €3.06 bn (2 percent of 2020 GDP under 16 components) to Climate Transition pillar; measures supporting climate change objectives account for 38 percent of plan allocation.
  - Main RRP projects:
    - Sustainable mobility: €0.97 billion.
    - Decarbonisation of industry and businesses: €0.75 billion.
    - Green hydrogen and renewable technologies: €0.37 billion.
    - Energy efficiency of buildings and public administration: €0.61 billion.

- CPAT simulations and scenarios (IMF/World Bank Carbon Price Assessment Tool):
  - Baseline:
    - Baseline carbon price: US$28/tCO2.
    - Baseline emissions path: GHG estimated at 55 million tons (mts) in 2022 rising to 58 mts in 2030 (+4.7 percent between 2022 and 2030).
  - Higher carbon price (price increase only):
    - Increase to US$75/tCO2 in 2030: GHG projected to drop by 1.3 percent compared to 2022, reaching 55 mts by 2030.
    - Increase to US$100/tCO2 in 2030: GHG projected to drop by 5.3 percent compared to 2022, reaching 53 mts by 2030.
  - Coverage and subsidy removal (coverage increase only):
    - Cover all non-ETS sectors with carbon tax and remove fuel subsidies at baseline price: GHG projected to reach 56 mts in 2030 (0.9 percent higher than 2022 estimate).
  - Combined reform (price increase + broader coverage + subsidy elimination):
    - Linearly increase carbon price to US$100/tCO2 by 2030 and eliminate fossil fuel subsidies and exemptions: GHG projected to drop to 48 mts by 2030, close to intermediary objective for carbon neutrality by 2050.
  - Main conclusion: carbon pricing essential but not sufficient alone; broader coverage and subsidy elimination materially improve outcomes.

- Scenario “d” (gradual combined reform) quantified results and impacts:
  - Monetized co-benefits: annual average at 0.2 percent of GDP (81 percent domestic environmental co-benefits; 19 percent better air quality and fewer deaths).
  - Global climate benefit adds 0.1 percent of GDP, increasing total welfare benefit to 0.3 percent of GDP.
  - Efficiency cost: estimated to reach 0.38 percent of GDP in 2030.
  - Energy price impacts (2030 projections under Carbon tax $100 + increased coverage):
    - Gasoline: from US$ per liter 1.80 to 2.27 → 26.4% change
    - Diesel: from US$ per liter 1.56 to 2.08 → 33.3% change
    - LPG: from US$ per liter 0.76 to 1.12 → 48.2% change
    - Non-road oil: from US$ per barrel 68.32 to 165.70 → 142.5% change
    - Kerosene: from US$ per liter 1.20 to 1.73 → 43.6% change
    - Electricity: from US$ per kwh 0.18 to 0.19 → 10.1% change
    - Natural gas: from US$ per gigajoule (GJ) 14.03 to 19.92 → 42.0% change
  - Distributional impacts:
    - Direct energy consumption represents almost 20 percent of total consumption of lower income groups.
    - Higher energy prices require offsetting measures; National Long-Term Strategy under development to address energy poverty.

- Fiscal revenue potential:
  - Gradual increase of coverage and carbon price could raise public revenues by about 2½ percent of GDP (USD$7.4 billion) by 2030.
  - Revenues could finance public investment, compensate vulnerable households, or reduce labor/corporate taxes.

- Policy recommendations:
  - Increase explicit carbon price and broaden tax coverage to non-ETS sectors; eliminate fossil fuel subsidies and tax exemptions.
  - Use carbon revenues to finance green investment and protect vulnerable households; promote public and private R&D (target: 3 percent of GDP by 2030).
  - Complement pricing with expanded ETS coverage, sectoral NECP measures, renewable-based power generation, efficiency standards, building renovation, and adaptation/resilience investments.

*Source: INTERNATIONAL MONETARY FUND — excerpt from 1prtea2022002 (chapter content).*

### Annex I. Technical Notes _______________________________________________________________ 16

### HOW COULD THE COVID-19 PANDEMIC AFFECT FIRM PRODUCTIVITY AND THE SPEED OF THE RECOVERY?

### Firm demographics and corporate financial health: pre-pandemic and 2019 baseline
- NFC sector consolidated equity-to-total-liabilities ratio rose from 40 percent in 2011 to 51 percent in 2019.
- Combined loan and debt security liabilities decreased from 125 percent of GDP in 2012 to 85 percent of GDP in 2019.
- In 2019:
  - About one-third of firms did not generate positive net income.
  - A quarter of firms had negative equity.
  - Almost one-sixth did not generate enough earnings to cover financing expenses.
- Financial risk indicators were weaker in sectors most affected by the pandemic, notably accommodation and food services.
- Portuguese NFCs had relatively weaker financial ratios compared to euro area (EA) peers, particularly in the share of negative equity firms.

### Actual 2020 firm-level impacts
- Share of firms with negative equity rose marginally from 25.5 to 26.6 percent (aggregate Orbis reporting).
- Among firms with data for both 2019 and 2020:
  - 6 percent of firms that had positive equity in 2019 became insolvent in 2020.
  - Transition into insolvency in the three most affected NACE sectors rose to about 14 percent from about 6–8 percent in the previous year.
- Exit and entry dynamics:
  - Overall exit rate moved from 5.4 percent to 5.7 percent in 2020.
  - Aggregate firm birth rate fell sharply to the lowest level since 2009.
  - For affected sectors, exit rates did not move much but birth rates fell even more sharply.
  - Share of insolvent firms that exited increased from 13.7 percent in 2019 to 19.6 percent in 2020.
  - Share of solvent firms that exited increased from 5.7 percent to 11.9 percent.
  - Share of insolvent firms among all firms that exited decreased from 44.4 percent in 2019 to 34.9 percent in 2020.
- Aggregate balance-sheet changes (Orbis, reporting firms):
  - Aggregate equity-to-GDP rose from about 108 to 116 percent of GDP in 2020 (equivalent to about 6 billion euros).
  - Aggregate equity gap of insolvent firms deteriorated by about 1 percent of GDP in 2020.
  - Among firms reporting both 2019 and 2020, the aggregate equity gap widened by about 2.3 percent of GDP.
  - Widening in affected sectors (excluding transport) was about 0.8 percent of GDP.
  - Transport sector equity gaps accounted for about 3 percent of GDP.
  - Firms with negative equity of about 2½ percent of GDP in 2019 have not reported 2020 data to date.

### Leverage, interest coverage, and vulnerability comparisons
- Portugal experienced a deeper GDP fall in 2020: GDP fall of 8.4 percent in 2020 vs. 6.5 percent in the EA.
- Leverage changes:
  - Leverage ratio decreased (improved) in 43 percent of Portuguese firms, compared to 50 percent in the EA.
  - Leverage increased in about 1/3 of firms (both Portugal and EA).
  - Using EU definition of “undertaking in difficulty” (debt-to-equity ratio exceeding 7.5 or technical insolvency), share of Portuguese continuing firms with financial difficulty rose from 20 to 28 percent (EA: rose from 14 to 20 percent).
- Interest coverage (ICR) dynamics:
  - Share of Portuguese firms unable to cover interest costs by operational income (ICR<1) jumped from 22 in 2019 to 33 percent in 2020.
  - Among continuing firms, about one-third with ICR<1 in 2020 also had ICR<1 in 2019, indicating pre-existing weakness.
  - In affected sectors (e.g., hotels and food services), 20 percent of continuing firms had ICR<1.
  - Only about half of nearly 400 thousand Portuguese firms represented in Orbis reported interest payments in 2019; among interest-paying firms the share with ICR<1 may have jumped to nearly two thirds in 2020.
- Interest-rate risk:
  - Nearly 60 percent of NFC loans estimated to be contracted on variable rate with a fixation up to one year.
  - Firm-level simulation: a 100bps increase in borrowing rates would increase the share of firms with ICR<1 by 2 percentage points.

### Assessing impact of liquidity and solvency support during the pandemic
- Definitions used in simulations (methodology based on Ebeke et al. (2021) with adjustments):
  - Illiquid: liquidity position is negative at the end of the period.
  - Insolvent: equity position is negative.
  - Adjustments: firms can partially offset turnover declines by reducing wage and operating costs; latest policy parameters and turnover outturns used at NACE2 level; policy uptake distinguished by non-distressed and distressed firms; liquidity support carry-over into 2021 considered.
- Policy coverage estimates (end-2020):
  - Crisis-induced liquidity needs estimated at 8 percent of GDP.
  - Credit measures covered about 6½ percent of GDP of the liquidity needs:
    - Moratoria: 3½ percentage points of GDP.
    - Credit guarantees: 3 percentage points of GDP.
  - Job retention programs covered another 2/3 percentage point of GDP.
  - Policies also enhanced NFCs’ cash buffers:
    - Credit lines: 3 percent of GDP.
    - Other measures: 1 percent of GDP.
  - Support provided to liquid firms (on 2020 annual basis) estimated at 3/4 percent of GDP, primarily attributable to employment support schemes.
- Effectiveness on liquidity and solvency:
  - Credit support measures were key to closing large liquidity shortfalls; share of illiquid firms is smaller post-policies at the end of 2020 relative to no-policy scenario.
  - Policies restored solvency position of around 1½ percent of Portuguese NFCs by end-2020, reducing crisis-induced increase in the share of insolvent firms from 6½ to about 5 percent.
  - For accommodation and food sector, policies reduced the increase in the share of insolvent firms from 20 to about 14 percentage points.
  - Actual 2020 data shows a surge in insolvent firms in most affected sectors (from about 6–8 percent prior to the pandemic to around 16 percent).
  - Universal schemes effectively bridged systemic liquidity shortfalls but exhibited targeting inefficiencies (firms with positive liquidity also benefited).

### Aggregate caveats and survivorship considerations
- Aggregate improvements in NFC balance sheets in 2020 are partly driven by survivorship bias (non-reporting by firms with solvency gaps).
- Simulations for 2021 (discussed in source) indicate possible further aggregate balance sheet improvement and further widening of corporate negative equity under assumptions of no firm exit and no new external equity support — these assumptions likely overstate solvency gap deterioration.
- Banco de Portugal evidence:
  - Debt of vulnerable firms in the most affected sectors doubled between 2019 and 2020.
  - Firms that were financially vulnerable in 2020 increased their debt by 30 percent.
  - Drop in investment contributed to cash-flow adjustment; fall in investment was sharper in firms with greater observed decrease in cash flow from operations.

*Source: IMF staff calculations and firm-level data (Orbis), Banco de Portugal, and referenced methodologies as presented in Annex I. Technical Notes.*

### 11.      Corporate distress is expected to have remained stable in 2021. Simulations do not

### 1prtea2022002 - 11.      Corporate distress is expected to have remained stable in 2021. Simulations do not

### Corporate distress and zombification
- Corporate distress is expected to have remained stable in 2021 based on simulations for firms that were both solvent and liquid prior to the crisis and consequently reported data in 2020.
- The rise in the share of illiquid firms has been relatively small, reflecting strong policy support.
- Viability considerations played a limited role in lifeline programs, creating risks of an increased share of unviable firms that mask economic and fiscal risks.
- Simulations suggest the unwinding of liquidity support may have posed challenges for a small share of firms in 2021 that depleted cash buffers against a still challenging operating environment.
- The share of zombie companies (ICR<1 for three consecutive years and firm’s age over 10 year) is estimated to have risen since the start of the pandemic.
  - Zombie definition: ICR<1 for 3 consecutive years and age over 10 years; ICR is based on EBIT.
  - Note on ICR measure: EBIT vs. EBITDA choice affects ICR and incidence of zombie firms; EBIT deducts depreciation and amortization.
- Evidence: Banco de Portugal (BdP) results indicate a decline in zombification rate since the sovereign debt crisis (example figure: BdP reports 6.9 percent in 2019, a decline of 4 percentage points from the sovereign debt crisis peak, and an asset-weighted decline from 7.7 percent to 2.9 percent in 2019).
- Simulations and firm-level analyses (e.g., Marques and others (2022), Kozeniauskas and others (2022)) point to:
  - Reduction in profitability and capital ratio of worst-performing firms.
  - Heterogeneous recovery likely to increase corporate insolvency risk in the most affected sectors.
  - Proportion of firms with negative equity could rise between 2020 and 2023, though less than during 2010–2014 sovereign debt crisis and relatively less on an assets-weighted basis.

### Risks: Jobs, economy, and financial system
- Policy support prevented a severe impact on jobs and the economy; without support, the crisis could have destroyed up to a third of NFC jobs and 20 percent of economic output.
- In absence of lifelines support (job retention schemes, tax deferrals, credit):
  - Share of NFC employment by illiquid firms would have jumped from about 15 percent prior to the pandemic to 33 percent.
  - On a value-added weighted basis, share of economic activity of illiquid firms would have jumped from 10 to 28 percent.
- As of 2020, lifeline policies significantly helped illiquid firms relative to pre-Covid-19.
- Nonetheless, the share of NFC employment (based on pre-Covid-19 employment figures) in firms that ended 2020 with negative equity or were classified as zombies rose slightly.
- Financial stability indicators and loan exposures:
  - Share of loans to firms with negative equity estimated to have fallen from 13.3 percent at end-2019 to 12.5 percent by end-2020, as growth of total loans to NFCs (9 percent) outpaced growth of loans to insolvent firms (3 percent).
  - Share of banking loans to zombie firms rose from 7 percent pre-Covid-19 to almost 9 percent by end-2020 and is likely to have risen to almost 13 percent by end-2021 in line with projected increase in share of zombie firms.
  - Both insolvent and zombie firms have significantly increased reliance on short-term debt.
  - Share of stage 2 loans that benefitted from the moratoria rose from 17 percent in mid-2020 to 32 percent in December 2021, implying risks of higher eventual insolvencies and NPLs.
- Offsetting factor: if the recent lower flow of new loans to zombie firms is sustained, financial stability risks would remain contained.

### Vulnerability and labor-market impacts
- Vulnerable firms' liquidity: medians of net liquidity position (ratio of Cash and equivalents to Short-Term Debt, eop) indicate weaker liquidity for insolvent and zombie firms compared to solvent and non-zombie counterparts (chart-based evidence in source).
- Employment by insolvent and zombie firms:
  - Pre-Covid insolvent firms employment share: 9.2 percent.
  - 2020 insolvent firms employment share: 10.4 percent.
  - Pre-Covid zombie firms employment share: 2.1 percent.
  - 2020 zombie firms employment share: 3.6 percent.
- Sectoral employment adjustment (Q4/Q4 percent change, for 2021: 2021Q3 over 2020Q4) shows large negative impacts in Hotels and Restaurants, Arts, Entertainment, Sports & Recreation, and Transportation and Storage.

### Dynamism and allocative efficiency: lessons from past crises
- Firm dynamism historically exerted an overall positive “cleansing effect,” though productivity growth differed across firm size.
- Key findings across crises:
  - Exit contributed to improving total firm productivity: gains of 0.33 percentage points and 0.15 percentage points per year in two episodes.
  - During 2008–12 (GFC), aggregate productivity of micro and SME companies declined by 0.45 percentage points per year; during 2013–17 it accelerated to about 1.1 percent per year.
  - Entry created a drag on aggregate productivity in both periods, driven by compositional factors (new micro firms less productive than continuing SMEs).
  - Continuing firms contributed almost 1 percentage point per year to TFP growth during 2013–17, with about two thirds from within-firm productivity growth.
  - Large firms: TFP nearly flat during 2008–13; grew by almost 3 percentage points per year during 2013–17.
- Current episode:
  - Kozeniauskas and others (2022) find no rise in exit among lower-productivity firms, consistent with support policies offsetting the cleansing effect.
  - High-productivity firms have been less likely to take up government support.
- Zombies exert a sizable additional drag on aggregate productivity primarily via allocative efficiency losses.
  - Zombies are less productive and employ more people: among SMEs average employment 29 people vs. 22 among non-zombie firms.
  - Zombies tend to be 20 to 40 percent less productive within their industries.
- Historical decomposition examples:
  - 2008–12: total incumbent firms’ productivity loss of 0.49 percentage points decomposed into 0.28 loss from non-zombie firms and 0.21 percentage points among zombies; zombies represented about 6 percent of total yet materially dragged aggregate productivity.
  - 2013–17: total incumbent firms’ productivity gain of 0.98 percentage points decomposed into 1.31 percentage points gain from non-zombie firms and 0.33 percentage points loss among zombies; zombies imposed a 0.31 percentage points per year drag through allocative efficiency.

### Role of zombies and medium-term impact
- The rise in the share of zombie firms is estimated to have been nearly 3 percentage points.
- Based on past productivity drag estimates from zombies, allocative efficiency and productivity losses prevalent among zombie firms could chip away at aggregate TFP growth 0.2–0.4 percentage points per year over the medium-term.

*Source: IMF staff estimates and analysis as presented in the chapter.*

### 20.      The pandemic eroded equity positions of Portuguese firms with varying impacts

### 20.      The pandemic eroded equity positions of Portuguese firms with varying impacts

### Key findings on firm balance sheets and solvency
- The economy-wide share of negative equity firms has risen only marginally: "2 percentage points".
- The share of pre-Covid-19 solvent firms that turned insolvent by the end of 2020 surged in the affected sectors.
- Shares of firms with negative net income and unable to cover financing expenses out of operating revenues also increased.
- Over a third of companies in the affected sectors, such as food and hospitality and arts and recreation, are technically insolvent.
- The share of zombie firms rose from "about 1 percent" prior to the pandemic to "4 percent".
- Among firms reporting both 2019 and 2020 data, the aggregate equity gap widened by "about 2.3 percent of GDP".
- Firms that were insolvent or classified as zombies by end-2020 saw doubling of the ratio of their short-term to total loan liabilities, from "about a quarter" pre-Covid-19 to "almost a half".
- Additional vulnerabilities from the war in Ukraine, cost-push pressures, supply-chain disruptions and higher interest rate could elevate insolvency risks.

### Liquidity support, solvency support, and firm vulnerability
- Authorities' swift policy response largely addressed immediate liquidity shortages through moratoria and credit lines, providing firms with sufficient liquidity buffers.
- Support to solvency has been small thus far.
- Despite targeting, SMEs and micro enterprises remain vulnerable.
- Solvency-support element defined as non-refundable lifeline policy support is limited to:
  - (i) job retention and wage subsidy schemes including corresponding social security contribution exemptions, and
  - (ii) SME grant provided under APOIAR.PT.
- All other policies are considered to only affect liquidity.

### Debt overhang, sectoral risk, and SOEs
- The solvency picture is nuanced: pockets of corporate vulnerabilities that emerged in 2020 have been masked by improved aggregate NFC balance sheets.
- For affected sectors, risk could be higher if the economic recovery falters or sectoral pressure persists.
- State capital injections into main transport SOE (the Lisbon and Porto subways or the national rail network) amounted to "1 percent of GDP" in both 2020 and 2021.
- Support to the national airlines, including under the restructuring plan, is expected to be "close to 3 percent of GDP".
- Targeted support to transport-related SOEs via debt-equity swaps and capital injections helped with large solvency gaps, but enhanced governance and viability considerations are key to reducing fiscal risks.

### Banco Português de Fomento recapitalization schemes (Strategic Recapitalization and Consolidar)
- The schemes have many promising features but may need augmentation in size and instrument design and enhanced incentive structures.
- The Consolidar program offers venues for tapping private expertise and capital (venture capital and equity funds), although the envelope may require augmentation given the relatively large equity shortfall among affected SMEs and uncertainties surrounding the tourism recovery.
- Program flexibility is critical; a quantitative evaluation is desirable as new information becomes available on take-up rates, implementation challenges, strength of economic recovery, and the ability of the program to stabilize firms.

### Recovery dynamics, productivity, and policy recommendations
- Broad-based economic recovery underpinned by structural reforms would spur firm dynamism, productivity growth, and strengthen financial health metrics.
- Continued strong growth would help reduce balance-sheet vulnerabilities across firms.
- Past crisis recoveries reveal zombie firms chip away at aggregate productivity and congest reallocation, irrespective of non-zombie performance.
- Strong restructuring and insolvency regimes are recommended to facilitate effective reorganization and exit of businesses and optimize resource reallocation without overwhelming the financial system.

### Balance sheet simulation and data coverage (technical notes summary)
- Liquidity position is simulated with a multi-stage cash-flow dynamic that distinguishes use of policy support (e.g., credit moratoria, credit lines) and tax payment liabilities or tax loss carry-over in outer years (equations (2) and (3) provided in technical notes).
- Industry-specific shocks and adjustments include:
  - 훽훽_j: industry-specific turnover shock reducing operational cash-flows through a decline in sales.
  - 훾훾_j: extent of industry-specific wage bill adjustment; firms can partially offset turnover declines via reducing wage costs.
- Equity position is updated via equation (4), where the solvency support element (non-refundable lifeline policy support) is explicitly included.
- The 2021 forecast incorporates NACE1-level recovery to normal time responses from Phase 3 of Covid-19 WB Enterprise Surveys (February 2021), adjusted for turnover outrun through mid-2021.
  - The average recovery time across sectors equals "14 months" and implies economy-wide recovery to pre-pandemic activity level by the "first quarter of 2022".
- Data and sample coverage:
  - The analysis uses firm-level balance sheet and income statement data from the Orbis database.
  - The simulation covers "about 250 thousand firms" operating in Portugal during 2018, taking the latest financial statements available for each firm.
  - This represents "about a third of registered companies" (with micro firms slightly underrepresented) and "almost 80 percent of total operating revenue of corporates in Portugal".
  - Results are upscaled using OECD Structural Demographics and Business Statistics by aggregate turnover at the NACE2 and company size.

### Productivity decomposition (technical notes summary)
- Aggregate productivity change measured using Levinsohn-Petrin (2003) method is decomposed following Melitz and Polanec (2015) into:
  - Within-firm productivity changes of continuing firms.
  - Inter-firm resource reallocation toward more productive continuing firms.
  - Contributions from entering and exiting firms.
- Micro firms and SMEs (employing less than 250 persons or annual turnover below 50 mln euro) comprise "99.9 percent" of firms in the non-financial sector, and generate "55.8 percent" of value added and "64.1 percent" of employment.
- Excluded NACE1 categories: Education, Financial and insurance activities, Administrative and support service, Public administration and defense, and Human health and social work activities.

*Source: INTERNATIONAL MONETARY FUND — excerpt from the provided chapter content.*

### 6.      The wide range of measures to support the tourism sector alleviated some of the

### 6.      The wide range of measures to support the tourism sector alleviated some of the

### Measures implemented during the pandemic and near-term effects
- VAT tax rebate for catering, accommodation and culture supported demand in accommodation and food sectors.
- Job retention schemes (wage subsidies for hours not worked) and income tax and social security deferrals to employees, employers, and self-employed protected jobs.
- Direct support for small and micro businesses significantly helped contain liquidity and, to a limited extent, solvency pressures.
- Moratorium on bank loan repayments for hard-hit households and companies affected, extended until end-September 2021.
- State-guaranteed credit lines for hard-hit sectors (e.g., restaurants, travel agencies and tour operators).
- Result: the share of employment in illiquid firms in the tourism sector―measured by their employment―declined from 18 percent before the crisis to 16 percent in 2020, i.e., slightly below the pre-pandemic level.
- Counterfactual: without supporting factors, mainly policy support measures, unemployment levels could have risen to 62 percent during the crisis in the absence of the measures (Selected Issues Paper I).

### What to expect after the pandemic — uncertainty and offsets
- Major uncertainties: new infection waves, protracted containment measures, and subdued travelers’ confidence.
- Positive offsets: lower travel restrictions, faster global vaccination rates, stronger recovery in Portugal’s main tourism-source countries, introduction of digital identification tools, and domestic tourists as an additional offset against renewed global travel restrictions.
- Note: the share of domestic tourists increased from about 30 percent in 2019 to close to 60 percent in 2020 and 2021, and supported the sector through the pandemic, but it is expected to decline to pre-pandemic level in 2022 and 2023.

### IMF staff baseline forecast and sectoral outturns (2021:Q3 basis)
- IMF staff baseline: gradual recovery of the tourism sector to its 2019 GVA by end 2023.
- Based on 2021:Q3 data outturn:
  - GVA in tourism is 7.1 percent below the 2019 level.
  - Total GDP is 2.4 percent below the 2019 level.
  - Employment (hours worked) in tourism is 2.5 percent below 2019 levels.
  - Employment (hours worked) total economy is 1.0 percent above 2019 levels.
  - Employment (hours worked) total economy is 2.4 percent below 2019 levels (text notes both figures in comparison—preserve original phrasing).
- Implication: recovery in tourism will lag behind the rest of the economy.
- Scenario: if tourism recovery is delayed by 3-4 quarters, this would shave off some 0.8 pp from staff’s baseline growth projections in 2022 and real GDP in 2023 could be about 1 percent lower than current projected path.

### International projections and timing of recovery
- Most international organizations project tourism to recover to its 2019 level only by 2023–2024.
- UNWTO (World Tourism Barometer, January 2022) baseline: international tourist arrivals will rebound mostly in the third quarter of 2022 and reach somewhere between 40 and 60 percent below the 2019 level at the end of the year and reach full recovery only in 2024 or later.
- Other studies with comparable conclusions: EUROCONTROL (October 2021), European Travel Commission (2021), Mckinsey (2021).

### Scarring risks and projected sectoral GVA share effects
- Gradual recovery implies deeper scarring effects measured by shortfall in value-added relative to pre-crisis trends.
- Sectoral analysis suggests the share of tourism in GVA would have been nearly 2 percentage points higher by 2026 if pre-pandemic trends had continued.
- Factoring pandemic impact and market signals:
  - The share of tourism in GVA would remain below its pre-pandemic level by about two percentage points over the medium-term (blue bar referenced).
  - Assuming the tourism sector recovers faster (e.g., by end 2023 as in staff’s baseline), the share of tourism in GVA would still remain below its 2019 level by about ½ percentage point in 2026 (red cross referenced).

### Labor reallocation and employment implications
- Multi-speed sectoral recovery will be associated with substantial reallocation of labor and other factors of production.
- Sector-specific estimates suggest a sizable share of workers in contact-intensive services would need reallocation to other activities.
- IMF (2021a) analysis suggests that—relative to 2019—the share of employment in tourism may drop by almost 1 percentage point over the medium term.
- Drivers of employment-share changes: (i) level changes (growth) of own and other sectors; and (ii) estimated sectoral output-employment relationship.
- Reallocation risks amplified by:
  - Changes in consumer and worker preferences leading to stronger-than-envisaged demand shocks.
  - Acceleration of automation and digitalization.
- Labor reallocation is especially challenging given tourism’s high reliance on low-skilled and young workers with limited prospects of finding jobs in other sectors.
- If reallocation trends favor growing sectors (e.g., construction), strains on the labor market could be much lower.

### Policy conclusions and recommendations
- Targeted and time-bound support can shape the future of the tourism sector.
- For viable small and micro firms:
  - Liquidity-type support (guaranteed loans or lending rate subsidies) could mitigate long-term scarring.
  - Efficient and timely bankruptcy proceedings for unviable firms to limit rising share of zombie firms.
  - Increased access to SME restructuring tools, with possible public support, to avoid costly bankruptcies.
- Protect vulnerable groups (women, young people, informal workers) who are more likely employed in micro or small tourism businesses:
  - Near-term measures should ensure income replacement or wage subsidies as long as the tourism sector remains under stress from pandemic-induced restrictions.
  - Authorities are implementing measures (e.g., solvency support programs under Resilience and Capitalization Fund) and timely completion is important.
- Other targeted measures to maintain traveler confidence and limit uncertainty: provide clear information to travelers and businesses on epidemiological criteria.

### Medium-term priorities to strengthen resilience, productivity, and competitiveness
- Focus areas: environmental sustainability, digital transformation, and productivity of the tourism sector.
- Active labor market policies and structural reforms to incentivize training and education in companies are key to raising workers’ skills and facilitating reallocation.
- Authorities’ NGEU investment plans—including in skill building, digitalization and climate sustainability—are important to strengthen resilience of the tourism sector and facilitate resource reallocation in Portugal.

*International Monetary Fund — excerpt from the Portugal Country Report chapter on tourism and climate-related context*

### 4.      With per capita GHG emissions below EU average, Portugal’s contribution to global

### 1prtea2022002 - 4.      With per capita GHG emissions below EU average, Portugal’s contribution to global

### GHG emissions overview
- Portugal’s peak emissions: 69 mil tCO2e (peak in 2005).
- Share of larger aggregates at peak: 1.8 percent of EU’s total GHG and 0.13 percent of world’s GHG emissions.
- International ranking at peak: 59 out of the top 218 polluting countries.
- Per capita GHG emissions in 2019: 6.7 tCO2e (EU average 8.4 tCO2e).
- Carbon intensity: above EU average (carbon intensity defined as gCO2e per unit of GDP).
- Sectoral shares:
  - Transport: almost 30 percent of total emissions.
  - Electricity generation: one fifth of emissions.
  - Agriculture: among the lowest in the EU.
- Renewable share in electricity generation in 2020: 34 percent.
- Last coal-based power plant closed in 2021.
- Despite high renewables share, energy mix remains dominated by imported fossil fuels.

### Trends and drivers since 1990 / 2005
- Emissions path:
  - GHG emissions rose steadily in the 1990s with increasing coal-based electricity generation and car use.
  - Total emissions have been on a declining path since 2005, returning close to 1990 levels.
  - Decline drivers: greater reliance on natural gas and renewables in electricity generation, more efficient car engines, and improvements in energy efficiency (emissions per unit of GDP).
- Exceptions and variability:
  - 2017 steep jump in GHG emissions due to low rainfall (switch from hydro to fossil fuels) and extreme wildfires.
  - 2020 total GHG emissions dropped below 2019 level due to lower transportation emissions during the Covid-19 pandemic; a rebound was expected in 2021 with economic recovery.
- Forest carbon sink: excluding wildfires in 2017, average carbon sink by forests in Portugal has been about 10 Mt CO2 a year.

### Portugal’s climate goals and policies
- Strategic targets (Roadmap for Carbon Neutrality 2050 (RCN) and National Energy and Climate Plan (NECP)):
  - Carbon neutrality by 2050 (announced in 2016).
  - National and sectoral target: reduce GHG by 45-55 percent compared to 2005 by 2030.
  - Reduce Portugal’s primary energy consumption by 35 percent by 2030.
  - Increase share of energy from renewable sources to 47 percent by 2030 (EU minimum 32 percent).
  - Land use sector (LULUCF) commitment to compensate CO2 emissions as per Paris agreement and EU directives.
  - Increase support for public and private research and innovation on climate change by 3 percent of GDP by 2030.
  - Address impacts of energy transition on vulnerable citizens and energy poverty.
- EU context and mechanisms:
  - Emissions from large companies in energy, industry, and aviation covered by EU Emission Trading System (ETS).
  - EU ETS cap reduced annually aiming for EU emissions to reach 43 percent of its 2005 level by 2030.
  - Separate emissions trading system for non-ETS sectors under discussion and expected from 2026.
- Recovery and Resilience Plan (RRP) allocations:
  - Almost a fifth of Portugal’s RRP funds (€3.06 bn, 2 percent of 2020 GDP under 16 components) allocated to Climate Transition pillar.
  - Measures supporting climate change objectives account for 38 percent of Portugal’s plan total allocation.
  - Main RRP projects and allocations:
    - Sustainable mobility (Lisbon and Porto metro expansion, decarbonization of public transportation): €0.97 billion.
    - Decarbonisation of industry and businesses: €0.75 billion.
    - Promotion of green hydrogen and renewable technologies: €0.37billion.
    - Energy efficiency of residential, public administration, and commercial buildings: €0.61 billion.
- Policy measures expected or underway:
  - Gradual elimination of fossil fuel subsidies (initiated in 2018).
  - Ongoing revision of tax benefits to lower incentives to use fossil fuels.
  - Gradual increase in share of companies covered by ETS.
  - Revisions of vehicle and road taxes and adjustments in direct and indirect taxes and subsidies to incentivize electric mobility.
  - Tax incentives for (i) energy efficiency of buildings, (ii) production of energy from renewable sources in residential and services sectors (foreseen in 2022 State Budget), and (iii) low-carbon products and services expected by 2025.

### Carbon pricing coverage and fiscal signals
- Existing coverage and instruments:
  - About ¾ (75 percent) of Portugal’s total GHG emissions are already subject to some form of carbon pricing.
  - Almost half of Portuguese companies in energy and industry sectors participate in EU-ETS.
  - Explicit carbon tax for non-ETS sectors introduced in 2015 (add-on to ISP).
  - Carbon tax base: Petrol; Oil and colored and marked oil; Diesel; LPG (methane and petroleum gases); Natural gas used as a fuel or propellant; Fuel Oil; Petroleum coke; Coal and coke. Tax rate tied to arithmetic mean of previous year’s EU ETS auction price.
- Revenue and taxation trends:
  - Revenue from environmental taxes has declined as a share of GDP and public revenue since 1995, though it increased after the carbon tax was increased in 2015.
  - Energy subsidies projected to decline from 1.2 percent of GDP in 2019 to 0.67 percent in 2025.
  - Implicit tax rate on energy and explicit carbon tax remain low relative to estimates of carbon emission damage.
- International comparisons:
  - Portugal’s average effective energy tax rate and implicit tax rate on energy are below many EU peers (charts referenced).

### Simulations of carbon pricing reforms (CPAT results and scenarios)
- Tool: IMF/World Bank Carbon Price Assessment Tool (CPAT).
- Baseline scenario (preserve status quo):
  - Baseline carbon price: US$28/tCO2.
  - Baseline emissions path: GHG emissions estimated at 55 million tons (mts) in 2022 rising to 58 mts in 2030.
  - Change: +4.7 percent between 2022 and 2030 under baseline.
- Higher carbon price scenarios (price increase only):
  - Linearly increase carbon price from US$28/tCO2 in baseline to US$75/tCO2 in 2030:
    - GHG emissions projected to drop by 1.3 percent compared to 2022, reaching 55 mts by 2030.
  - Linearly increase to US$100/tCO2 in 2030:
    - GHG emissions projected to drop by 5.3 percent compared to 2022, reaching 53 mts by 2030.
  - Note: higher price alone falls short of trajectory to carbon neutrality by 2050 under current policies because of relatively narrow tax base.
- Coverage and subsidy removal scenario (coverage increase only):
  - Cover all non-ETS sectors with the carbon tax and remove all fuel subsidies and exemptions, keeping carbon price at baseline level:
    - GHG emissions projected to reach 56 mts in 2030 (0.9 percent higher than the 2022 estimate), effectively stabilizing emissions at about 2022 levels.
- Combined reform scenario (price increase + broader coverage + subsidy elimination):
  - Linearly increase carbon price to US$100/tCO2 by 2030, eliminate fossil fuel subsidies and carbon tax exemptions:
    - GHG emissions projected to drop to 48 mts by 2030, close to Portugal’s intermediary objective for carbon neutrality by 2050.
- Main simulation conclusions:
  - Carbon pricing is essential but not sufficient alone; broader coverage and subsidy elimination materially improve outcomes.
  - Well-designed carbon pricing can stimulate energy efficiency, reduce demand for energy-intensive products, promote green investment and innovation, and provide fiscal revenue to finance green measures and protect vulnerable households.

### Policy implications and recommendations (drawn from findings)
- Combine instruments for effectiveness:
  - Increase explicit carbon price and broaden tax coverage to non-ETS sectors.
  - Eliminate fossil fuel subsidies and tax exemptions to raise the effective carbon price and remove incentives to pollute.
- Use carbon revenues strategically:
  - Finance greening of the economy and compensate vulnerable users to address distributional concerns and energy poverty.
  - Promote public and private research and innovation (target: 3 percent of GDP by 2030).
- Complement pricing with regulatory and fiscal measures:
  - Expand ETS coverage and consider a separate trading system for transport and housing (expected by 2026).
  - Revise vehicle and road taxes and introduce tax incentives for energy efficiency and renewable production in buildings and services.
- Leverage RRP and public investments:
  - Prioritize RRP measures that expand sustainable mobility, decarbonize industry, promote green hydrogen and renewables, and improve building energy efficiency.

*INTERNATIONAL MONETARY FUND*

### 13.      A gradual carbon price reform―as described under scenario “d”

### 13.      A gradual carbon price reform―as described under scenario “d”

### Summary of the reform and overall assessment
- Scenario “d” is a gradual reform combining a higher carbon price with elimination of fuel subsidies and higher carbon tax coverage.
- The reform “seems the most effective in achieving carbon neutrality by 2050, although with large distributional consequences for lower income households.”
- If not combined with further measures (broader coverage and subsidy reform), even significantly higher carbon prices would not achieve required GHG emissions reductions.

### Quantified benefits and costs
- Estimated monetized co-benefits of the reform: an annual average at 0.2 percent of GDP.
  - About 81 percent of these benefits arise from domestic environmental co-benefits (such as less traffic congestion and lower number of accident-related externalities).
  - Remaining 19 percent come from better air quality and lower number of deaths.
- Global climate benefit is estimated to bring additional 0.1 percent of GDP, increasing the total welfare benefit to 0.3 percent of GDP.
- Efficiency cost: in scenario “d”, the efficiency cost is estimated to reach 0.38 percent of GDP in 2030.
  - These costs correspond to the value of foregone consumption to fossil fuel consumers, less savings in supply costs (annualized costs of adopting cleaner, more expensive technologies, net of lifetime energy savings).

### Energy price impacts (2030 projections under Carbon tax $100 + increased coverage)
- Gasoline: from US$ per liter 1.80 to 2.27 → 26.4% change
- Diesel: from US$ per liter 1.56 to 2.08 → 33.3% change
- LPG: from US$ per liter 0.76 to 1.12 → 48.2% change
- Non-road oil: from US$ per barrel 68.32 to 165.70 → 142.5% change
- Kerosene: from US$ per liter 1.20 to 1.73 → 43.6% change
- Electricity: from US$ per kwh 0.18 to 0.19 → 10.1% change
- Natural gas: from US$ per gigajoule (GJ) 14.03 to 19.92 → 42.0% change
- Additional summary: energy prices would respond sharply in scenario “d”: gas prices are projected to increase by more than 40 percent, diesel by more than 30 percent, gasoline by about 25 percent and electricity by 10 percent.

### Distributional impacts and vulnerable households
- Direct energy consumption represents almost 20 percent of total consumption of lower income groups.
- Higher energy prices would heavily impact the most vulnerable households and require offsetting measures.
- The authorities are developing a National Long-Term Strategy to analyze causes of energy poverty and propose measures focusing on:
  - (i) improving energy efficiency of homes,
  - (ii) better access to energy services,
  - (iii) improving energy literacy,
  - (iv) reducing the burden of energy consumption.
- NECP and RRP foresee additional measures to combat energy poverty and develop instruments to protect the most vulnerable.

### Fiscal revenue potential and uses
- A gradual increase of both the coverage and the carbon price could raise public revenues by about 2½ percent of GDP (USD$7.4 billion) by the end of the projection horizon in 2030.
- Newly generated revenue from carbon taxation could be used to:
  - (i) address critical public investment gaps;
  - (ii) offset the regressive effect of the carbon tax on the most vulnerable households;
  - (iii) reduce labor and/or corporate tax to avoid economic inefficiencies linked to double taxation.

### Emissions impacts and required complementary measures
- Under current policies, increasing carbon price from current US$28 t/CO2e to US$75(100) t/CO2e would reduce GHG emissions by 11(15) percent and thus not put the country on the path of carbon neutrality by 2050.
- Combining higher carbon price with energy subsidy reform and larger coverage of the carbon tax would reduce GHG emissions to 48 t/CO2e by 2030 and place Portugal on a trajectory towards carbon neutrality.
- The limited impact of higher carbon price alone is a result of existing tax exemptions and reduced rates; minimizing exemptions and reduced tax rates is justified.

### Contextual energy and emission facts (Portugal)
- Portugal remains heavily reliant on imported fossil fuels: 74 percent of primary energy supply in 2019 (44 percent oil, 25 percent natural gas and 6 percent coal).
- Transport sector: 94 percent of transport energy demand was covered by oil; transport GHG emissions increased by 10 percent from 2014 to 2019.
- Fossil fuel subsidies are estimated at 0.6 percent of GDP in 2021.
- Two thirds of buildings do not meet energy performance requirements.
- Portugal met its 2020 targets on non-ETS emissions; share of renewables in heating and cooling reached 41 percent; share of renewable energy in overall energy consumption increased by 11 percentage points between 2005 and 2019, reaching about 30 percent of gross final energy demand in 2019.
- Government target: increase the share of renewables to 47 percent by 2030.

### Policy recommendations and supporting measures
- Use carbon pricing revenue to:
  - finance reduction of other (more distortionary) taxes,
  - provide transfers to vulnerable households,
  - invest in infrastructure, clean technologies, and innovations.
- Complement carbon pricing with:
  - elimination of fuel subsidies;
  - larger coverage of the carbon tax (minimize exemptions and reduced rates);
  - sectoral measures in NECP and RNC, including investment in public transportation infrastructure and urban planning;
  - renewable-based power generation;
  - introducing or raising efficiency standards;
  - water, land and forest management;
  - investment in R&D initiatives.
- Additional adaptation and resilience measures required given projected climate risks:
  - investments in risk prevention and preparedness (water management, rural fire prevention, circular economy, waste management);
  - exploring offshore wind and ocean energy and increasing solar energy generation;
  - advancing building renovation programs to improve energy efficiency.

*Source: 1prtea2022002 - 13.      A gradual carbon price reform―as described under scenario “d”*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1prtea2022002.pdf_