## _cr13160

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---

### EXECUTIVE SUMMARY — Key takeaways
- All performance criteria and structural benchmarks underpinning the review have been met.
- Some two-thirds of the close to 10 percentage points of GDP structural primary adjustment required to stabilize public debt has been effected through end-2012; additional adjustment has been legislated and is under way.
- Banking sector recapitalized; liquidity buffers comfortable.
- Current account correction exceeded expectations; Portugal returned to international bond market in January 2013.
- Constitutional Court ruling in early April 2013 found a number of 2013 budget provisions unconstitutional, opening a fiscal gap of about 0.8 percent of GDP.

### Economic developments and outlook — Findings and projections
- Growth and output:
  - GDP shrank by 1¾ percent in Q4 2012 (program assumption: 1 percent).
  - Output contracted by 3¼ percent in 2012 (programme expectation at sixth review: 3 percent).
  - Preliminary Q1 2013: output contracted -0.3 percent q-o-q (other mention: -0.4% q-o-q, -4% y-o-y in INE Q1 data).
  - 2013 growth projection revised down by 1¼ percentage points to -2¼ percent.
  - Modest recovery expected in Q4 2013 (one quarter later than previously thought).
- Inflation and labor market:
  - Inflation expected to average around ¾ percent in 2013.
  - Unemployment: about 17¾ percent in Q1 2013; youth unemployment about 40 percent.
  - Unemployment rate projected to reach an average of 18½ percent in 2014.
  - Compensation per employee declined by 2½ percent in 2012.
- External sector and competitiveness:
  - Current account deficit shrunk to 1.5 percent of GDP in 2012 (adjustment of 10 percentage points from late 2008 peak).
  - Exports volumes declined by 2 percent in Q4 relative to previous quarter.
  - Economy-wide unit labor costs (ULC) declined by 3¾ percent in 2012 and stand about 8 percent below their 2009 Q1 peak; about one-fourth of the increase in ULC since 2000 reversed so far.
  - Export-led gains and private sector ULC improvements remain limited.

### Risks and vulnerabilities
- Key risks:
  - Politics: weakening social and political consensus and waning appetite for reform as financing improves.
  - Recovery: risk that adjustment occurs through demand compression rather than expenditure switching and export-led gains.
  - Euro area: weak partner demand and euro-area sentiment pose significant headwinds.
- Program success depends on:
  - Continued strong policies and reform implementation.
  - Resumption of growth.
  - Supportive euro area environment.

### IMF staff recommendation
- Staff supports authorities’ request for completion of the seventh review.
- Purchase at completion: SDR 574 million.

---

### Fiscal policy, program recalibration, and Public Expenditure Review (PER)
- Recalibration rationale and revised headline path:
  - Deterioration in macro-fiscal outlook and Constitutional Court impacts led to easing of deficit targets.
  - Revised headline deficit path:
    - 2013: 5½ percent of GDP
    - 2014: 4 percent of GDP
    - 2015: 2½ percent of GDP
  - This delays attainment of the SGP 3 percent threshold by one year while keeping target of overall structural deficit of ½ percent of GDP by 2017.
- Constitutional Court ruling (early April 2013) effects:
  - Cuts in the 14th monthly payment to public wage earners and pensioners (projected yield ~0.7 percent of GDP) struck down.
  - Contribution on sick leave and unemployment benefits (estimated yield 0.1 percent of GDP) ruled unconstitutional.
  - Fiscal gap for 2013: about 0.8 percent of GDP (Table/Letter: about €1.3 billion).
- Measures to fill 2013 gap and PER outcomes:
  - About a quarter of gap measures temporary (reprogramming of EU structural funds, some expenditure compression); remainder front-loaded PER measures.
  - PER permanent savings identified: expected yield of some €4.7 billion (2.9 percent of 2013 GDP) in net savings (cumulative covering 2013-14).
  - One-off cost: €0.5 billion (0.3 percent of GDP) severance payments payable in 2014.
  - PER distribution: pensions; changes to public sector employment and wage rules; line ministries’ goods and services budgets.
  - Prior actions met: Council of Ministers adopted medium-term fiscal framework (2013–17) and fully-specified measures for 2013-14 (prior action).
  - Submission of draft laws to implement PER set as structural benchmarks (June–July).
- Aggregate indicators (Appendix I):
  - Total PER measures (headline in millions of euros): 2013: 1,411; 2014: 3,289; 1/Total: 4,700.
  - Memorandum item: Upfront costs (severance payments) 2/0: 507.

---

### Public debt outlook, financing, and market access
- Debt projections and vulnerabilities:
  - Debt-to-GDP ratio projected to peak close to 124 percent of GDP in 2014 (two percentage points higher than at sixth review).
  - Drivers of revision: higher deficit path and downward revision to nominal GDP; partial offset from one-off transactions.
  - Sizeable contingent liabilities remain a risk, including 9 percent of GDP in SOE debt classified outside general government.
  - Debt remains sustainable under baseline but plausible shocks could generate unsustainable dynamics.
- Market access and financing developments:
  - January 2013: reopened five-year bond, borrowing €2.5 billion (1½ percent of GDP) at a yield just under 5 percent.
  - May 2013: 10-year bond raised some €3 billion at a yield slightly below 5.7 percent.
  - Yields on these issues are 100-200 basis points below assumptions in staff’s debt sustainability analysis.
  - Privatization: ANA sold for €3.1 billion (1.9 percent of GDP).
  - S&P revised sovereign rating outlook from negative to stable.
  - Expected extension of EFSF/EFSM maturities and potential ECB OMT eligibility cited as supportive to market access.
- Fund exposure and repayment capacity:
  - Fund exposure to Portugal rises to 16.3 percent of GDP in 2014.
  - Debt service expected to peak in 2018 at 5.7 percent of exports of goods and services, or 2.7 percent of GDP.

---

### Financial sector — capitalization, liquidity, credit conditions, and supervision
- Bank capitalization and buffers:
  - All banks met the program Core Tier 1 target of 10 percent after 2012 capital augmentation.
  - Portuguese State injected €1.1bn in Rentipar-Banif on January 25, 2013.
  - Core Tier 1 ratio (end-2012) cited elsewhere as 11.5% (increase of 2.8 percentage points since Dec-2011).
- Liquidity and market funding:
  - Banks reduced reliance on Eurosystem liquidity by over €11 billion since June 2012, including €3.5 billion in early repayments of the 3-year LTROs.
  - Collateral buffer around €28 billion (one year of banks’ refinancing needs).
  - Two major banks returned to international bond markets: CGD placed €750 million covered bond (5-year, 3.75 percent coupon); BES placed €500 million senior unsecured bond (5-year, 4.75 percent coupon).
- Profitability and credit access:
  - 2013 Q1 results: further decline in bank profitability and net interest income.
  - Low spreads on legacy mortgage loans and high funding costs are significant profit drags.
  - Credit continues to contract in aggregate, though at a slower pace; lending rates on new corporate business remain well above euro area peers.
  - Access to credit for indebted SMEs remains highly constrained.
- Supervisory and resolution framework:
  - Amendments to law governing banks’ access to public capital approved in May to allow state control under strict guidelines.
  - Decree law on banks’ contributions to the Resolution Fund entered into force in February 2013; initial contributions by mid-2013.
  - Recovery and resolution planning: review of largest banks’ recovery plans progressing; recovery plans for other institutions expected by end-November 2013; resolution plan inputs expected by end-July 2013.
  - BdP will continue to review Funding and Capital Plans and update quarterly stress tests; requires quarterly reports on restructured loans.
  - Thematic review of banks’ operational capacity in loan restructurings planned.

---

### Private sector deleveraging, restructuring tools, and SME support
- Deleveraging and restructuring:
  - Households and non-financial corporates continue to improve financial balances.
  - Corporate insolvencies have risen.
  - New restructuring tools: PER and SIREVE fully operational; SIREVE in force since September 2012 (SME out-of-court mediation); PER fast-track in-court approval available since May 2012.
  - As of April 2013: about €3 billion in credit considered under general household debt restructuring regime; 56 percent of terminated processes ended in payment of overdue amounts.
  - Extraordinary mortgage regime: €5 million renegotiated as of April 2013.
- Government-sponsored SME support:
  - About €12 billion in government-guaranteed credit lines disbursed via PME Invest and Crescimiento.
  - Government reviewing schemes; external audit of the National Guarantee System (NGS) conducted; recommendations to enhance pricing, selection, risk management, and governance.
  - Authorities considering a €220 million venture capital line.
  - Measures to improve SME access to capital markets: align tax treatment of commercial paper; promote securitization and pooled SME issuances; draft amendments by end-June; detailed proposals expected by end-May.
- Credit information and registries:
  - BdP enhancing Central Credit Registry (CCR) coverage; subject to Portuguese Data Protection Authority authorization for historical access.
  - BdP assessing access to Central Balance Sheet Database (CBSD).

---

### Structural reforms and external competitiveness
- Labor market reforms:
  - Substantial reduction in severance pay; further reduction legislated: 12 days per year of salary for all new permanent contracts (effective October 1, 2013); transitional provisions for existing contracts (18 days first three years, 12 days thereafter).
  - Revisions to working time flexibility, reductions in holidays and overtime payments; unemployment benefit reform; active labor market policies reoriented.
- Product and service market reforms:
  - New Competition Law; specialized Competition Court; Framework Law for Regulators submitted to Parliament to strengthen independence and autonomy.
  - Ports: second ten-percent cut in port user administrative fees; Ports Work Law adopted aiming to lower wage costs and increase labor flexibility.
  - Energy sector: objective to eliminate tariff debt by 2020; structural benchmark to update projections and identify corrective measures by June 15, 2013.
  - Services: alignment with Services Directive; licensing and administrative burden reductions; inventory of regulatory costs due end-June 2013.
- Outcomes and competitiveness indicators:
  - Current and capital account turned positive in 2012; current account deficit narrowed to below 2 percent of GDP in 2012 from 6.5 percent in 2011.
  - Exports accounted for around 60 percent of external adjustment in 2009-12.
  - NEER decreased around 10 percent from late 2009 peak; CPI-based REER broadly unchanged; GDP-deflator and ULC-based REER declined around 10 percent.
  - ULC developments: economy-wide ULC declined by 3½ percent in 2012 (or 3.75 percent noted elsewhere); private sector ULC reduction more modest.
  - Mark-ups in tradable and non-tradable sectors declined in 2010-12; non-tradables mark-ups shrunk faster.
- Assessment:
  - Structural reforms need time to bear fruit; rising unit costs of capital and high credit costs remain a major obstacle.
  - Reforms to reduce nominal rigidities and nontradable sector rents recommended.

---

### Policy priorities, staff appraisal, and recommended actions
- Fiscal and expenditure reform:
  - Sustain fiscal consolidation; early implementation of PER measures critical.
  - Prompt enactment of required legislation to advance expenditure reforms; any PER modifications require offsetting permanent measures of equivalent yield and quality.
  - Address public expenditure weaknesses: public service size, public sector wages and pensions.
  - Ensure government entities respect expenditure commitment control system, especially ahead of local elections.
- Revenue administration and tax policy:
  - Strengthen revenue administration with emphasis on PIT and VAT compliance; establish a permanent Compliance Risk Management Unit.
  - Proceed with comprehensive CIT reform in fiscally neutral manner; draft law by end-June 2013.
- Financial stability and credit supply:
  - Maintain supervisory vigilance; promote rapid restructuring of troubled loans to support private sector balance sheet adjustment while protecting viable firms.
  - Improve efficiency of government initiatives to assist viable companies; ensure targeting of guaranteed credit lines.
- Competitiveness:
  - Address nominal rigidities forcefully to foster competitiveness: combine measures to raise productivity and reduce input costs, including wages for the tradable sector.
  - Explore options to lower production costs and compress excessive profit margins in the nontradable sector.
- Monitoring and conditionality:
  - Staff recommended completion of the seventh review and modification of end-June performance criteria.
  - Continued external support and effective euro-area crisis management policies deemed essential.

---

### Selected program-specific quantitative and reporting items (preserved exactly)
- Revised headline deficit path:
  - 2013: 5½ percent of GDP
  - 2014: 4 percent of GDP
  - 2015: 2½ percent of GDP
- PER expected yield: some €4.7 billion (2.9 percent of 2013 GDP) net savings (cumulative covering 2013-14).
- PER upfront cost (severance payments): €0.5 billion (0.3 percent of GDP).
- PER headline totals (millions of euros): 2013: 1,411; 2014: 3,289; 1/Total: 4,700.
- Privatization receipts and transactions:
  - ANA privatization: €3.1 billion (1.9 percent of GDP).
  - January 2013 five-year bond: €2.5 billion (1½ percent of GDP), yield just under 5 percent.
  - May 2013 10-year bond: some €3 billion, yield slightly below 5.7 percent.
- Banking sector:
  - Collateral buffer: around €28 billion.
  - Reduction in Eurosystem reliance: over €11 billion since June 2012, including €3.5 billion in early repayments of 3-year LTROs.
  - As of January 25, 2013: State injected €1.1bn in Rentipar-Banif.
- Fund exposure and debt service:
  - Fund exposure: 16.3 percent of GDP in 2014.
  - Debt service peak: 5.7 percent of exports of goods and services in 2018, or 2.7 percent of GDP.

---

*Source: EXECUTIVE SUMMARY and selected chapters and appendices — _cr13160 (June 12, 2013).*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Background
- All performance criteria and structural benchmarks underpinning the review have been met.
- Some two-thirds of the close to 10 percentage points of GDP structural primary adjustment required to stabilize public debt has been effected through end-2012, and still more adjustment has already been legislated and is under way.
- The banking sector has been successfully recapitalized and liquidity buffers remain comfortable.
- The current account correction has continued to exceed expectations.
- Portugal was able to return to the international bond market in January for the first time since early 2011.
- In early April, the Constitutional Court found a number of 2013 budget provisions unconstitutional, opening up a fiscal gap of about 0.8 percent of GDP and raising questions about the feasibility of some policy and reform options planned to underpin fiscal adjustment.

### Economic developments and outlook — Key findings
- The economic outlook remains somber despite progress on imbalances:
  - Strong export growth that had helped offset contraction in domestic demand has started to decrease reflecting weakening demand from the rest of the euro area.
  - Labor market situation remains extremely difficult, with unemployment already at some 18 percent and employment losses set to continue.
- Real economy developments:
  - GDP shrank by 1¾ percent from the previous quarter in Q4 (compared to 1 percent assumed under the program).
  - Output contracted by 3¼ percent in 2012 (sharper than the 3-percent decline expected at the sixth review).
  - Preliminary data indicate output contracted at a slower pace (-0.3 percent quarter-over-quarter) in Q1 2013.
  - Household saving rate at all-time highs; corporate sector undergoing unprecedented balance sheet deleveraging.
- Labor market specifics:
  - Overall unemployment rose to some 17¾ percent in Q1 2013 (from 17 percent in Q4), with more than half unemployed for over a year.
  - Youth unemployment is about 40 percent.
  - Compensation per employee declined by 2½ percent in 2012, driven largely by public sector wage cuts which are being reversed following the Constitutional Court ruling.
  - Nominal wage increases for existing contracts in the private sector have decelerated but remain slightly positive.
- External sector and competitiveness:
  - Current account deficit shrunk to 1.5 percent of GDP in 2012, an adjustment of 10 percentage points from its peak in late 2008.
  - Exports volumes declined by 2 percent in Q4 relative to the previous quarter (partly reflecting temporary factors such as port strikes and factory shutdowns).
  - Economy-wide unit labor costs (ULC) declined by 3¾ percent in 2012 and currently stand about 8 percent below their 2009 Q1 peak; about one-fourth of the increase in ULC since 2000 has been reversed so far.
  - Gains in private sector ULC and adjustment in relative prices of nontradables to tradables remain limited.

### Program recalibration and fiscal policy
- Seventh review discussions focused on:
  - Recalibrating fiscal targets to reflect the revised macroeconomic outlook.
  - Addressing the impact of the Constitutional Court ruling.
  - Finalizing the public expenditure review.
- With the financing picture having improved, the authorities and staff agreed there is a strong case for revisiting the mix between adjustment and financing toward the latter.
  - Consequently, the deficit targets have been eased—by 1 and 1½ percentage points of GDP in 2013 and 2014, respectively.
- Limitations:
  - Scope for more financing is limited given a fragile public debt trajectory—set to peak at 124 percent of GDP on current policies and outlook.
  - The Constitutional Court ruling opened a fiscal gap of about 0.8 percent of GDP for 2013; alternative measures were identified to close this gap and underpin required 2014 adjustment.
- Staff supports authorities’ request for completion of the seventh review:
  - The purchase released upon completion of this review would be in an amount equivalent to SDR 574 million.

### Market and financing developments
- Market access resumed:
  - In mid-January, the government reopened a five-year bond, borrowing €2.5 billion (1½ percent of GDP) at a yield of just under 5 percent.
  - In early May, a new 10-year bond issue raised some €3 billion at a yield slightly below 5.7 percent.
  - Yields on these issues are 100-200 basis points below what is assumed for comparable maturities in staff’s debt sustainability analysis.
- Investor confidence:
  - Strong demand for bond issues, mainly from nonresidents, with increased interest from long-term investors at the second issue.
  - Successful privatization of the airport concessionaire ANA for €3.1 billion (1.9 percent of GDP).
  - S&P revised the sovereign rating outlook from negative to stable.
- Financing outlook influenced by expected extension of loan maturities and improved market sentiment.

### Risks and vulnerabilities
- Risks to attainment of program core objectives remain high and include:
  - Politics: The social and political consensus that supported strong program implementation has weakened; appetite for reform is waning as financing conditions improve.
  - Recovery: Economic recovery is proving elusive; relaxation of fiscal adjustment pace will help but near-term tools to boost competitiveness are limited, raising the risk that adjustment will occur through further demand compression rather than expenditure switching and export-led gains.
  - Euro area: Weak demand and sentiment from the broader euro area greatly exacerbate domestic difficulties and pose significant headwinds to exports and growth.
- Program requires:
  - Continued strong policies and reform implementation.
  - Resumption of growth.
  - A supportive euro area environment to deepen and broaden market access.

### Policy discussions and structural agenda (high-level)
- Discussions addressed:
  - Allowing automatic stabilizers to operate fully to accommodate lower growth and higher unemployment.
  - Measures to facilitate orderly restructuring of the corporate sector and alleviate tight credit conditions facing smaller firms.
  - Advancing broad structural agenda to reduce nominal rigidities and boost competitiveness and growth.
- Finalization of ongoing public expenditure review and identification of alternative fiscal measures to address Constitutional Court impacts.

*Source: EXECUTIVE SUMMARY — _cr13160 (June 12, 2013).*

### 9. The recession is still expected to trough later this year, but following a deeper output

### 9. The recession is still expected to trough later this year, but following a deeper output contraction

### Growth outlook and risks
- 2013 growth projection revised down by 1¼ percentage points to -2¼ percent.
  - Revision composition:
    - large negative carry-over from the 2012 outturn: accounts for one-half of the revision.
    - revised assessment of domestic demand prospects, particularly for investment: accounts for one-fourth of the revision.
    - latest outlook for partner country demand projected weaker by almost 1¼ percentage points: accounts for the remaining one-fourth of the revision.
- Modest recovery expected in the fourth quarter of the year—one quarter later than previously thought—underpinned by a gradual increase in investment outlays by more export-oriented firms, particularly in equipment and machinery, as capacity constraints become more binding.
- Risks to the baseline are tilted to the downside:
  - Near-term main risk: combination of fiscal adjustment and private sector deleveraging could curtail growth even more than projected.
  - Uncertain growth prospects in Europe could keep demand for Portuguese exports weak.
  - Current strength of the euro could limit further gains in market share in export markets outside the euro area.
  - Modest improvement in price-competitiveness indicators risks reforms being insufficient to boost supply conditions quickly enough to prevent a protracted demand slump.
  - Political and social situation could deteriorate further, complicating the reform process.

### Inflation and labor market projections
- Inflation is expected to average around ¾ percent in 2013.
- Unemployment rate projections revised up—reaching an average of 18½ percent in 2014.

### Recent fiscal developments and 2012 outturn
- Authorities offset broad-based weak revenue collections in the last quarter with expenditure savings, particularly by reducing intermediate consumption and slowing public investment outlays.
- General government deficit for program purposes is estimated at 4.7 percent of GDP (smaller than the 5 percent foreseen at the time of the last review).
- ESA-definition (headline) deficit for 2012 is estimated at 6.4 percent of GDP due to a number of one-off transactions that are excluded from the program deficit measure.
- Underlying fiscal adjustment:
  - Structural primary balance improved by close to 3 percentage points of GDP in 2012.
  - Cumulative adjustment effected under the program about 6¼ percentage points of GDP, out of the required total of 10 percentage points of GDP.
  - Other metrics indicate about two-thirds of the required adjustment has already been affected.

### Constitutional Court ruling and implications
- In early April the Constitutional Court (CC) declared a number of provisions of the 2013 State Budget Law unconstitutional:
  - Cuts in the 14th monthly payment to public wage earners and pensioners (projected to yield net savings of about 0.7 percent of GDP) were struck down.
  - Contribution on sick leave and unemployment benefits (estimated to yield savings of 0.1 percent of GDP) was ruled unconstitutional.
- The CC assessed violations of the principles of equality and proportionality; measures would have affected public sector employees more and reduced incomes for recipients below socially acceptable income levels.
- The ruling delayed the Public Expenditure Review (PER) process somewhat and raised questions about the feasibility of some reforms, requiring more time to fine tune exercises to limit future legal risks.

### Fiscal structural reforms (status and components)
- Public Financial Management:
  - Treaty on Stability, Coordination, and Governance in the EMU (Fiscal Compact) incorporated into the domestic Budgetary Framework Law (BFL).
  - Further reforms launched to streamline budgetary procedures.
- Expenditure controls and arrears:
  - New expenditure commitment control system fully operational in the majority of budgetary entities.
  - General Inspectorate of Finance controlling implementation.
  - Underlying stock of arrears declined by €700 million in Q4 2012, increased slightly in February (typical), but domestic arrears reduced by €1 billion between September 2012 and February 2013.
  - Remaining stock of arrears stood at 2.6 percent of GDP in February 2013.
- Revenue Administration:
  - Large Taxpayer Office operational (end-December Structural Benchmark).
  - Property revaluation project involves appraising some 5 million properties; timely conclusion key for 2013 budget tax handle.
  - FAD mission identified need to increase focus on protecting PIT revenues.
- Public-Private Partnership (PPP):
  - PPP institutional reforms accelerated; PPP unit quasi-operational.
  - PPP contracts’ renegotiations well advanced to support envisaged 2013 fiscal savings on PPPs.
- Local and Regional Finances:
  - Draft regional and local finance laws submitted to Parliament by end-2012 (structural benchmark).
  - Proposals include extension of BFL principles to sub-national governments, revision of local/regional indebtedness rules, creation of a municipal insolvency fund, and establishment of a coordination council between central and sub-national governments.
- Tax courts:
  - Rate of resolution of high-value tax court cases by task forces since May 2011 has been very encouraging; efforts continue to speed up litigation.

### Policy discussions and revised fiscal path
- Agreement reached that the fiscal deficit path under the program needed recalibration given the deterioration in the macro-fiscal outlook.
  - Significant negative carry-over from 2012 (of at least ½ percent of GDP) and worse prospects for growth and employment in 2013 implied maintaining headline deficit objectives unchanged would have entailed even more drag on output and employment.
- Revised headline deficit path:
  - 2013: 5½ percent of GDP
  - 2014: 4 percent of GDP
  - 2015: 2½ percent of GDP
- This revision delays attainment of the Stability and Growth Pact (SGP) deficit threshold (3 percent of GDP) by one year while keeping Portugal on track to meet its Fiscal Compact (and Budget Framework Law) objective of reducing the overall structural deficit to ½ percent of GDP by 2017.
- The revised path reflects considerations to:
  - accommodate automatic stabilizers,
  - continue advancing structural fiscal adjustment,
  - contain the debt-to-GDP ratio to facilitate a deepening of market access.
- The shift in composition of adjustment (particularly in 2013) allows remaining fiscal adjustment to be more evenly spread over 2013-15.
- On financing: authorities argued for revisiting the mix between adjustment and financing given improved financing picture; staff agreed but noted scope for financing is not unlimited and implications for the debt trajectory must be considered.

### Measures to fill the 2013 gap and PER implementation
- To offset the gap created by the Court ruling and achieve the revised 2013 fiscal target:
  - About a quarter of the measures are temporary, including reprogramming of EU structural funds and some expenditure compression.
  - The remainder is filled by front loading some PER measures.
  - As a prior action for the completion of the review, authorities submitted to Parliament a supplementary budget ensuring these savings are realized (MEFP, ¶6).
- PER permanent savings identified:
  - Expected yield of some €4.7 billion (2.9 percent of 2013 GDP) in net savings (cumulative covering 2013-14).
  - One-off cost of €0.5 billion (0.3 percent of GDP) due to severance payments to be paid in 2014.
  - Savings distributed across: pension reform; changes to public sector employment and wage rules; line ministries’ goods and services budgets.
- PER adoption and publication of the 2013-17 medium-term fiscal framework—including specific measures for 2013-14 to meet revised deficit targets—by the Council of Ministers is a prior action for completion of the program review; it was met in early May (MEFP, ¶7).
- Public consultation may lead to modifications (for example strong opposition to introduction of a sustainability contribution on pensions), but authorities committed to offset any changes by equivalent permanent measures.
- Some PER elements require significant legislative amendments; submission of relevant draft laws and legislative proposals to Parliament set as structural benchmarks to be met in June and July (MEFP, ¶8).

### Steps to mitigate legal risks from the CC ruling
- Authorities’ intended measures:
  - Rely as much as possible on general laws—rather than one-year budget laws—consistent with structural nature of the reforms to allow prior review by the Court before draft legislation is signed into law.
  - Justify reforms by stressing the need to comply with fiscal sustainability rules embedded in the recently-ratified Fiscal Compact, which ranks higher than ordinary legislation.
  - Design expenditure reforms with the principle of public/private sector and intergenerational equity in mind to respond to issues raised by the Court.

*Source: IMF staff report excerpt, chapter titled "9. The recession is still expected to trough later this year, but following a deeper output contraction."*

### 20. The outlook for public debt remains very fragile (see Appendix II). The debt-to-GDP ratio

### _cr13160 - 20. The outlook for public debt remains very fragile (see Appendix II). The debt-to-GDP ratio

### Public debt outlook
- The debt-to-GDP ratio is now projected to peak at close to 124 percent of GDP in 2014, two percentage points higher than had been expected at the time of the sixth review.
- Drivers of the revision:
  - Higher deficit path.
  - Downward revision to nominal GDP.
  - Only partial offset from one-off transactions such as the planned sale of foreign assets of the social security fund and transfer of the government’s shares in state-owned bank CGD to Parpública.
- Contingent liabilities and risks:
  - The sizeable contingent liabilities of the public sector—including the 9 percent of GDP in debt of the SOEs that are classified outside the general government—remain a significant source of risk to debt sustainability.
- Scenario assessment:
  - Debt remains sustainable under the baseline scenario.
  - A combination of plausible shocks could generate unsustainable debt dynamics.

### Privatization and asset sales (2013 outlook)
- Privatization process expected to continue in 2013:
  - TAP privatization to be re-launched later in the year after previous postponement.
  - Sale of the postal company, CTT, expected to be launched in the second quarter and completed by year-end.
  - Privatization of rail cargo company CP Carga to get underway in the second half of the year.
- Water and waste sector actions:
  - Strategic review of the water sector completed in December 2012.
  - Next steps include possible sale of the waste management company and assessment of potential for concessions and private management in water companies.
  - Binding offers for the sale of waste management business currently anticipated for the end of 2013.
  - Opening water concession to private capital and management expected to take longer due to need for substantial legal changes and participation of municipal governments.

### Tax compliance and revenue protection
- Staff recommendations to guard against revenue shortfalls:
  - Enhance PIT and VAT compliance actions given increasing incentives for tax evasion.
  - Adopt proactive short-term initiatives to promote voluntary compliance—through communication campaigns and meetings with business associations—and focus on taxpayer segments prone to high evasion.
  - Establish a permanent Compliance Risk Management Unit to enhance analytical and strategic capacity of the revenue administration.
  - Strengthen exchange of information between tax and anti-money laundering authorities and make greater use of the anti-money laundering framework to support revenue collection.
- Authorities’ view:
  - Authorities consider that tax compliance has not deteriorated significantly during the crisis.

### Public financial management (PFM), PPPs, and health sector reforms
- PPPs:
  - Discussions centered on strategy underpinning negotiations and ensuring savings under the 2013 budget materialize.
  - Staff supported strategy of reducing fiscal burden from PPPs through cuts in operational and capital expenditures, and reduction and convergence of contracts’ internal rates of return.
- Health sector:
  - Development of an enhanced system for monitoring fiscal outcomes welcomed.
  - The monitoring system will provide timely information on the general government health system and hospitals to improve control over budget execution.

### Recent financial developments and bank capitalization
- Bank capitalization:
  - All banks met the program Core Tier 1 target of 10 percent following the 2012 capital augmentation exercise.
  - One aided institution already able to make early repayments to the State of contingent instruments issued in June 2012.
  - On January 25, 2013, the Portuguese State injected €1.1bn in Rentipar-Banif, allowing the bank to meet the program’s capital requirements. A private rights issuance is expected by June 2013, allowing the bank to further increase its capital buffer and repay part of the state aid received.
- Stress tests and inspections:
  - Latest stress tests (reference date September 2012; Core Tier 1 hurdle rate of 6 percent for the adverse scenario) indicate banks’ capital buffers are sufficient to withstand further deterioration.
  - Banco de Portugal’s On-Site Inspection Program highlighted only modest understatements of impairment levels that have been addressed by the banks.

### Funding pressures, collateral buffer, and market access
- Eurosystem reliance:
  - Banks have reduced reliance on Eurosystem liquidity support by over €11 billion since the peak in June 2012, including €3.5 billion in early repayments of the 3-year LTROs.
- Collateral buffer:
  - The collateral buffer stands at around €28 billion or one year of banks’ refinancing needs.
- Market access:
  - Two major banks successfully returned to international bond markets; prospects for the rest of the system remain uncertain and tied to broader regional market developments.
  - Following successful issuances in 2012, CGD placed a €750 million covered bond (5-year and 3.75 percent coupon) and BES placed a €500 million senior unsecured bond (5-year and 4.75 percent coupon) in January of this year.

### Bank profitability and credit conditions
- Profitability pressures:
  - 2013 Q1 results indicate a further decline in bank profitability and notably net interest income.
  - Low spreads on legacy mortgage loans (rates linked to Euribor with a small fixed margin while current funding costs are much higher) are a significant drag on profits.
  - Positive contributions from foreign operations and operating cost savings help but do not fully offset domestic challenges.
- Credit access:
  - Access to credit for the more indebted SME segment remains highly constrained.
  - Credit continues to contract in aggregate, although at a slower pace in recent months.
  - Lending rates on new corporate business are well above those in euro area peers, even for firms with comparable balance sheet strength.
  - Staff analysis attributes high lending rates and credit segmentation to still-high sovereign spreads, weak domestic conditions, and banks’ profitability.

### Private sector deleveraging and restructuring tools
- Deleveraging trends:
  - Households and non-financial corporates continue to improve their financial balances, reflecting precautionary motives and need to service high debt burdens.
- Corporate insolvencies and workout tools:
  - Pronounced increase in corporate insolvencies.
  - New restructuring tools, PER and SIREVE, now fully operational, but it is too early to judge their effectiveness.
- Household restructuring:
  - As of April 2013, about €3 billion in credit had been considered under the general household debt restructuring regime, with 56 percent of the terminated processes ending in the payment of overdue amounts.
  - Extraordinary mortgage regime: only €5 million of credit renegotiated as of April 2013, with negligible implications for banks.

### Bank recapitalization, resolution frameworks, and supervisory actions
- Legal and institutional measures:
  - Parliament approved in May amendments to the law governing banks’ access to public capital (submitted end-January structural benchmark) to allow the state—under strict guidelines—to exercise control over recapitalized institutions and to perform mandatory recapitalizations.
  - Decree law on banks’ contributions to the Resolution Fund entered into force in February 2013; foresees payment of initial contributions by mid-2013, followed by the periodical contribution for 2013 in September.
- Recovery and resolution planning:
  - Review of largest banks’ recovery plans is progressing; recovery plans for other institutions expected by end-November 2013.
  - Banks’ input for resolution plans, following the supervisory notice on resolution plans published in December 2012, is expected by end-July 2013.
- Supervisory vigilance:
  - BdP will continue to carefully review banks’ Funding and Capital Plans (FCPs) and update its quarterly stress test exercise.
  - BdP requires banks to submit, as of September 2012, quarterly reports on the amount of restructured loans.
  - BdP plans a thematic review of banks’ operational capacity in loan restructurings to ensure timely engagement with troubled debtors.

### Ongoing restructuring of state-aid recipients and implications for credit supply
- Asset disposals:
  - State aid recipients have already shed a significant proportion of assets since onset of crisis; further reductions foreseen in current FCPs.
- Policy concern:
  - Importance of ensuring any future downsizing remains in line with macro-financial assumptions embedded in FCPs and does not unduly constrain domestic credit supply to viable companies in the tradable sector or trigger material erosion of banks’ capital buffers and profitability.

### Government-sponsored initiatives for SMEs and capital access
- Guaranteed credit lines:
  - About €12 billion in government-guaranteed credit lines have been disbursed to SMEs through the PME Invest and Crescimiento initiatives.
  - Government reviewing these schemes to ensure effective targeting to viable and productive companies.
  - External audit of the National Guarantee System (NGS) conducted; preliminary policy recommendations identified to enhance pricing mechanisms, investment selection, NGS risk management capabilities, and governance.
  - Specific modalities to tie government-sponsored support to successful completion of corporate restructuring processes are being considered.
  - Authorities establishing a new quarterly monitoring framework including key balance sheet indicators of firms benefiting from credit lines.
- Measures to improve SME access to capital markets:
  - Government exploring measures to align tax treatment of commercial paper to other debt instruments and promote securitization through pooled SME issuances.
  - Detailed proposals by relevant entities expected by end-May; first draft of necessary amendments governing the commercial paper market to be prepared by end-June (subject to review of potential tax implications).
  - Authorities considering a €220 million venture capital line.
- Rationalization of initiatives:
  - Government assessing possible modalities to centralize resources and rationalize initiatives, focusing on few targeted and successful ones, aiming to minimize fiscal burden and risks for the state.

### Credit information, registries, and data-sharing improvements
- Central Credit Registry (CCR) enhancements:
  - BdP enhancing data coverage of the CCR to include additional financial products and supplementary classifications (e.g., guaranteed and restructured loans).
  - Subject to authorization of the Portuguese Data Protection Authority, financial institutions would be able to access historical information on potential new clients.
- Access to other data sources:
  - BdP assessing options to allow access to the Central Balance Sheet Database (CBSD).
- Expected benefits:
  - Initiatives expected to support BdP supervisory activities, reduce information asymmetries (especially for SMEs), and help diversify funding availability from banks and other investors.

*Source: IMF staff report excerpts provided in the content unit.*

### 34. Staff encouraged the authorities to closely monitor the performance of the new debt

### _cr13160 - 34. Staff encouraged the authorities to closely monitor the performance of the new debt

### Monitoring of new debt restructuring tools
- Authorities to launch a survey of key stakeholders, to be completed by July 2013, on the usefulness and appropriateness of the new corporate debt restructuring tool.
- BdP will continue to conduct quarterly assessments of the household debt restructuring regimes.
- The Ministry of Economy, in consultation with the BdP, will monitor, on a quarterly basis, selected financial and debt restructuring indicators to assess progress in the various debt restructuring processes.
- A first monitoring report will be issued by end-June 2013.

### Recent structural developments (Boosting competitiveness and growth)
- Regulatory framework:
  - Government submitted to Parliament a draft framework law governing regulatory agencies to strengthen independence and financial, administrative and management autonomy.
  - Ongoing service sector reforms in line with EU directives to increase competition in nontradable sectors.
- Ports and administrative costs:
  - A second ten-percent cut in port user administrative fees was introduced in January.
  - Adoption of a new Ports Work Law aimed at lowering wage costs and making labor use more flexible; authorities engaging with concessionaires to transmit lower labor costs to end-users (MEFP ¶29).
- Administrative burdens and licensing: ongoing cuts to reduce companies' operating costs.
- Labor market reform delays:
  - Delays in the next step of the planned severance pay reform due to political and social pressure.
  - Authorities submitted to Parliament a law that further reduces severance payments to 12 days of salary per year of service for all tenures.16

### Judicial and enforcement reforms
- Pace of resolution of backlogged enforcement cases has increased.
- Two major legislative initiatives:
  - Code of Civil Procedure to speed up court procedures (scheduled to enter into force in the fall of 2013).
  - Bill for a new judicial roadmap to streamline court structure (scheduled to enter into force in early 2014).
- Preparatory steps for implementation of both bills have started.
- Enforcement agents and supervision:
  - Authorities will refine and strengthen the enforcement agents’ fee system and the framework for supervision and monitoring (CACAJ).
  - Revised fee structure and a strengthened independent entity for monitoring and supervision are scheduled to be adopted by end-June 2013 (MEFP ¶34).

### Policy discussions — key areas and measures
- Labor market:
  - Compromise: reduce severance payments to 12 days per year of service for all new permanent labor contracts.
  - For existing permanent contracts and all fixed-term contracts: 18 days per year of service for the first three years of the contract, and 12 days per year of service for subsequent years (MEFP ¶28).
  - Authorities committed to enact the reform by October 2013 (structural benchmark).
- Corporate Income Tax (CIT):
  - Preparatory work for comprehensive CIT reform to simplify tax structure, reduce compliance and administrative costs, and gradually lower the tax rate (MEFP ¶11).
  - Reform will envisage reducing policy-induced debt bias.
  - A detailed and fully quantified proposal to be developed over the next few months, leading to a draft law by end-June 2013.
  - Authorities investigating possible short-term CIT incentives consistent with fiscal targets.
- Nontradable sector and network industries:
  - Concern that consumer prices in network industries (electricity and communications) do not yet reflect depressed demand conditions.
  - Concrete steps to consider: tackle policies that limit market entry, hinder competition, and guarantee high rates of returns to incumbents.
  - Authorities noted long-term character of some contracts; more intrusive regulatory approaches and reexamination of existing contracts may be unavoidable.

### Financing and risks
- Near-term financing:
  - Ended 2012 with a stock of deposits of some €15 billion.
  - Adequate resources to meet expected financing needs for the next 12 months.
  - Further bond issuance or stepped-up net Treasury bill issuance will increase cash buffers.
- Investor base and market access:
  - January bond issue shifted investor base toward hedge funds and active fund managers rather than pension funds and large institutional investors.
  - May bond issue saw an increased proportion of real money accounts.
  - Final green light by European authorities to extend EFSF/EFSM maturities by 7 years on average will be particularly welcome.17
  - Eligibility to the ECB’s Outright Monetary Transaction (OMT) program would help improve monetary transmission and secure durable market access, though OMT is not an alternative to market financing.
- Justification for exceptional access:
  - Exceptional access under the program remains critical (Criterion 1).
  - Exceptional access continues to be justified on the basis of systemic international spillover risks given euro area fragility (Criterion 2).
  - Commitments by euro area leaders to support Portugal until full market access is regained—provided strict program implementation—give additional assurances that financing will be available to repay the Fund (Criterion 3).18
  - Implementation capacity and prospects for program success remain reasonably strong, given the solid track record to date, including a majority in Parliament (Criterion 4).
- Fund exposure and repayment capacity:
  - Fund’s exposure to Portugal rises to substantial levels, reaching 16.3 percent of GDP in 2014.
  - Debt service expected to peak in 2018, at 5.7 percent of exports of goods and services, or 2.7 percent of GDP.
- Downside risks:
  - Downside risks to attainment of program objectives are significant.
  - Fiscal front: unavoidable cuts make the PER one of the most difficult components; political and legal risks exist.
  - Financing front: renewed stress in euro area financial markets or realization of fiscal risks could delay market re-access.
  - Materialization of downside risks may require prompt corrective measures.

### Staff appraisal and recommendations
- Program implementation:
  - On track amid difficult conditions and legal challenges; fiscal adjustment advancing and external imbalances being corrected at a faster pace than expected.
  - Successful re-access to international bond market for the first time since early 2011.
  - Recent Constitutional Court ruling complicated policy making; authorities reacted quickly to address fiscal consequences.
- Macroeconomic outlook:
  - Weak business and consumer confidence, high private sector debt, and euro area headwinds weigh on growth and employment.
  - Modest economic recovery envisaged later in the year, but recession set to be deeper and unemployment to peak at a higher level than previously envisaged.
- Fiscal recalibration:
  - Markedly weaker outlook provides strong case for recalibrating the program’s fiscal targets.
  - Fiscal parameters being adjusted to balance sustainability and avoiding undue strains on the economy and employment.
- Debt trajectory and financing space:
  - Debt now set to peak at 124 percent of GDP on current policies and outlook.
  - Risk of a higher debt peak is high due to downside risks and possible contingent liabilities.
  - Scope to deviate from the current fiscal deficit path is minimal without raising debt sustainability concerns.
- Policy priorities and recommendations:
  - Sustain fiscal consolidation; early implementation of measures identified in the PER is critical.
  - Prompt implementation of required legislation to advance expenditure reforms.
  - Any modifications to PER require offsetting permanent measures of equivalent yield and quality.
  - Address key public expenditure weaknesses, including public service size, public sector wages and pensions.
  - Ensure all government entities respect the new expenditure commitment control system, particularly ahead of local elections.
  - Further public financial management reforms: tighter control over PPPs, strengthen medium-term fiscal framework for all general government entities.
  - Continue strengthening revenue administration with emphasis on reducing compliance risks.
  - Reform state-owned enterprises to limit fiscal risks.
  - Maintain vigilance to secure financial stability as deleveraging advances:
    - Improve efficiency of government initiatives to assist viable companies in funding.
    - Promote rapid restructuring of troubled loans by banks to support private sector balance sheet adjustment while protecting viable firms.
  - Address nominal rigidities forcefully to foster competitiveness:
    - Combine measures to raise productivity and reduce input costs, including wages for the tradable sector.
    - Explore alternative policy options to lower production costs and compress excessive profit margins in the nontradable sector.
    - Ensure the comprehensive reform of the corporate income tax is done in a fiscally neutral manner.

*Source: _cr13160 - 34. Staff encouraged the authorities to closely monitor the performance of the new debt*

### 52. Program success also hinges on continued external support and effective crisis

### 52. Program success also hinges on continued external support and effective crisis management policies at the euro-area level

### Program implementation and domestic reforms
- Strong implementation of the adjustment program is key for addressing Portugal’s deep-seated economic problems.
- Risks are considerable and Portugal remains vulnerable to shocks stemming from other euro area countries or from policy failures at the regional level.
- Domestic efforts therefore need to be complemented by institutional reforms and strong crisis management policies at the euro-area level to support Portugal’s path toward a durable return to market financing.

### External support and crisis-management tools
- The commitment by European leaders to support Portugal until market access is restored, as long as the program is on track, continues to provide a valuable financing assurance.
- The envisaged lengthening of the maturities of EFSF and EFSM loans to smooth the debt redemption profile will also support the government's return to full market financing during 2013.
- Recourse to the ECB’s Outright Monetary Transactions would help address credit market segmentation and restore an appropriate monetary policy transmission.

### Staff recommendation
- Staff recommends completion of the seventh review and the modifications of end-June PCs.

*Source: PORTUGAL — INTERNATIONAL MONETARY FUND*

### Box 1. Reforms to the Legal Toolkit for Corporate Debt Restructuring

### Box 1. Reforms to the Legal Toolkit for Corporate Debt Restructuring

### Overview
- The authorities have undertaken important steps to enhance the legal toolkit for corporate debt restructuring.

### Out of Court Guidelines
- In September 2011, the authorities adopted Guidelines on the Extrajudicial Recovery of Debtors to promote the use of out of court debt restructuring.
- These voluntary Guidelines intend to facilitate corporate debtors to restructure their debts in good faith out of court by providing guidance on how to achieve consensual debt restructuring.
- The Guidelines are in line with international best practices, such as the INSOL Global Principles for Multi-Creditor Work-outs.
- Since only recently adopted, it needs to be seen how widely such Guidelines are being used.

### SIREVE (SME Formal Out‑of‑Court Regime)
- Since September 2012, a formal out of court regime to facilitate debt restructuring tailored to SMEs through mediation by IAPMEI, the so-called SIREVE, has been in force.
- This regime is formalized in a law and for instance involves a standstill for participating creditors.
- The tax and social security authorities are required to participate in the negotiations.
- There is no cram down (on dissenting creditors by a court) and only participating creditors are bound by an agreement.
- Given that this regime has only been recently adopted, there are many pending SIREVE cases but only a few cases have so far emerged successfully.

### Insolvency Code and PER (Pre-Arranged Restructuring)
- The Insolvency Code is a modern unitary law that provides for rehabilitation of viable firms and liquidation of non-viable firms.
- The Code was amended effective May 2012 (the “May 2012 Amendment”) to, in particular, introduce/strengthen:
  - Fast track in-court approval. The May 2012 Amendment provides, in line with international best practice, for a rapid restructuring within short deadlines of up to three months, including a “fast track” court approval process by which pre-arranged restructuring plans can be approved rapidly by the court (so called PER) if they are supported by the requisite majority of creditors (cram down). Since its introduction, there have been many successful restructurings under the PER.
  - Priority financing. The Code provides for priority for new financing, if envisaged under the restructuring plan in an insolvency administrator supervised process. The May 2012 Amendment further strengthened the priority of new financing by protecting it from certain legal challenges.

### Other initiatives
- The authorities also addressed other disincentives for debt restructuring.
- For instance, in September 2011, the authorities unified the public creditors’ legal framework for debt restructuring by enabling the tax authorities to participate in debt restructuring at the same terms as the social security authorities (i.e., agreeing to up to 150 installments).

*Source: IMF staff summary of Box 1. Reforms to the Legal Toolkit for Corporate Debt Restructuring.*

### Appendix I. Public Expenditure Review Measures

### Appendix I. Public Expenditure Review Measures

### Summary of measures and fiscal impact (in millions of euros, unless specified otherwise)
- Headline columns: 2013 2014 1/Total
- Wage bill: 777 1,395 2,172
- Special mobility (requalification): 481 191 672
- Convergence public-private working rules: 176 365 541
- Mutual agreements (voluntary separation): 0 252 252
- Single wage and supplement scale: 0 44 44 45
- Termination of fixed-term contracts: 74 214 288
- Attrition: 479 0 479
- Pensions: 0 1,378 1,378
- Increase in retirement age: 0 27 0270
- Equality between public sector and private sector schemes: 0 67 2672
- Sustainability contribution: 0 43 6436
- Intermediate consumption: 334 520 854
- Savings from the line ministries: 284 470 754
- Other: 50 50 100
- Other: 300 -4 296
- Total: 1,411 3,289 4,700

### Aggregate indicators
- in percent of 2013 GD: P0.92.02.9

### Memorandum item
- Upfront costs (severance payments) 2/0 507

### Notes
- 1/ Incremental with respect to 2013.
- 2/ This is a one-off cost.
- (in millions of euros, unless specified otherwise)

*Public Expenditure Review Measures, PORTUGAL, INTERNATIONAL MONETARY FUND*

### Appendix IV. Structural Reforms and External

### Appendix IV. Structural Reforms and External Competitiveness: Where Do Things Stand?

### Background
- Prior to the global financial crisis in 2008 Portugal exhibited a significant and growing external competitiveness gap. Since 2000, the external current account deficit remained at unsustainably high levels of around 10 percent of GDP.
- The large and persistent external imbalance coupled with internal activity running below capacity level suggests currency overvaluation had become fairly significant and entrenched.
- Structural reforms, together with fiscal adjustment and financial sector measures, are required to make Portugal’s tradable sectors significantly more attractive for investment and production. Conceptually, structural reforms promote external competitiveness through two channels:
  - Containing or reducing the cost of factor inputs in the tradable sectors (reducing unit costs via lower input prices, increasing tradable sector profit mark-ups).
  - Increasing the productivity of factor inputs across all sectors (reducing unit costs by raising output per unit of factor inputs).

### Key Structural Reforms under the Program
A. Labor Market Reforms
- Portugal had one of the highest levels of employment protection for workers with permanent labor contracts in Europe circa 2011, producing a highly segmented labor market with a high share of fixed-term workers.
- Measures enacted or planned:
  - Substantial reduction in severance pay; a further reduction to be legislated later in the year, bringing severance compensation closer to the EU average.
  - New definitions of individual dismissals to give more discretion to firms in separations.
  - Labor Code revisions to facilitate working time flexibility: reduction in the number of holidays and annual leave days, and reduction in required overtime payments.
  - Reforms to wage setting and bargaining: clear criteria for collective agreement extension; agreements by associations with less than 50 percent of total work force will not be extended to all firms unless they specifically exclude micro and small enterprises. Multi-year tripartite agreement on minimum wage increases were halted; minimum wage frozen for the duration of program.
  - Unemployment benefit reform: delinked benefit from worker’s age, shortened duration, introduced a declining profile and a cap.
  - Active labor market policies reoriented toward training and reinsertion; education reform emphasizing vocational training.

B. Product Market Reforms
- Major changes to legal framework to enhance competition and contain excessive mark-ups and rents in non-tradable sectors:
  - New Competition Law harmonized with EU law; strengthened powers of the Competition Authority (PCA); separation of criminal from administrative procedures.
  - New specialized Competition Court established.
  - Framework Law for Regulators submitted to parliament to strengthen regulators’ independence and autonomy.
  - Privatization program aimed at raising efficiency and reducing state involvement; certain special rights of the state ("golden shares") abolished.
- Sector-specific measures:
  - Telecommunications: reduction in high mobile termination rates; successful spectrum auction broadened access; transposition of the EU Regulatory Framework for Electronic Communications.
  - Electricity: near completion of transposition of the EU's Third Energy Package; strategy to re-negotiate legacy contracts has had limited results in some areas; rent-reducing measures to alleviate pressures on end-user prices.
  - Services: progress toward full compliance with the EU service directive and reforms of regulated professions to remove unjustified restrictions.
  - Transportation: landmark Port Work reform enacted; SOEs in transport being reformed for efficiency gains.

C. Other Reforms of Business Environment
- Judicial system reforms to address backlog of court cases: expedite resolution, establish cost-effective enforcement, modify Code of Civil Procedure, plans to reduce court districts and close underutilized courts, strengthen arbitration and mediation.
- Urban rental legislation revisions to liberalize the rental market: phases out old system over a 5-year transitory period for leases signed before 1990; increases contract flexibility, rent updating, incentives for renovation, and a rapid extrajudicial eviction procedure.
- Public administration reform underway to increase productivity and quality of public services (improving training, raising qualification levels, better human resource management).
- Initiatives to reduce excessive licensing procedures, regulations, and other administrative burdens to lift explicit and implicit barriers to firm establishment, operation, and expansion.

### Outcomes — Indicators of External Competitiveness
A. Recent Mark-Up Developments
- During 2010-12, mark-ups in both tradable and non-tradable sectors declined, reflecting the deep recession.
- Encouraging sign: mark-ups in non-tradable sectors shrunk much faster, narrowing the gap between the two sectors’ mark-ups to the level observed in the mid-1990s.
- Drivers behind downward pressures on tradable sector profitability:
  - Falling unit labor costs supported tradable sector mark-ups, but only moderately, reflecting slow labor productivity growth combined with limited nominal wage declines.
  - Rising costs of capital compressed mark-ups significantly, reflecting increasing corporate credit cost.
  - Rising intermediate input costs reduced tradable sector mark-ups (mainly higher import costs, particularly energy). Conversely, falling unit costs of intermediate inputs from non-tradable sectors helped boost tradable sector mark-ups.

B. Effective Exchange Rates
- The nominal effective exchange rate (NEER) decreased by around 10 percent from its peak in late 2009, broadly mirroring euro depreciation.
- The CPI based real effective exchange rate (REER) has been broadly unchanged over the program period, mainly reflecting higher tax-policy induced inflation relative to trading partners.
- The GDP deflator and unit labor cost (ULC) based REERs showed a relatively larger decline (around 10 percent) than their CPI based counterparts since late 2009.
- Economy-wide unit labor cost (ULC) declined by 3½ percent in 2012 (to about 5½ percent below its 2009 peak). Reduction in private sector ULC was more modest, helping reverse only around a third (7 percentage points) of the 25 percent increase in ULC since 2000. The ULC gain has been driven mostly by productivity increases through job shedding rather than reductions in nominal wages.

C. Sectoral Developments
- Wages across sectors generally mirror output evolution:
  - Tradable sectors (industry and manufacturing) saw significant increases in productivity and in compensation.
  - Public administration compensation declined reflecting program wage cuts.
  - In other sectors, despite sharp output falls, compensation declines were limited.
- Breakdown of CPI into tradable and non-tradable components indicates limited adjustment in the relative price of non-tradables vis-à-vis trading partners.
- Prices in network industries (electricity and communications) have shown muted moderation despite the recession, partly reflecting policy decisions (e.g., VAT increase in mid-2011, binding purchasing contracts in electricity sector). Some effects are prevalent in other periphery countries too, though prices moderated more in those cases.

D. Export Indicators
- External current account deficit narrowed rapidly from some 10 percent of GDP in 2010 to less than 2 percent of GDP in 2012.
- Exports of goods and services represented around 60 percent of the external adjustment in 2009-12.
- For the first time since World War II, the trade balance swung into a surplus on a 12-month cumulative basis.
- Import compression has inflated recent export improvements to some extent:
  - Since 2011, fuel exports have increased by around some €2 billion reflecting diversion of oil products previously consumed domestically abroad.
- Export market shares: despite robust exports growth and diversification into non-European markets, the overall trend continues to be one of gradual decline for goods and broad stability in services.

### Assessment and Policy-Relevant Conclusions
- Portugal’s external competitiveness was eroded over a prolonged period, primarily due to weak productivity growth—particularly for capital and intermediate inputs—culminating in the sudden stop in capital inflows in early 2011.
- Structural reforms under the program need to make tradable sectors significantly more attractive for investment and production to restore competitiveness.
- Evidence of progress:
  - Some containment of unit labor cost, more so in tradable than in non-tradable sectors; part of this may reflect labor market reforms but also the large increase in unemployment.
  - Earlier pressures on tradable sector mark-ups from rising unit costs of intermediate inputs have reversed during 2010-12, likely reflecting a combination of structural reforms and slack in non-tradable sectors.
- Major obstacle: rising unit costs of capital have more than offset progress on labor and intermediate inputs, reflecting fragmentation of credit costs across the euro area.
- Other indicators (effective exchange rates, price indicators, export performance) broadly support the assessment of only limited progress on restoring external competitiveness.
- Caveats and time horizon considerations:
  - Some structural reforms—particularly those increasing product market competition—may need considerable time to bear fruit.
  - Reforms in public administration and courts still need full implementation.
  - Current depressed domestic demand and high credit costs may need to recede before structural reforms yield expected productivity improvements of labor, capital, and intermediate inputs.

*Prepared by Albert Jaeger, Yanliang Miao, and Stephane Roudet.*

### Appendix V. Portugal: Letter of Intent

### Appendix V. Portugal: Letter of Intent

### Overview and commitments
- Letter dated Lisbon, June 12, 2013, addressed to Ms. Christine Lagarde, Managing Director, IMF.
- Request for completion of the seventh review under the Extended Arrangement and the eighth purchase under the arrangement in the amount of SDR 574 million.
- Eight review mission by the IMF, the European Commission, and the ECB staff expected to take place by mid-July 2013.
- Attachments: 1. Memorandum of Economic and Financial Policies (MEFP); 2. Technical Memorandum of Understanding (TMU).

### Macro-financial adjustment: progress and priorities
- Program implementation has strengthened market prospects and preserved financial stability.
- Key recent achievements:
  - End-December and end-March deficit and debt performance criteria were met.
  - Two end-December 2012 structural benchmarks on the regional and local finance laws and implementation of the Large Taxpayer Unit completed on time.
  - Amendments to the law governing banks’ access to public capital submitted to Parliament as structural benchmark for end-January 2013.
- Identified measures to close the fiscal gap created by an unfavorable Constitutional Court ruling on provisions in the 2013 budget.
- Policy focus: strengthen sustainability, effectiveness, and social equity of expenditure programs; strengthen budget controls; streamline public administration; curb tax evasion.

### Activity outlook
- Recent outturns:
  - Economy contracted by 3¼ percent in the previous year.
  - Unemployment rose to 17¾ percent in Q1 2013.
- Updated outlook:
  - Output expected to contract by 2¼ percent in 2013 (previously 1 percent at sixth review).
  - Recovery expected to start in Q4 2013, one quarter later than previously expected.
  - Headline inflation expected to average around ¾ percent in 2013.
  - Unemployment expected to peak at 18½ percent in 2014.

### External adjustment
- Current account and external debt:
  - Current and capital account turned positive in 2012.
  - Current account deficit narrowed to below 2 percent of GDP in 2012 from 6.5 percent of GDP in 2011 (implying a total adjustment since 2009 of some 9 percentage points of GDP).
  - Current account expected to reach a balanced position in 2013.
- Risks: slowdown of main trading partners could pose additional challenges; commitment to structural reforms to bolster competitiveness and reduce external indebtedness.

### Fiscal policy — 2012 outturns and 2013–15 path
- 2012 fiscal outturns:
  - Government deficit for program purposes reached 4.7 percent of GDP in 2012 — 6.4 percent of GDP excluding the one-off ANA concession transaction and including increase in CGD share capital (as capital expenditure), reclassified operations of Sagestamo, and valuation changes of BPN SPVs.
  - This compares with a deficit target of 5 percent of GDP.
  - Result consistent with a structural primary adjustment of some 2.8 percentage points of GDP.
  - Broad-based tax revenue shortfalls in 2012 were in the order of ½ percent of GDP.
  - Domestic arrears declined by €700 million in the fourth quarter, but increased slightly in February; stock of domestic arrears declined by €1 billion between September 2012 and February 2013.
- Revised 2013–15 fiscal path:
  - Deterioration in macro outlook and negative carry-over from 2012 opened a fiscal gap of over 1 percent of GDP in 2013.
  - Recalibrated fiscal targets: contain deficit to 5½ percent of GDP in 2013 and 4 percent of GDP in 2014.
  - Estimate that permanent measures of about 2.9 percent of 2013 GDP will be necessary to achieve revised objectives, with the equivalent of 0.9 percent of GDP frontloaded to the second half of 2013.
  - Commitment to complete consolidation under the Excessive Deficit Procedure by 2015 with a targeted deficit of 2½ percent of GDP.

### Supplementary budget for 2013 and Constitutional Court ruling
- Constitutional Court ruling (April 5) declared unconstitutional:
  - Cuts in the 14th monthly payment to public wage earners and pensioners.
  - A new contribution on illness and unemployment benefits.
- Fiscal gap from Court ruling: about €1.3 billion (0.8 percent of GDP).
- Measures identified to cover the gap and meet revised 2013 objective include:
  - Expenditure compression in line ministries.
  - Reprogramming of EU structural funds.
  - A minimum threshold for applying the contribution on illness and unemployment benefits.
- These measures were included in a supplementary budget submitted to Parliament at end-May (prior action).
- Some savings are temporary; commitment to replace them with permanent savings from the Public Expenditure Review (PER) starting in 2014. Some PER measures will be frontloaded.

### Public Expenditure Review (PER) and medium-term fiscal framework
- PER completed and used to underpin fiscal adjustment for 2013–17.
- Council of Ministers adopted and published a medium-term (2013–17) fiscal framework (DEO).
- Fully-specified measures to meet revised 2014 deficit target approved by Council of Ministers and made public (prior action).
- Deadline: finalize all key legislative changes required to implement the PER by end of the legislative session (July 15, 2013), via Council approval or submission to Parliament.

### Expenditure reforms: composition and major pillars
- Total package of measures for 2014 will amount to €4.7 billion (net of reduced income tax and social contribution collections).
- Three main pillars:
  - Well-targeted wage bill reform (at least one-third of savings, €2.2 billion):
    - Objectives: reduce size of public sector workforce, tilt composition to high-skilled civil servants, converge public sector work rules toward private sector regimes, increase beneficiaries’ contributions to public sector health subsystem, simplify remuneration via single wage scale and streamlined supplements, reduce fringe benefits.
    - Workforce reduction facilitated by increasing working hours to 40-hours per week; achieved via lower replacement of retirees, voluntary separations, enhanced use of redesigned mobility pool.
    - Implementation via legislative and regulatory amendments: submit new draft public administration labor law by end of legislative session (July 15) (structural benchmark); submit draft law on redesigned mobility pool by end-June (structural benchmark); single wage scale and wage supplement reforms effective by January 1, 2014 through specific law.
  - Comprehensive pension reform:
    - Principles: preserve minimum socially-acceptable income levels; reduce differences between civil servants’ regime and general social security regime.
    - Main elements:
      - Effective increase by one-year in statutory retirement age to 66 years (implemented by adjusting the demographic sustainability factor).
      - Align rules and benefits of public sector pension funds (CGA) to general pension regime by changing one replacement rate parameter from about 90 to about 80 percent for all applicable beneficiaries.
    - Legislative proposals to be submitted to Parliament by end of legislative session (July 15) (both structural benchmarks).
    - Contingent option: a sustainability contribution on pensions that lowers pension replacement rates, to be used only if strictly necessary and potentially replaced by equivalent measures.
  - Sector-specific savings:
    - Targeted dismissals of personnel and intermediate consumption cuts.
    - Additional cutbacks in SOE and PPP expenditure through negotiation and operational restructuring.
    - Education: rationalization of school network and convergence of class size indicators toward peer levels.
    - Health: further reforms in hospitals network.

- Consultation clause: some measures may be replaced by others of equivalent value and quality after consultations with social and political partners and EC/ECB/IMF staff, in time for finalizing legislative changes by July 15, 2013.

### Legal safeguards against Constitutional Court risks
- Steps to mitigate legal risks:
  - Design expenditure reforms with public/private sector and intergenerational equity in mind and address sustainability of social security systems.
  - Justify legislation on compliance with fiscal sustainability rules in the recently-ratified European Fiscal Compact, which ranks higher than ordinary legislation.
  - Rely on general laws rather than one-year budget laws to allow prior constitutional review where appropriate.

### Financial sector stability and support for deleveraging
- Banking system capital and liquidity conditions significantly strengthened under Banco de Portugal supervision.
- Policy priorities:
  - Promote adequate funding conditions for productive and innovative economic segments.
  - Ensure prompt restructuring of viable firms in financial difficulties.
  - Explore mechanism to securitize high-quality mortgage credit with a supranational guarantee.
  - Promote initiatives to support viable SMEs: develop access to financial markets, retarget existing government-sponsored initiatives, facilitate information sharing.

### Structural reforms and competitiveness
- Continued structural agenda to bolster price and cost competitiveness and support durable recovery.
- Measures underway to:
  - Improve labor market dynamism and efficiency.
  - Reduce costs for exporters.
  - Address excessive rents in the energy sector and port costs.
  - Improve the business environment.

### Debt outlook
- Under revised fiscal path, debt is set to peak at close to 124 percent of GDP in 2014.
- Projection contingent on implementation of two planned measures:
  - Partial reallocation of the Social Security portfolio from foreign assets to government securities.
  - Transfer of CGD shares to Parpública.

*Appendix V. Portugal: Letter of Intent, Lisbon, June 12, 2013.*

### 11. CIT Reform. We have launched a far-reaching reform of the Portuguese corporate income

### 11. CIT Reform

### Corporate Income Tax (CIT) reform objectives and timeline
- Goal: boost investment and growth by simplifying the CIT system through:
  - redefinition of the tax base,
  - gradual lowering of the rate,
  - reduction of multiple surcharges,
  - rationalization of the incentive schemes.
- Additional aims: enhance legal stability, lower compliance costs, reduce litigation, improve international competitiveness, strengthen territorial approach (including adoption of a universal participation exemption regime), and reduce policy-induced debt bias.
- Process and timetable:
  - Work on a detailed and fully quantified proposal over the next months in consultation with EC/ECB/IMF staff.
  - Prepare a first draft law by end-June 2013 for public discussion ahead of submission to Parliament.
- Temporary investment stimulus (2013):
  - Grant a CIT credit limited to 20 percent of investment expenses or €1 million (corresponding to a maximum eligible investment of €5 million).
  - Applicability: eligible investments made between June 1, 2013 and December 31, 2013.

### Containing Fiscal Risks — Public Financial Management
- Legislative and procedural reforms:
  - Parliament approved legislation transposing the EU economic and governance fiscal framework into the Budgetary Framework Law (BFL).
  - Further changes expected by year end to streamline budgetary procedures.
- Transparency and arrears:
  - Published a comprehensive tax expenditure report to accompany the budget proposal.
  - Commitment to reduce the stock of outstanding arrears (€ 3.1 billion in December 2012) and halt its accumulation.
  - Second health-sector settlement program in the value of € 432 million to settle debt overdue above 60 days.
  - Enforcement: working with authorities to sanction public officials not complying with the commitment law.

### Revenue Administration
- Anti-evasion and compliance measures:
  - Full functionality of the new Large Taxpayer Unit.
  - Successful implementation of the VAT invoicing reform.
  - Establish a Risk Management Unit and phase in a modern compliance risk model under the aegis of the new Compliance Council.
- PIT priorities:
  - Strengthen PIT compliance management given high reliance of the 2013 fiscal targets on this tax.
  - Accelerate pilots on High Net Wealth Individuals and the Self-employed Professionals.
  - Strengthen control of monthly PIT withholding information.
- Property tax base:
  - Completed property revaluation process to bring tax base closer to market values.
- Tax litigation:
  - Task force of judges increasing pace on high-value tax cases; State registered a positive win/loss balance in merit-based decisions in 2012.

### Public Administration
- Reduction in public employment:
  - Reduced number of public employees by 4.6 percent in 2012, above the 2 percent target.
- New framework measures:
  - Increased flexibility of working hours, geographical mobility, and regulation of mutual agreement on contract termination.
- Foundations:
  - Steps taken to streamline the sector and reduce budgetary support based on a survey.

### State-Owned Enterprises (SOEs)
- Results and objectives:
  - Cost-reduction and voluntary redundancy programs returned SOE sector to operating balance ahead of schedule.
  - Continue formal cost-cutting objectives for firms with operating deficits; others to improve operating balances to reduce debt burdens and financial costs.
  - Treasury support has remained within budgeted transfers.

### Privatization
- Key transactions and plans:
  - Sale of airport operator ANA expected to complete by end-July (meeting revenue objectives for full privatization program).
  - Sale of airline TAP did not complete; process to be relaunched this year.
  - Launch privatization process for rail cargo firm CP Carga in the second half of the year for completion by year end.
  - Launch privatization process for postal company CTT in the second quarter; receive binding offers by end-2013.
  - Strategic plan for water and waste sector prepared; binding offers for sale of waste management business sought by end of the year; opening water concessions to private capital and management is in course and will take longer.

### Public-Private Partnerships (PPPs)
- Institutional and renegotiation actions:
  - Staffing of newly-created PPP unit to reach full operational status.
  - Enhancing fiscal transparency and reporting in PPPs.
  - Appointed additional renegotiation commissions to extend efforts to other road concessions; meetings expected to start until the end of 2Q2013.
  - Preliminary agreements with majority of private partners set terms for reformed concession contracts and expected public savings.
  - Revised savings goal of €300 million in 2013 from renegotiations.
  - Ongoing revision of regulatory framework to achieve road sector sustainability by reviewing downwards service levels and capturing additional savings.
  - PPP unit supporting negotiation efforts in Madeira and re-appraisal of the Lisboa Oriental PPP hospital.

### Regional and Local Governments
- Fiscal framework and coordination:
  - Draft Regional and Local Finance Laws submitted to Parliament last-December 2012 to apply BFL principles to sub-national governments.
  - Establishment of a coordination council between central and sub-national governments to enhance information exchange for budgetary planning.
- Arrears support and Madeira:
  - Implementing €1 billion credit line to support local governments’ arrears settlement.
  - Madeira: progress in budget consolidation and PFM reforms justified release of disbursements under its adjustment program; vigilance to budget risks remains.

### Safeguarding Financial Stability — Capital Augmentation
- Bank capitalization and resilience:
  - Following capital augmentation exercise, all banks met the 10 percent Core Tier 1 target set under the program.
  - On-site inspections focused on construction and commercial real estate assets and recent stress tests confirmed continued resilience, including under adverse conditions.
  - Commitment to provide further support if new capital needs arise; encourage private solutions, while Bank Solvency Support Facility (BSSF) resources remain available for viable banks if needed.
  - BSSF resources to be solely utilized to provide public support, if needed, to the banking system.
  - State aid subject to strict conditionality in line with EU rules to avoid subsidizing private shareholders and migration of private liabilities to public balance sheet, while ensuring adequate lending to the real economy, with special focus on SMEs in tradable goods and services.

### Funding and Liquidity Conditions
- ECB measures and market access:
  - Non-standard ECB measures eased liquidity pressures and improved market conditions, supporting banks’ gradual return to international bond markets.
  - Better funding conditions, stable customer deposits, and capital exercise resources, plus orderly deleveraging, enabled reduction in reliance on Eurosystem liquidity, including partial early repayment of the 3-year LTROs.
  - Exceptional liquidity support remains pivotal to absorb funding constraints and mitigate excessive credit contraction risk.
  - Strengthened collateral buffers provide protection against adverse shocks.
  - BdP created a platform for interbank unsecured lending and launched in early May a new platform for secured transactions.

### Credit Conditions and Orderly Deleveraging
- Ongoing credit environment challenges:
  - Credit situation remains difficult despite improved market sentiment and liquidity.
  - Sustained decline in bank credit broadly in line with demand and necessary private sector deleveraging.
  - Lending rates on new business remain elevated across all segments.
  - Large corporations increasing access to capital markets; smaller firms cannot currently access these alternatives.
- Policy guidance:
  - Banks’ funding and capital plans should ensure orderly deleveraging aligned with program macroeconomic framework and objectives.
  - Presented initial proposal for securitizing banks’ high quality mortgage credit to support objective and reinforce long-term bank viability.

### Initiatives to Support Funding to SMEs
- Review of Government-Guaranteed Credit Lines:
  - Continue improving performance of existing guarantee schemes in line with international best practice.
  - External audit of the National Guarantee System (NGS) conducted; preliminary recommendations to enhance pricing, investment selection, risk management, and governance.
  - Prepare by mid-June a detailed implementation plan of key report recommendations including a timetable.
  - Explore guaranteed credit modalities conditional on successful corporate restructuring; initial proposal expected by early September.
  - Establish a new quarterly monitoring framework with key balance sheet indicators of firms benefiting from guaranteed credit lines; first report by end-June.
- Development of SMEs Commercial Paper:
  - Exploring regulatory and taxation changes to expand commercial paper market to a wider investor base.
  - Detailed proposals requested last April and expected by end-May.
  - First draft of necessary rule amendments to be prepared by end-June and reviewed for tax implications.
- Broader approach:
  - New initiatives to focus on streamlining and improving efficiency of existing schemes without creating additional burden or risks to public finance.
  - Government conducting stock-taking exercise to streamline and centralize management of EU structural funds.

### Central Credit Registry (CCR)
- Enhancements and timeline:
  - BdP to enhance data coverage and detail of CCR to include additional financial products and supplementary classifications.
  - Implement possibility for financial institutions to access historical information on potential new clients, subject to Portuguese Data Protection Authority (CNPD) authorization.
  - BdP assessing options to reduce information asymmetry for smaller companies, considering other data sources like Central Balance Sheet Database (CBSD).
  - Enhancements and a first progress report on the two last issues expected to be completed by end-October 2013.

### Private Sector Debt Restructuring
- Monitoring and reporting:
  - Prepare quarterly reports on application of new corporate restructuring tools, including viability indicators for companies in these processes by end-June 2013.
  - Continue assessing effectiveness of new household debt restructuring regimes.
  - Conduct survey of all insolvency stakeholders on appropriateness of existing debt restructuring tools and possible gaps by end-July 2013.

### Bank Supervision
- Operational and restructuring capacity:
  - Banks progressing on stress testing methodologies and impairment projections per Special On-site Inspections Program recommendations.
  - BdP to launch thematic review of banks’ operational capacity in loan restructuring and asset recovery to be completed by end-October 2013.
  - Aim: ensure banks can support private sector balance sheet adjustment by timely engagement with troubled debtors.

### Bank Recapitalization and Resolution Frameworks
- Legal and supervisory measures:
  - Submitted to Parliament amendments to law on banks’ access to public capital allowing state control over recapitalized institutions under strict circumstances and mandatory recapitalizations.
  - Reviewing recovery plans of largest banks; expect recovery plans from all other banks by end-November 2013.
  - Institutions with mandatory resolution plans to submit required data per supervisory notice of December 2012 by end-July 2013.
  - Committed to swiftly transpose new EU Directive on bank recovery and resolution once adopted.

### BPN SPVs
- Management and disposal:
  - Implementing strategy for managing distressed assets from Banco Português de Negócios (BPN).
  - Competitive bidding to select third-party manager for credits held by Parvalorem launched in January; on track to complete by mid-2013.
  - Ensure timely disposal of subsidiaries and assets in other two state-owned SPVs.
  - CGD’s state guaranteed claim to be gradually settled in cash per schedule agreed with EC, ECB, and IMF staff.
  - Any net recoveries realized on assets to be applied towards settlement of CGD’s claim.

### Boosting Employment, Competitiveness, and Growth — Labor Market Institutions
- Reforms undertaken and planned:
  - Adopted revised labor code, reformed unemployment benefits, and reformed wage-setting mechanism.
  - New reform of severance pay under consideration (structural benchmark):
    - Reduce severance payments to 12 days per year of service for all new permanent labor contracts.
    - For existing permanent contracts and all fixed-term contracts: reduce severance to 18 days per year of service for the first three years, and to 12 days per year of service for subsequent years.
    - Cap of 12 months of pay remains for all contracts; acquired rights protected.
    - Relevant law to become effective on October 1, 2013.

### Ports
- Measures to reduce exporter costs and improve efficiency:
  - Reduced fees on port use (TUP-Carga) by 20 percent to date.
  - Ports Work Law revision effective February 2013 to lower wage costs and increase labor flexibility.
  - Engage with concessionaires to modify concession contracts to foster price reductions.
  - Adopt new performance-based model for future concessions and encourage entry of new operators.
  - Review of overall savings generated by these reforms to be conducted by December 2013.

*Source: IMF staff report — Portugal (chapter/section: 11. CIT Reform).*

### 30. Energy. We continue our efforts to reduce excessive policy-induced rents and improve the

### 30. Energy. We continue our efforts to reduce excessive policy-induced rents and improve the sustainability of the national electricity system.

### Energy: objectives, risks, and required actions
- Objective: reduce excessive policy-induced rents and improve the sustainability of the national electricity system.
- Status: overall cost reduction targets broadly within reach, but shortfalls are emerging with respect to a specific measure.
- Risks:
  - Shortfalls on the specific measure.
  - Downward pressures on demand for electricity.
  - These factors are likely to lead to upward revisions to tariff debt projections.
- Required actions:
  - The government will update its projections of the medium-term tariff debt path.
  - The government will identify policy options—including additional cost reduction measures—to achieve the initial objective of eliminating the tariff debt by 2020.
  - Deliverable timing: revised projections and potential corrective measures will be prepared by mid-June (structural benchmark) and discussed at the time of the 8th review.
- Structural benchmark timing (from the structural conditionality table): Update projections of the medium-term energy tariff debt path and identify policy options to eliminate the tariff debt by 2020 — June 15, 2013.

### Services: regulatory reform and professional mobility
- Aim: eliminate entry barriers and increase competition in the services sector.
- Progress:
  - Significant progress made in amending sector-specific legislations to align with the Services Directive.
  - Expectation of adoption of remaining necessary amendments (including for construction, universities and higher education courses) by Parliament by end-June 2013.
  - A new legal framework to improve the functioning of regulated professions (such as accountants, lawyers, notaries) was recently published.
  - Professional bodies' statutes are being amended for approval by Parliament, including by eliminating unjustified restrictions to activity and improving conditions for mobility of professionals in line with EU Directives.

### Licensing and administrative burden: streamlining and digitalization
- Issues: excessive licensing procedures, regulations, and administrative burdens impede firm establishment, operation, and expansion.
- Actions:
  - Carrying out an inventory of the costs of regulations in the economy, starting with the most burdensome.
  - Analysis to be presented by end-June 2013, upon which the government will devise a roadmap for regulatory simplification.
  - Step up efforts to make operational the Point of Single Contact e-government portal to allow administrative procedures online.
  - Progress toward implementing the New Late Payments Directive to promote liquidity conditions for businesses.

### Regulation: framework law for regulators and independence
- Action taken: framework law for the functioning of regulators approved ahead of schedule and submitted to Parliament.
- Purposes of the law:
  - (i) Establish a regulatory environment that protects the public interest and promotes market efficiency.
  - (ii) Guarantee independence and financial, administrative and management autonomy of the National Regulatory Authorities (NRAs), including necessary conditions to guarantee adequate human and financial resources to attract and retain sufficiently qualified staff.
  - (iii) Strengthen the role of the Competition Authority in enforcing competition rules.
- Follow-up:
  - Corresponding amendments to the bylaws of the National Regulatory Authorities will be approved by the Government in the three month following publication of the framework law.
  - Once the NRA framework law and follow-up bylaws and internal regulations are in place, regulators will pursue adoption of best international regulatory practices, including organizing international peer review exercises.

### Judicial reforms and enforcement backlog reduction
- Progress:
  - An additional 52,000 enforcement cases have been cleared, bringing down the total number by about 165,000 enforcement cases since November 2011.
- Measures:
  - Inter-agency task forces have set quarterly targets for reviewing enforcement cases to be closed.
  - Advanced reforms to improve judicial efficiency, starting preliminary steps to implement a comprehensive judicial roadmap to reduce the number of courts and streamline court structure and the new Code of Civil Procedure to speed up the judicial process.
  - Draft bill to strengthen the authority and financing structure of the oversight body for enforcement agents and insolvency administrators (CACAJ) and recruitment will be submitted to Parliament by end-June 2013.
  - The government will approve by end-June 2013 a fee structure that incentivizes speedy enforcement.

### Key quantitative program targets and outcomes (selected figures preserved exactly as in source)
- Quantitative Performance Criteria (Table 1 excerpts; values in billions of euros unless otherwise specified):
  - Floor on the consolidated General Government cash balance (cumulative):
    - Jun-13 Program: -9.0
    - Jun-13 Actual: -8.3
    - Sep-13 Program: -1.9
    - Sep-13 Actual: -1.4
    - Dec-13 Program: -6.0
    - Dec-13 Actual: -7.3
    - Dec-13 Program (other column): -8.9
  - Ceiling on the overall stock of General Government debt:
    - Jun-13 Program: 180.0
    - Jun-13 Actual: 177.2
    - Sep-13 Program: 182.2
    - Sep-13 Actual: 178.5
    - Dec-13 Program: 187.3
    - Dec-13 Actual: 188.9
    - Dec-13 Program (other column): 187.4
- Domestic arrears and movements:
  - Domestic arrears for the purpose of the program declined by close to €0.7 billion between end-September and end-December 2012, but increased in February 2013.
  - Overall, domestic arrears declined by €1 billion between September 2012 and February 2013.

### Structural conditionality (selected items and timings)
- Prior Actions:
  - Adopt medium-term fiscal framework including fully-specified measures to meet the 2014 deficit target — Met.
  - Submit to Parliament the supplementary budget that includes measures needed to meet the 2013 fiscal objective — Met.
- Structural Benchmarks (selected):
  - Submit to Parliament a new draft public administration labor law aligning public employment regime to private sector rules — July 15, 2013.
  - Submit to Parliament a draft law on the redesigned mobility pool — End-June 2013.
  - Submit to Parliament a legislative proposal that increases the statutory retirement age to 66 years — July 15, 2013.
  - Submit to Parliament a legislative proposal that aligns the rules and benefits of the public sector pension fund, CGA, to the general pension regime — July 15, 2013.
  - Enact the severance pay reform that reduces severance payments to 12 days per year for all new permanent labor contracts — October 1, 2013.
  - Update projections of the medium-term energy tariff debt path and identify policy options to eliminate the tariff debt by 2020 — June 15, 2013.
  - Revise and submit to Parliament the draft regional and local public finance law — End-Dec 2012 — Met.
  - Implement a full-fledged Large Taxpayer Office (LTO) covering audit, taxpayer services, and legal functions for all large taxpayers — End-Dec 2012 — Met.

### Technical Memorandum of Understanding (TMU): monitoring definitions and reporting
- Program exchange rates (as defined in the TMU, prevailing on May 5, 2011):
  - €1 = 1.483 U.S. dollar
  - €1 = 116.8390 Japanese yen
  - €1.09512 = 1 SDR
- Reporting and data provision timelines:
  - MoF will provide data on cash balances of the State Budget to the EC, the ECB and the IMF within three weeks after the end of the month.
  - Data on cash balances of other parts of General Government will be provided within seven weeks after the end of the month.
  - BdP will provide data on domestic and external debt redemptions and new issuance within 40 days after the closing of each month.
  - BdP will provide detailed monthly data on the financing of the General Government within seven weeks after the closing of each month.
  - Data on revenues, operating expenses, capital expenditure, remuneration of personnel, EBITDA, and number of staff for SOEs will be provided quarterly within 7 weeks after the end of each quarter. Aggregate data for SOEs within the perimeter and company-specific information for REFER, Estradas de Portugal, Metro de Lisboa, and Metro de Porto will be provided; data for Comboios de Portugal and Parpública (outside the perimeter) will also be provided.
- General Government definition (Program purposes, per Budget Framework Law No. 91/2001 of August 20, amended by Law 22/2011 of May 20):
  - Includes: Central Government (entities covered under the State Budget and other entities including ISOE or EBFs classified by INE as part of the Central Government), Regional and Local Governments (including Regional Governments of Madeira and Azores and local governments, and regional/local government-owned enterprises or institutions classified by INE as Local Government), and Social Security Funds.
  - The definition includes any new funds or entities created during the Program period that are classified by INE in the corresponding subsector under ESA95.
  - The General Government measured for Program monitoring in 2013 shall not include entities or operations re-classified into the General Government during 2013, but shall include those reclassified in 2011-12.
- Consolidated General Government cash balance (CGGCB) measurement and adjustments:
  - CGGCB defined as sum of cash balances of entities covered by the State Budget, ISOE, Regional and Local Governments, Social Security Funds, and other entities and EBFs as defined in paragraph 4.
  - Privatization receipts excluded from cash receipts.
  - Revenues from reclassification of pension funds into General Government will not be accounted as cash revenues in 2012 and beyond for CGGCB calculation.
  - In 2012-13, cash proceeds from the sale of the ANA airport concession will be accounted for as cash expenditure-reducing transactions.
  - Net acquisition of financial assets for policy purposes recorded as cash expenditures, except transactions related to the banking sector support and restructuring strategy under the Program.
  - Called guarantees (excluding those related to banking sector support and restructuring strategy) where General Government entities make cash payments on behalf of non-General Government entities will be recorded as cash expenditures.
  - 2013 quarterly floors on CGGCB will be adjusted for the cumulative amount of arrears settled in the context of the arrears clearance strategy:
    - (i) health sector arrears (up to €432 million),
    - (ii) local government arrears settled through the €1 billion credit facility created in May 2012,
    - (iii) RAM government arrears subject to concluding the agreement with the central government (up to €1.1 billion).
- Reporting frequency and inclusion rules:
  - Quarterly consolidated accounts for the General Government on a cash basis will be reported for EC/ECB/IMF monitoring 7 weeks after the reference period, starting with Q1 2012.
  - Reports published externally starting with December 2011 data.
  - SOEs will be consolidated with general government accounts starting with Q1 2012.
  - Larger municipalities (population of 100,000 voters or more) required to provide monthly reports; their cash balance included in monthly cash General Government balance.
  - Cash balance of smaller municipalities (population under 100,000 voters) excluded until necessary legal changes require monthly reports; during transitory period the MoF will provide a monthly estimate of their cash balance to the EC, ECB, and IMF.

*IMF staff report excerpts (June 12, 2013) contained in the cited document.*

### 9. Supporting Material

### 9. Supporting Material

### A. Cash and General Government Accounts Reporting
- Monthly cash-balance data on the State Government, ISOEs, Regional and Local Government and Social Security Funds:
  - Provided to the EC, the ECB and the IMF by the MoF within seven weeks after the end of each month.
  - Includes general government net acquisitions of financial assets for policy purposes, including loans and equity participations, and called guarantees where entities part of the General Government make cash payments on behalf of entities not part of the General Government.
- Quarterly data on General Government accounts:
  - Submitted by the MoF, determined by the INE in accordance with ESA 95 rules.
  - Must show main items of the transition from cash balances to General Government balances in national accounts.
  - Reconciliation accompanied by explanatory materials for any indication of potential deviation of the annual general government cash target from the annual general government accrual target determined in accordance with ESA 95 rules.

### B. Non-Accumulation of New Domestic Arrears by the General Government (Continuous Indicative Target)
- Definitions (key points preserved exactly as in source):
  - Commitments: explicit or implicit agreements to make payment(s) in exchange for goods and services or other conditions; can arise from issuance of a purchase order or signing a contract; can also be continuing in nature (e.g., salaries, utilities, and entitlement payments).
  - Liabilities: present obligations arising from past events, settlement of which is expected to result in an outflow of resources.
  - Payables/creditors: subset of liabilities; for the purposes of the program exclude provisions, accrued liabilities.
  - Arrears: subset of payables/creditors.
  - Domestic arrears (Program definition): payables/creditors (including foreigner commercial creditors) that have remained unpaid for 90 days or more beyond any specified due date (regardless of any contractual grace period). If no due date specified, arrears are payables/creditors that have remained unpaid for 90 days or more after the date of the invoice or contract.
- Reporting and monitoring:
  - Data on arrears to be provided within seven weeks after the end of each month.
  - Continuous indicative target requires total arrears at the end of any month are not greater than the corresponding total at the end of the previous month—based on the same perimeter with respect to entities covered.
  - This includes arrears being accumulated by the SOEs not included in the General Government.
- Supporting material and measurement:
  - Stock of arrears measured through a survey.
  - Reports on the stock of arrears of the General Government are published monthly.
  - MoF to provide consistent monthly data on expenditure arrears of the General Government as defined above, within seven weeks after the end of each month.
  - Data to include total arrears classified by the constituent sectors of the General Government sub-sector and monthly amounts of arrears cleared under the arrears clearance strategy (see paragraph 6.3).
- Adjustor for 2013:
  - Monthly change in the stock of arrears will be adjusted for any stock adjustment related to the arrears clearance strategy as per paragraph 6.3 to allow monitoring the underlying flow of new arrears.

### C. Ceiling on the Overall Stock of General Government Debt (Performance Criterion)
- Definition:
  - Overall stock of General Government debt refers to the definition established by Council Regulation (EC) No 479/2009 of 25 May 2009 on the application of the Protocol on the Excessive Deficit Procedure annexed to the Treaty establishing the European Community.
  - For Program purposes, the stock excludes:
    - (i) debt contracted for bank restructuring, when carried out under the Program’s banking sector support and restructuring strategy;
    - (ii) IGCP deposits; and
    - (iii) (from end-September 2011) the ‘prepaid margin’ on all EFSF loans.
- Adjustors:
  - For 2013, the ceiling will be adjusted upward (downward) by the amount of any upward (downward) revision to the stock at end-December 2012 general government debt of EUR 204.5 billion.
  - From 2014 onwards, the ceiling will be adjusted upward (downward) by the amount of any upward (downward) reclassification of entities or operations that affects the stock at end-December of the previous year.
- Supporting material and reporting:
  - Quarterly data on total stock of General Government debt provided to the EC, ECB, and IMF by the BdP no later than 90 days after the end of each quarter, as reported to the ECB and Eurostat.
  - Monthly estimates provided to the EC, ECB and IMF by BdP no later than seven weeks after the end of each month.

### D. Non-Accumulation of New External Debt Payments Arrears by the General Government (Continuous Performance Criterion)
- Definition:
  - Debt definition is the same as in paragraph 12.
  - External debt payment arrear: payment on debt to nonresidents, contracted or guaranteed by the general government, not made within seven days after falling due (taking into account any applicable contractual grace period).
  - Performance criterion applies on a continuous basis throughout the Program period.
- Reporting:
  - Any external debt payment arrears of the General Government will be immediately reported by the MoF.

### E. Bank Solvency Support Facility
- The dedicated Bank Solvency Support Facility (BSSF) account will be maintained at the Bank of Portugal.
- Resources for the BSSF will be agreed at each review and deposited in the dedicated account.

### F. Overall Monitoring and Reporting Requirements
- Program performance monitored from data supplied to the EC, the ECB, and the IMF by the MoF and BdP.
- Authorities will transmit any data revisions to the EC, ECB, and IMF in a timely manner.

### Press Release Highlights and Selected Program Statistics (Press Release No.13/209, June 12, 2013)
- IMF completed the seventh review under a 3-year EFF arrangement of SDR 23.742 billion (about €27.19 billion).
- Completion enabled immediate disbursement of SDR 574 million (about €657.47 million).
- Total disbursements under the EFF arrangement reached SDR 19.700 billion (about €22.56 billion).
- The Executive Board approved the authorities’ request for modification of the end-June 2013 performance criteria.
- The EFF arrangement approved on May 20, 2011 is part of a cooperative financing package with the European Union amounting to €78 billion over three years.
- The arrangement entails exceptional access to IMF resources amounting to 2,306 percent of Portugal’s IMF quota.
- Quoted assessments and policy direction:
  - Need to sustain reform effort to improve competitiveness, boost long-term growth, and further advance fiscal consolidation.
  - Fiscal targets recalibrated to preserve balance between consolidation and support for economic growth and employment; scope for further deviation from the revised deficit path is limited due to elevated medium-term financing needs and debt ratios.
  - Importance of early implementation of measures identified in the public expenditure review and continued strong implementation of the fiscal structural reform agenda.
  - Planned corporate income tax reform can help foster investment and competitiveness.
  - Progress noted in strengthening banks’ liquidity and capital buffers; channeling credit to viable firms remains important.
  - Further structural reforms needed to remove bottlenecks, reduce production costs, and minimize rents in network industries.
  - Success depends on external support and effective crisis management policies at the euro area level; envisaged lengthening of maturities of the EFSF and EFSM loans welcomed.
- Authorities’ overview:
  - Primary structural balance improved from -6% of GDP in 2010 to a surplus of 0.2% in 2012.
  - Current and capital account balance turned positive in 2012, a major correction relative to the deficit of 9% of GDP in 2010.

*IMF — 9. Supporting Material, Press Release No.13/209 (June 12, 2013)*

### 2010. As a result, the Portuguese economy turned from a net borrowing position to a net

### _cr13160 - 2010. As a result, the Portuguese economy turned from a net borrowing position to a net

### Program status and macroeconomic context
- Portuguese economy turned from a net borrowing position to a net lender, creating conditions to reduce the accumulated external debt.
- Deleveraging continued and financial stability was preserved.
- Current challenges: weakening external demand, rising unemployment, and implementing deep reforms in the functioning of the State implied by the Public Expenditure Review (PER).
- Priority objectives: restart growth, create employment, and achieve broad political and social consensus on the program going forward.

### Fiscal policy and medium-term targets
- Fiscal consolidation to proceed as indicated in the medium-term budgetary strategy document (published end of April).
- During the seventh review, fiscal deficit targets were revised upwards:
  - "5.5% in 2013 (from 4.5%)"
  - "4.0% in 2014 (from 2.5%)"
  - "2.5% in 2015 (from 2.0%)"
- Revision rationale: fiscal adjustment should be achieved in structural terms; IMF report indicates the new targets deliver appropriate fiscal correction over the medium-term.
- Emphasis on structural balance to account for social and economic costs of adjustment.
- Nominal targets were changed twice (first time during the fifth review) to avoid risks from excessive austerity and negative confidence effects.
- Authorities view: improvement in financing conditions (illustrated by the 10-year bond issuance in May 2013) created room to adjust fiscal targets without adversely affecting market access.
- Authorities propose allowing automatic stabilizers to work if economic activity disappoints, taking into account sovereign financing conditions.
- Constitutional Court ruling of April 5 required identifying new measures to close a fiscal gap in 2013 of about "0.8 percentage points of GDP"; measures were included in the supplementary budget submitted on May 31.

### Economic activity and external adjustment
- INE data for 2013Q1: quarterly GDP rate of change was "-0.4% (-4% y-o-y)", indicating a slowdown of the recession versus 2012Q4 ("-1.8% q-o-q").
- 2013Q1 GDP figures close to euro area average ("-0.2% q-o-q"); the fall is milder than in other euro area countries.
- Q2 figures suggest some improvement relative to Q1.
- IMF staff note: important progress in labor and product market reforms; progress on price-competitiveness modest.
- Evidence of declining markups in both tradable and non-tradable sectors, with a steeper decline in non-tradables.
- Unit labor costs have been declining, yielding competitiveness gains.
- Government view: labor reforms provided companies broader tools to improve competitiveness and adjust to market cycles.
- External rebalancing driven by removal of past incentives for strong domestic demand (easy credit, expansionary fiscal policies); much of the adjustment likely structural and sustainable.

### Initiatives to promote growth and relieve financial constraints
- Temporary and targeted investment tax credit in Corporate Income Tax (CIT): benefit amounts to "20% of the investment made, with a limit of up to 70% of CIT collection"; eligible investments between "June 1 and December 31, 2013".
- Plan to create a financial development institution to propose financing and industrial development plans (including corporate recapitalization); expected fully operational in 2014.
- Review of commercial paper legal framework to facilitate market expansion and diversify financing alternatives for firms, particularly SMEs.
- Review of government guaranteed credit lines to enhance effectiveness.
- Approved VAT Cash Accounting Scheme operational in October: businesses can account for VAT on payments received/made rather than tax invoices, reducing firms' liquidity needs.
- Sovereign bond market developments:
  - Regained full bond market access with a new 10-year bond issued on "May 7", following a previous tapping of a bond maturing in 2017.
  - Issuance attracted strong foreign demand and a composition more tilted to longer-term investors.
- Memorandum for "Growth, Employment and Industrial Development" emphasizes improving financial conditions for viable firms oriented to tradable sector.

### Financial sector policies and banking system stability
- Portuguese financial sector remained broadly resilient through global turmoil but is affected by the broader economic adjustment.
- Recent banking system changes: widespread strengthening of core solvency ratios, improved liquidity, reduction of leverage, improved transparency, stronger regulatory framework.
- Bank profitability pressured by recession, low money market rates, and deleveraging.
- Core Tier 1 ratio in December 2012: "11.5%", an increase of "2.8 percentage points since December 2011".
  - Increase driven by capitalization operations and issuance of hybrid instruments eligible as Core Tier 1 subscribed by the State amounting to nearly "€5 billion".
  - At end-2012, seven of eight largest banking groups had Core Tier 1 ratio above the "10% goal"; the remaining institution was recapitalized in January 2013.
- Liquidity improvements: strengthened collateral buffers for Eurosystem financing; new interbank unsecured lending platform by Banco de Portugal operational since September 2012; gradual decrease in banks' risk premia and some access to senior medium term debt markets, though wholesale access not yet normalized.
- Household deposits remain resilient despite movement toward alternative investment products; pronounced reduction in interest rates on new deposits noted.
- Drivers of reduced bank profitability:
  - Increased impairments due to recession.
  - Low profitability of residential mortgage portfolios originated at fixed spreads.
  - Persistence of high funding costs in deposit base and hybrid instruments.
  - Low short-term interest rates compressing margins on sight deposits.
  - High operational costs amid lower demand for financial services.
- Credit and deleveraging dynamics:
  - Household debt declining since 2009.
  - Non-financial corporations remain highly indebted.
  - Need to balance deleveraging with ensuring productive and competitive sectors retain access to finance.
  - Banco de Portugal closely monitors this balance; expects credit risk to continue materializing in 2013.
- Supervisory and regulatory actions:
  - Banco de Portugal issued an Instruction to identify restructured loans in bank balance sheets.
  - Larger banks submit funding and capital plans under program; quarterly stress-testing implemented.
  - Reinforced on- and off-site supervision and asset quality review programs.
  - 2012: thorough assessment of construction and commercial real estate credit portfolios.
  - 2013: further inspections focusing on impairments and credit risk management.
  - Use of macroprudential instruments highlighted as useful going forward.
  - New legislation enacted on bank access to capitalization with public investment recourse; preventive early intervention and resolution; deposit guarantee schemes; prevention and management of non-compliance.
- Ongoing negotiations with European Commission (DG-Competition) to ensure bank restructuring plans preserve individual viability and avoid systemic effects threatening financial stability and regular financing of the economy.
- Assessment: asset quality reviews, strengthened supervision, and improved regulatory framework place the Portuguese banking system in a favorable position to face challenges from the Single Supervisory Mechanism.

### Structural reforms and competitiveness measures
- Government committed to structural reform agenda to boost growth potential; regular introduction of new policy initiatives including licensing reform and legislative simplification.
- Product market reforms: discussion of a reduction of "20% of the port cargo tariff (TUP-Carga)" to foster export competitiveness; government committed to further reductions and to ensure savings from new port labor law trickle down.
- Health sector cost control:
  - Limit spending on drugs to "1.25% of GDP" following negotiations with pharmaceutical industry.
  - Reorganization and rationalization of hospital network expected to produce significant savings.
  - Measures continuing: compulsory e-prescription, changes in pharmacies' margins, international reference pricing system changes, and pricing of generics.
  - Approval of a new list of countries of reference for pharmaceutical pricing expected to yield "circa 7% in savings".
- Privatization program commitments:
  - Aim to open up economy and attract investment.
  - Government working to ensure binding offers for CTT and EGF are received by end of 2013; privatization of TAP to be launched during 2013.
  - Restructuring of Águas de Portugal underway aiming to establish a concession in 2014.
- Judicial reform: Code of Civil Procedure approved by Parliament on "April 19, 2013" and submitted to the President for promulgation.
- Continued commitment to tackle excessive licensing procedures, regulations, and administrative burdens to remove growth bottlenecks and cut companies' operating costs.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13160.pdf*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13160.pdf_