Portugal: 2012 Article IV Consultation Concluding Statement of the IMF Mission

November 20, 2012

Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.

November 20, 2012

1. Portugal’s crisis is due to a legacy of policy failures in the face of a rapidly changing environment. Economic institutions and policies proved ill-adapted to the demands and opportunities of monetary union and globalization. The rapid transition from decades of financial repression and monetary instability was proving difficult. Monetary union, instead of delivering on the promise of sustainable catch-up growth to EU living standards, facilitated the accumulation of economic and financial imbalances. The competitiveness of the tradable sector eroded. Abetted by a banking system prone to allocating too much credit to poor risks, leverage in the non-tradable sector increased markedly, notwithstanding weak productivity growth. The public sector in turn financed rapidly growing spending, particularly on social protection, through higher taxes and accumulating debts. And in the face of all this, the policy response was, at best, muted. Consequently, in the first half of 2011, Portugal’s government and banks were shut-out from financial markets.

2. In response, the Portuguese authorities have mounted an impressive policy effort to gradually reverse the accumulated imbalances and forestall crisis. A front-loaded fiscal adjustment program is aiming at restoring credibility in government bond markets, while jump-starting external adjustment. Financial sector measures seek to keep banks well capitalized and liquid, while facilitating orderly deleveraging. And structural reforms, ranging from reforming inefficient courts to phasing out rent controls, aim to revitalize the economy’s supply side. Considerable progress has already been made. In spite of setbacks, underlying fiscal adjustment has advanced markedly; external account adjustment has also made significant strides.

3. Yet the near-term outlook is uncertain, and sizable medium-term economic challenges remain. With trading partner growth slowing, the economy will likely be in recession in 2013, while unemployment will rise further from already record high levels. Beyond the short term, maintaining and anchoring fiscal discipline and deleveraging private-sector balance sheets will remain imperatives, but also generate headwinds for growth. In particular, fiscal adjustment needs to continue, although unexpectedly large revenue shortfalls are delaying the achievement of the original nominal deficit path. Fostering more competitive tradable sectors while reducing excessive mark-ups in the non-tradable sectors requires politically difficult structural reforms. Overcoming these challenges will continue to test Portugal’s so far remarkably sturdy social and political consensus.

4. Success of the program will also depends on whether European policymakers forge ahead with reforms to overcome euro area fissures. While implementation of the adjustment program remains the key for mending Portugal’s own deep-seated economic problems, these domestic efforts will need to be complemented by reforms of euro area arrangements to clear a path not only toward a durable return to market financing for Portugal but also to avoid a repeat of the build-up of unsustainable imbalances in the future. The public commitment by European leaders to provide adequate support to Portugal until market access is restored, provided the program is on track, provides a valuable safety net. To overcome credit market segmentation and restore an appropriate monetary policy transmission, it would also be important to further clarify the eligibility criteria for the ECB’s Outright Monetary Transactions as the country starts regaining bond market access.

Restoring and Anchoring Fiscal Responsibility

5. Despite setbacks, fiscal adjustment remains broadly on track. The authorities have made good progress implementing a range of strong revenues and expenditure measures. The objectives remain to contain and gradually reduce public debt, while restoring the credibility of fiscal policy, both in terms of achieving announced targets and in terms of strengthening the budgetary framework, in line with Portugal’s EU obligations. The program’s fiscal adjustment path remains ambitious, although with the economy’s external and internal adjustment proceeding faster than expected, the associated revenue shortfalls have necessitated a somewhat slower adjustment path than originally envisaged.

6. Given the still significant fiscal adjustment ahead, public debate is needed on how to share the burden of remaining fiscal adjustment fairly and in a growth-friendly manner. Fiscal spending, particularly on public wages and social transfers, ratcheted up for many years, with a weak link between the state’s goals and the budget’s spending allocation. The main focus will have to be on further rationalizing public sector pay and employment as well as reforming pensions and other social transfers, aiming at more efficient public services and more equitable re-distribution. At the same time, while it will be difficult to reduce the overall tax burden in the coming years, there is scope to reduce tax distortions and simplify the tax system. In particular, tax expenditures could be streamlined further, while existing tax incentives need to be made more effective and targeted to tradable sector activities. A broader tax base would allow reducing the current high income tax rates, including of the corporate tax, to help attract more FDI.

7. Beyond progressing on fiscal adjustment, anchoring fiscal responsibility will require a much stronger budgetary framework. Political economy biases favoring higher spending and debt financing will likely remain strong, and the previous drift toward undisciplined fiscal policies may recur. Much has already been done to reform the budgetary framework, including by setting up a fiscal council. However, the obligation to implement the EU fiscal compact offers a good opportunity to reach political consensus to hard-wire budgetary prudence into the country’s legal fabric. Maintaining the efforts to strengthen oversight and control over revenue mobilization and public financial management will be critical to deliver on budget promises.

Deleveraging Private Sector Balance Sheets

8. While the over-indebted private-sector is gradually adjusting, high debts still pose risks to growth and bank profitability. Corporate sector deleveraging is essential to restore firms’ productivity and growth, but it is expected to take time and lower prospects for investment in the short to medium term. While adequate banks’ buffers have managed to prevent an abrupt adjustment, risks of adverse shocks raising corporate defaults and resulting in additional bank losses remain. Private household leverage appears more manageable, also reflecting the absence of a past housing bubble in Portugal and low mortgage rates, but also calls for close monitoring given rising unemployment and income losses.

9. Policies under the program aim at mitigating the risk of a credit crunch, while facilitating orderly deleveraging. Liquidity support provided by the Eurosystem, together with the completion of the 2012 bank capital augmentation exercise and enhanced supervisory measures, is helping to maintain the resilience of the banking sector in the face of potential shocks. Moreover, efforts to buttress the supply of credit to healthy firmswhile avoiding additional risks to the sovereign balance sheethave been taken or are underway. The overhaul of the tools for corporate debt restructuring has been completed in line with international best practices, but its effective utilization needs to be monitored. Finally, a framework was established to facilitate out-of-court debt restructuring for households.

10. To lower the risk of a renewed run-up in private indebtedness, Portugal needs to sustain the ongoing reforms to foster a sound financial system. Bank deleveraging is expected to reduce banks’ reliance on non-deposit funding. In addition, the proactive use of macro prudential policy tools could help to forestall excessive bank asset growth. Moreover, banks need to continue rationalizing their operations, focusing on reducing the cost base of their domestic operations. Initiatives to promote capital markets can also help diversify firms’ funding structure. Finally, tax policy initiatives could lower the bias of firms toward debt-financing over the medium term.

Restoring Competitiveness and Growth

11. A more competitive tradable sector is the key to sustainable growth and reducing high unemployment over the medium term. As highlighted by the experience of other countries, particularly in the EU, a competitive tradable sector that is well integrated into regional and global supply chains is the most effective engine for sustainable convergence growth. Progress on this front requires structural reforms across all sectors that target growth bottlenecks, reduce production costs, and compress excessive non-tradable sector profit mark-ups. While the external current account deficit narrowed at an unexpectedly fast pace over the last two years, this welcome development still needs to be locked in by a durable improvement in the country’s competitive fundamentals.

12. The program’s structural reform agenda is comprehensive and deep, and implementation efforts have been commendable. The authorities have already implemented or initiated a wide range of institutional and structural reforms in the labor, product, and financial markets that should help lower the cost of doing business, raise competitive pressures in non-tradable sectors with excessive profit mark-ups, and render the economy more resilient to adverse shocks. Although in part reflecting the weak economy, unit labor costs are already declining and profit mark-ups in non-tradable sectors are under pressure. However, additional steps may be needed to increase the momentum and depth of reforms, which could include additional targeted incentives to promote tradable sector activities.

13. Structural reform efforts will need to be sustained well beyond the present program horizon. Whether the program is effective in removing key growth bottlenecks will need to be monitored, and the reform agenda may have to be modified in response to readings of key performance indicators. One medium-term risk is that growth recovers too slowly to make a meaningful impact on high unemployment, triggering outward migration by young, well-educated workers that may be difficult to reverse. And, over the longer term, Portugal will need to make more progress on deeper-seated obstacles to growth, particularly still low educational levels relative to trade partners and competitors. Against this backdrop, and especially if the economy recovers on schedule, Portugal this time needs to resist the earlier reform complacency that got the economy in trouble.


The mission is grateful to the authorities and other counterparts for their gracious hospitality and constructive discussions.

1 As part of its mandate to oversee the international monetary system, the IMF periodically has an in-depth discussion with each of its member countries about their economic policies. This exercise, known as the Article IV consultation, involves a detailed examination of fiscal, financial sector and other key policies from a medium-term perspective. It is separate from the regular quarterly review of Portugal’s IMF-EU supported program. The IMF’s last Article IV consultation with Portugal was conducted in January 2010.


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