Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey : Portugal: Recovery on Track but Higher Growth Needed

April 1, 2016

  • Portugal’s recovery is on track and unemployment is back to precrisis levels
  • Yet public and private debt is high, limiting fiscal room and constraining growth
  • Structural reforms to remove growth bottlenecks need to continue

Portugal has emerged from a severe economic slump: it has regained market access and unemployment has returned to precrisis levels.

Production of Queijo de Sao Jorge cheese, São Jorge, Portugal; unemployment in Portugal has returned to precrisis levels (photo: Food Passionates/Corbis)

Production of Queijo de Sao Jorge cheese, São Jorge, Portugal; unemployment in Portugal has returned to precrisis levels (photo: Food Passionates/Corbis)

Interview with Mission Chief

This recovery was enabled by Portugal’s successful three-year adjustment program supported by the European Commission, the European Central Bank, and the IMF. The third post-program monitoring (PPM) report, published today, acknowledges the progress made by Portugal in recent years, but also points out areas to focus on to raise the economy’s growth potential. IMF Survey discussed the findings of the report with Subir Lall, the mission chief for Portugal.

IMF Survey: Portugal’s economy is in its fourth year of recovery and the country enjoys market access on favorable terms. Its unemployment rate has also significantly declined. Yet there are signs that the recovery is losing steam.

Lall: Based on our most recent projections, we think that the economy is gradually easing to its medium-term growth rate of about 1.2 percent. In part, this is because the positive impact of generally favorable global conditions tends to decline over time. In addition, the role of consumption—the main driver of this recovery—will also diminish over the medium term. The growth of the disposable household income is constrained by taxes, which are in turn necessary to support the authorities’ overall fiscal policy objectives. Therefore a further reduction of household savings allows for only limited additional consumption growth. Private sector investment remains constrained by the high level of corporate debt, despite a recent pick-up.

IMF Survey: The PPM report notes concerns over the health of the Portuguese banking sector. What is the main problem with this sector?

Lall: Since the end of the crisis, Portuguese banks have remained burdened by a large stock of legacy assets, some of which are of weak quality. This constrains banks’ ability to provide financing to new and highly productive sectors of the economy, which would be the future drivers of growth and employment. Instead, significant economic resources remain tied up in low-productivity firms. Banks need to move expeditiously to adapt to the new environment, which is markedly different from the precrisis normal. Before the crisis, banks profitably channeled large capital inflows into the Portuguese economy. In the new environment, however, banks need to cut costs, strengthen their balance sheets, and divest from noncore and unprofitable activities.

IMF Survey: Since last November, the new government has advocated supporting growth through appropriately targeted fiscal policy measures and by scaling back on austerity. Isn’t boosting growth a valid policy goal?

Lall: We share the view that Portugal needs high sustained growth. However, we think that fiscal policy may not be an effective tool to achieve this medium-term objective and that the structural reforms that were undertaken in recent years must be continued to ensure higher growth. On near-term fiscal policy, we agree with the direction of the 2016 budget. It aims at further fiscal consolidation, which is essential given the high level of public debt. The question is how much consolidation can be undertaken without undermining the ongoing economic recovery, and whether the measures in the budget are sufficient to achieve these targets.

IMF Survey: Which structural reforms are needed? How could Portugal achieve a higher level of sustained growth?

Lall: There are a number of structural impediments to growth in Portugal. The large overhang of private debt constrains the ability of banks to finance new and higher productivity enterprises that can create new jobs and boost exports further. More competitiveness would also support export growth. Additional reforms to improve labor market flexibility would be beneficial. The authorities’ emphasis on life-long learning would also support competitiveness. Removing the structural obstacles to job creation in the private sector could help reduce poverty. Finally, a reform of public administration is an important element of the overall policy mix. Of course, implementing structural reforms requires broad support, helped by an inclusive social dialogue. The government has already initiated discussions with social partners to achieve consensus on the future direction of reforms.