Portugal: Staff Concluding Statement of the 2017 Article IV Mission

IMF News, June 30, 2017

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An IMF mission visited Lisbon during June 19—29, 2017, for the 2017 Article IV consultation and issued this concluding statement.
Near-term outlook strengthened considerably, supported by a pick-up in investment and continued growth in exports as the euro area recovery gained momentum.
Notable progress in addressing near-term risks: exit from the Excessive Deficit Procedure following a strong 2016 fiscal outturn; improvements in banking system stability and confidence.

Drivers:
- Continued strong growth in tourism and related construction.
- Tourism revenues on track for a fourth consecutive year of near double-digit growth.
- Investment in tourism has supported a marked rebound in the construction sector in H1 2017.
- Broad-based pickup in exports, boosted by the robust euro area recovery.
- Strengthened domestic confidence indicators and rising employment.
- House price increases in 2017, supported in part by non-resident real estate investment.
Projections:
- Real GDP growth projected to accelerate to around 2.5 percent in 2017 and remain at 2 percent in 2018.

2016 fiscal outturn significantly better than expected, allowing Portugal to exit the Excessive Deficit Procedure (in place since 2009).
The 2017 headline fiscal deficit target of 1.5 percent of GDP appears well within reach due to stronger growth and containment of spending.
Policy recommendations:
- Use favorable cyclical conditions to pursue a more ambitious reduction of public debt in support of the authorities’ Stability Program medium-term targets.
- Maintain durable structural fiscal consolidation to ensure sustainability of public finances as monetary accommodation is eventually reduced.
- Focus fiscal adjustment on reforms to improve public spending efficiency to be more growth-friendly and reinforce predictability of the tax regime over the investment horizon.

Recent improvements:
- Stability and confidence have improved, including public recapitalization of Caixa Geral de Depósitos and ongoing sale of Novo Banco.
- BCP received a large capital injection; BPI taken over by Spain’s CaixaBank.
- Improved market sentiment led to sharp narrowing in sovereign debt spreads since mid-March.
Remaining challenges:
- Low asset quality, weak profitability, and limited capital buffers persist.
- Non-performing loans (NPLs) declined by 0.3 percentage points in 2016 to 17.2 percent of total loans under the European Banking Authority definition, with weakness concentrated in the corporate sector.
- Reduced operational costs have not offset low interest margins and higher loan loss impairments.
Policy recommendations and needed actions:
- Ambitious efforts to strengthen bank balance sheets to improve financial intermediation and raise potential growth.
- Recent capital increases should be accompanied by comprehensive cleanup of balance sheets and reduction in corporate debt.
- Implement credible and time-bound plans to write-off, restructure, or sell non-performing assets across banks.
- Support efforts via the NPL enhanced coordination platform being developed by banks with authorities’ support.
- Strengthen banks' business models and profitability, including further cost-cutting.
- Implement the new provisioning standards and build additional buffers.

Investment:
- Recent investment growth has been partly financed through internal corporate funding.
- Investment levels need to increase substantially to raise medium-term growth potential.
Labor market and competitiveness:
- Need for a more flexible labor market where wage increases align with productivity.
- Aim to take advantage of higher-skilled entrants while safeguarding competitiveness.
Business environment bottlenecks to address:
- Inefficient judicial processes.
- Complexity of regulations governing enterprise operations.
Structural reform focus:
- Boost investment and productivity through reforms addressing the above bottlenecks.

Projections: 2016 | 2017 | 2018
Real GDP: 1.4 | 2.5 | 2.0
Private consumption: 2.3 | 2.2 | 1.8
Public consumption: 0.5 | 0.6
Gross fixed capital formation: 0.1 | 6.9 | 5.7
Exports: 4.4 | 7.6 | 5.2
Imports: 4.5 | 7.3 | 5.1
Contribution to growth (Percentage points):
- Total domestic demand: 1.5 | 2.6
- Foreign balance: -0.1
Resource utilization:
- Employment: 1.2 | 1.6 | 0.9
- Unemployment rate (Percent): 11.1 | 9.7 | 9.0
Prices:
- GDP deflator: 1.7
- Consumer prices (Harmonized index)
Money and credit (End of period, percent change):
- Private sector credit: -3.7 | -0.5
- Broad money: -0.4 | 4.3 | 3.2
Fiscal indicators (Percent of GDP):
- General government balance: -2.0 | -1.5 | -1.4
- Primary government balance: 2.7
- Structural primary balance (Percent of potential GDP): 3.0
- General government debt: 130.4 | 125.8 | 122.6
Current account balance (Percent of GDP): 0.8
Nominal GDP (Billions of euros): 184.9 | 193.8 | 201.1

Sources: Bank of Portugal; Ministry of Finance; National Statistics Office (INE); Eurostat; and IMF staff projections.