Lessons from Portugal’s Recovery

IMF News, March 25, 2019

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Keynote Speech by First Deputy Managing Director David Lipton at the conference "Portugal: Reform and Growth within the Euro Area", Lisbon, Portugal.
Emphasis on political cohesion and ownership of reforms by successive Portuguese governments and the Portuguese people as central to the recovery.
Main themes addressed: global slowdown and uncertainty; preparedness for the next downturn; EU institutional reforms and remaining gaps; Portugal’s recovery achievements, vulnerabilities, and reform priorities.

Global growth has slowed, including in Europe; trade tensions continue to undermine confidence.
Financial markets react quickly to perceptions of vulnerability; political divisions have been heightened by rising inequality, economic divergence within the EU, migrant and refugee flows, and Brexit.
The post-World War II consensus on multilateral solutions appears to be fragmenting.
Key warning: the tools used to confront the Global Financial Crisis may not be as available or potent next time—monetary policy space likely more constrained; fiscal resources may be limited; political resistance to bailouts may be greater.
Policy implication: all countries need to renew commitment to reforms that support current growth and strengthen long-term potential.

Anticipation that a downturn (garden variety recession or worse) lies ahead; countries must be prepared to sustain growth, prevent systemic shocks, and react effectively.
Europe must address policy shortcomings that could exacerbate a future downturn.

Progress noted:
- The ESM provides firepower to support countries in need of financing.
- The Single Supervisory Mechanism has bolstered bank surveillance.
- The Single Resolution Mechanism has enhanced credibility of bank resolution and reduced likelihood of taxpayer-funded bailouts.
- Agreement on establishing a common backstop for the Single Resolution Fund reached after long deliberations.
Remaining gaps and vulnerabilities:
- Bank supervision remains too fragmented; banking union lacks a common deposit insurance scheme.
- Capital markets are fragmented along national lines, limiting cross-border risk sharing.
- A fiscal-stabilization capacity at the center is needed to respond to macroeconomic shocks and improve the fiscal-monetary policy mix; in its absence the euro area is over-reliant on monetary policy and crisis response burdens fall unevenly on individual countries.
Conditionality: greater risk sharing must be paired with risk reduction via strong regulation and supervision to avoid moral hazard.

U.S. fiscal consolidation is necessary; U.S.-China trade tensions pose the largest risk to global stability.
Beijing should continue shift toward high-quality growth and support sustainable globalization.
Emerging markets must face up to external shocks and volatile capital flows.
Unresolved issues (e.g., Brexit) contribute to uncertainty.
Countries with glaring vulnerabilities (notably Italy) should act now or risk severe damage in a serious recession.
Some countries (notably Germany) have fiscal space to increase spending and can support others.

Unemployment:
- Peaked at 16 percent in 2013.
- Now at 7 percent, its lowest level since 2004.
- Sharp decline in long-term unemployment and impressive reduction in youth unemployment (not far above the EU average).
Sovereign borrowing costs:
- Yields on Portugal’s bonds were in double-digit territory during 2011-2012.
- The yield on the 10-year bond is currently around 1.3 percent.
Fiscal position:
- Overall fiscal deficit in 2010 was about 11 percent of GDP.
- The government is targeting a small deficit this year.
- The primary balance is expected to hit its highest level since 1992.
- Public debt was about 120 percent of GDP last year, the third highest in the euro area, and unlikely to fall below 100 percent until 2025.
External sector and activity:
- Exports and tourism have boomed.
- The current account has been nearly balanced for the last several years after a long period of very large external deficits.
Financial sector and private sector leverage:
- Non-financial corporate debt is about 140 percent of GDP.
- Household debt is about 75 percent of GDP.
- Non-performing loans (NPLs) declined to about 11 percent in the third quarter of 2018 from above 17 percent in 2015, but remain high; bank profitability continues to be low.

High public debt (about 120 percent of GDP) requires continued debt reduction to restore fiscal space useful in a downturn.
High private sector leverage (non-financial corporate debt about 140 percent of GDP; households about 75 percent of GDP) increases vulnerability.
Banking system still vulnerable despite progress; NPLs remain around 11 percent (Q3 2018) and profitability is low.
Need to lift productivity to improve long-term growth prospects while repairing balance sheets.

Recent growth has been above estimated potential, reflecting recovery momentum and a favorable external environment; the core challenge is improving longer-term growth prospects through higher productivity.
Labor market:
- Employment gains notable, many new jobs are permanent.
- Concern: too many new jobs are minimum wage.
- Economy’s increased export orientation places a premium on a flexible workforce with advanced skills; education levels among young Portuguese are much higher than earlier generations.
Product and business environment:
- Portugal’s product market needs reforms; the business sector must adapt to artificial intelligence, robotics, and e-commerce.
- Decline in NPLs is freeing capital that can be reallocated to 21st century needs, but NPL ratios remain high.
- The government can facilitate transformation by focusing on reforms and ensuring regulations do not discourage dynamic and innovative activities.

Portugal’s top five export markets are in the EU, led by Spain, France and Germany; higher growth in those partners supports Portugal’s transformation.
Political consensus and cooperation were central to Portugal’s recovery; conflict and unilateral action heighten vulnerabilities and hamper high-quality growth.
The path forward for the EU lies in a combination of cooperation and reforms—Portugal achieved this amid crisis; Europe can pursue the same without a crisis.

IMF Communications Department, March 25, 2019