Portugal: Staff Concluding Statement of the 2019 Article IV Mission

IMF News, May 17, 2019

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Economic expansion in its sixth year; growth slowed in 2018 after 2017.
Real GDP growth:
- 2.7 percent in 2017
- 2.1 percent in 2018
- Forecast to ease to 1.7 percent in 2019
- Estimated medium-term potential: 1.4 percent
Unemployment rate: 6.5 percent (seasonally adjusted) in the first quarter of 2019.
Inflation: consumer prices decelerated in 2018 and are expected to remain low.
External current account: shifted into deficit in 2018 and projected to post moderate deficits in coming years.
Public debt trajectory: expected to decline in 2019 and, absent adverse developments, to fall to about 100 percent of GDP in 2024.

Main risks are external:
- Further deceleration in Europe.
- Rising protectionism.
- A disorderly Brexit, which could notably affect tourism.
Domestic risks:
- Pressures for increased spending from vocal groups.
Policy implication:
- Maintaining strong domestic policies is essential to mitigate external risks and reduce vulnerabilities from high public and private debt.

2018 headline fiscal balance improved by 2.5 percent of GDP, reaching -0.5 percent of GDP.
- Improvement drivers: large drop in bank recapitalization costs, declining interest bill, stronger-than-potential growth, tight budget execution.
2019 fiscal targets and projections:
- 2019 nominal fiscal deficit target: -0.2 percent of GDP — described as feasible.
- The deficit is projected to be eliminated in 2020 under unchanged policies.
Recommendation for additional consolidation:
- The mission recommends an additional 1 percent of GDP tightening of the structural primary balance over the next two years.
- In case of a material downturn, a neutral fiscal stance would be appropriate provided the public debt ratio remains on a downward trajectory.

Need to rebalance spending toward higher-priority public investment (e.g., healthcare).
Concerns about the government wage bill:
- Latest official projections of the government wage bill are significantly higher than projected last year, implying additional pressure on public finances.
- The stop-and-go cycle of career progressions since 2005 has been disruptive and raises sustainability questions.
Policy recommendations:
- Conduct a comprehensive review of the level, composition, and rules of public employment to better control current spending without sacrificing service delivery.
- Consider targeted pension system adjustments to curb aging-related expenditure increases and to reduce high inequality among pensioners (noted as high by European standards).

Progress:
- Bank capital ratios boosted by 2017-18 capital augmentations.
- Profitability has improved; banking system reported positive profits since the beginning of 2017.
- Nonperforming loan (NPL) ratio declined to 9.4 percent at end-2018, with a provisioning ratio above 50 percent.
Remaining challenges:
- NPLs remain high relative to desired standards.
- Bank profitability remains low relative to pre-crisis levels and below the cost of equity.
Supervisory recommendations:
- Ensure banks follow through on NPL reduction targets.
- Strengthen corporate governance, internal controls, and risk management.
- Encourage banks to improve operational efficiency and profitability.
- Reform financial supervision to ensure independence of supervisors, timely decision making, cost efficiency, and a leading macroprudential role for the central bank.
- The financial supervision reform bill aims to enhance coordination among the three sectoral supervisors; concerns raised by Banco de Portugal, Comissão do Mercado de Valores Mobiliários, and Autoridade de Supervisão de Seguros e Fundos de Pensões merit careful consideration in Parliament.

Key areas to raise productivity and investment:
- Streamline the regulatory environment.
- Strengthen product market competition, notably in energy and transport.
- Improve skills and the efficient use of labor.
- Enhance labor market flexibility by making permanent contracts less rigid.
Saving and investment balance:
- Corporate and household saving are below Euro Area averages.
- Sustaining higher investment rates without external imbalances requires stronger domestic saving rates.
Policy measures to boost saving:
- Issue regulations for complementary second-tier occupational pension schemes as called for in existing legislation.
- Explore options, including tax incentives, to encourage well-regulated complementary occupational and individual retirement saving schemes.

The mission emphasizes that strong policies at home are needed to make Portugal more resilient and to foster higher productivity, investment, and saving for balanced long-run growth.
The mission expresses gratitude to the Portuguese and European authorities and other interlocutors.

Portugal: Staff Concluding Statement of the 2019 Article IV Mission