Portugal: Policies for a Strong Economy

IMF News, July 1, 2022

Source details

After a deep pandemic-induced recession, the Portuguese economy gained ground in 2021 and GDP surpassed its pre-pandemic level in the first quarter of 2022.
The recovery was driven by strong domestic demand and a bounce back in tourism from the second half of 2021, aided by one of the world’s highest vaccination rates.
Wide-ranging policy support helped to sustain employment and income growth and to maintain financial stability.

The war in Ukraine will be a drag on the economy in 2022-23 through:
- increasing commodity prices;
- longer-lasting supply disruptions;
- souring confidence;
- lower world demand for Portugal’s exports.
Surging food and energy prices have contributed to the strongest inflationary pressures for over a decade.
Inflation will remain high this year but should start to fall back next year.
Amid exceptional uncertainty, policies need to balance short-term priorities with medium-term objectives for durable growth and resilience.

After providing timely and comprehensive pandemic support, the fiscal deficit narrowed significantly in 2021, and is set to improve further this year despite policy measures to alleviate the economic effects of high energy prices.
Policy guidance:
- More fiscal support—targeted to vulnerable households and the most affected but still viable businesses—may be required if severe downside risks materialize.
- Conversely, there will be scope for savings if the economy performs better than expected.
- Assuming continued economic recovery, fiscal consolidation needs to resume from 2023 to rebuild fiscal space, make room for much-needed public investment, and alleviate risks from high public debt.

Although the banking system has held up well, continued monitoring of credit quality is needed, including in light of risks from rising house prices and tightening financial conditions.
Efforts to further strengthen bank capital buffers are essential.

Structural reforms are key to unlocking Portugal's growth potential and accelerating income convergence with the rest of the euro area.
The National Recovery and Resilience Plan appropriately focuses on longstanding structural needs to improve skills and increase competitiveness, and on other priorities, notably climate and digital transitions.
Specific reform areas highlighted:
- Strengthen insolvency regimes to allow non-viable businesses to wind up smoothly and increase competitiveness.
- Reduce differences between permanent high- and temporary low-value jobs.
- Improve education and training under the Recovery and Resilience Plan to help workers find jobs in expanding sectors and limit scarring.

Once uncertainty surrounding the energy crisis subsides:
- Further raising the carbon price, combined with continued improvement of energy efficiency and shielding the most vulnerable households from its impact, will be important to achieve Portugal’s ambitious climate targets.

Balance short-term support with medium-term consolidation and investment.
Target additional fiscal support to vulnerable households and viable firms if downside risks materialize.
Resume fiscal consolidation from 2023 to rebuild fiscal space and enable public investment.
Monitor credit quality and strengthen bank capital buffers.
Implement structural reforms via the National Recovery and Resilience Plan to boost skills, competitiveness, and facilitate climate and digital transitions.
Advance carbon pricing and energy efficiency while protecting vulnerable households.

By the Portugal Country Team, IMF European Department, July 1, 2022.