Portugal Staff Concluding Statement of the 2023 Article IV Mission
IMF News, May 9, 2023
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- Published: May 9, 2023
Recent Developments and Outlook
- An IMF mission conducted discussions for the 2023 Article IV consultation with Portugal during April 26-May 5, 2023.
- 2022 performance and early-2023 momentum:
- Output surpassed its pre-pandemic level in early-2022.
- Growth in 2022: 6.7 percent (Portugal) versus 3.5 percent (euro area).
- Growth drivers: rebounding tourism and private consumption (policy support, labor market strength, pent-up demand).
- Q1 2023 growth: 2.5 percent (year-on-year).
- Inflation and financial conditions:
- Headline inflation averaged 8.1 percent in 2022.
- Headline inflation in April 2023: 6.8 percent.
- Inflation initially driven by global energy and food prices, amplified by spillovers from Russia’s war in Ukraine.
- High share of variable interest rate loans means monetary tightening has translated into significantly higher borrowing costs.
- Strong house price growth has dampened housing affordability.
- Projections:
- Real GDP growth is expected to average 2.6 percent in 2023.
- Inflation is expected to recede to 5.6 percent in 2023.
- Growth projected to stabilize to around 2 percent over the medium term.
- Core inflation is projected to be stickier due to a tight labor market and elevated profit margins.
- Risks to the outlook:
- Downside: greater-than-expected tightening of financial conditions; sharper global or regional slowdown; greater volatility in commodity prices; banks tightening lending standards; potential sharp correction in housing prices—these could raise systemic risk and crimp domestic demand.
- Upside: faster tourism momentum and sustained labor market resilience.
- Medium-term risks: global fragmentation or slower use of Next Generation EU (NGEU) funds could hamper growth potential.
- Inflation upside risks: higher-for-longer energy prices and nominal wage pressures.
Fiscal Policy
- 2022 fiscal outcomes:
- Fiscal measures in 2022: 2 percent of GDP (support to households and energy-intensive firms and tax reduction on energy-related products).
- Despite measures, the fiscal deficit sharply narrowed due to revenue overperformance.
- Public debt-to-GDP ratio declined faster than the euro area and fell below its pre-pandemic level.
- 2023 fiscal stance and near-term guidance:
- Fiscal policy needs to remain non-expansionary to preserve fiscal space and support monetary policy, while being nimble if shocks materialize.
- Additional fiscal support for 2023: around 2 percent of GDP (public wage and pension increases, temporary VAT exemption on essential items, and housing support measures).
- Receding energy prices provide an opportunity to phase out broad-based measures and target support to vulnerable households.
- If growth weakens appreciably, automatic stabilizers should be fully deployed; conversely fiscal overperformance must be saved.
- Further fiscal support should be reserved only for severe downside scenarios and designed to be temporary, non-price-distortionary, and well targeted.
- Medium-term priorities:
- Sustain strong fiscal effort to rebuild fiscal space and mitigate public debt risks.
- Fiscal consolidation combined with strong medium-term growth is key to steady public debt reduction, while continuing public investment even after the end of NGEU funds.
- Recommended revenue and expenditure measures:
- Tax reforms: eliminate distortions, roll back reduced VAT rates, rationalize tax expenditures, modernize tax system including digitalizing tax administration, and strengthen property taxes.
- Use falling energy prices as a window for a timely increase in carbon taxes.
- Expenditure: increase the share of public investment—including by implementing the NGEU-financed Recovery and Resilience Plan—over current spending, reversing recent trends.
- Main expenditure priorities: improving pension sustainability; containing upward creep in the public wage bill; strengthening the financial position and efficiency of the National Health Service (NHS); further improving targeting of social spending.
- Structural fiscal reforms: improve public sector efficiency, governance, and fiscal sustainability of state-owned enterprises (SOEs); fully implement the 2015 Budgetary Framework Law to strengthen the medium-term budgetary framework.
Financial and Macroprudential Policies
- Banking sector condition:
- Banks’ tier 1 capital ratios (CET1) are comfortably above minimum requirements, though below euro area average and edging down slightly in 2022 amid dividend distributions and some valuation losses.
- Liquidity buffers remain high.
- Nonperforming loan ratios have declined.
- Profitability has risen with strong interest income.
- Spillovers from recent global financial stress have been limited.
- Macroprudential framework and vulnerabilities:
- Introduction and tightening of macroprudential measures by Banco de Portugal since 2018 have helped strengthen underwriting standards.
- Rising cost of living is stretching household finances and could weigh on debt servicing capacity; asset quality deterioration could materialize with a lag.
- Housing market assessed as overvalued following years of strong house price growth.
- Policy recommendations:
- Continue prudent risk management, close monitoring of banking vulnerabilities, vigilance on credit quality, interest rate risk, and liquidity management.
- Improve capital headroom and contingency planning; caution in capital distributions, especially if buffers weaken under stressed conditions.
- Consider a further gradual macroprudential policy tightening to contain systemic risks from housing market vulnerabilities—e.g., gradually phasing in a sectoral systemic risk capital buffer, provided procyclical effects are avoided.
- Flexibly adjust macroprudential policies if downside macro-financial risks begin to materialize.
- Over the medium term, consider a positive neutral counter-cyclical capital buffer (CCyB) to further support financial stability.
- Housing supply and private debt resolution:
- Policies to support housing supply are recommended to ease housing affordability strains; measures to increase supply of residential and rental property—supplemented by public investment for social housing under the National Recovery and Resilience Plan—are key.
- The anticipated termination of the Golden Visa program is not expected to significantly impact housing prices.
- Strengthen private debt resolution: continue streamlining judiciary processes and strengthening out-of-court procedures; reinstate the duty to file for bankruptcy (suspended during the COVID pandemic) to improve resource allocation.
Structural Policies
- National Recovery and Resilience Plan (NRRP) implementation:
- Timely implementation would support transition to a more productive, resilient, and green economy.
- NRRP expected to boost productivity by increasing R&D and public spending to support small and medium enterprises, catalyze digital transformation, promote digital skills, modernize education, support renewable energy, and revamp active labor market policies.
- Effective completion would help spur private investment.
- Labor market reforms:
- Address long-standing labor market issues to boost labor productivity and external competitiveness.
- Reduce duality in the labor market to increase efficiency and enhance equality.
- The Decent Work Agenda: aims to promote job stability by reducing the maximum number of renewals for temporary employment contracts.
- Make permanent contracts more flexible to reduce duality while preserving efficiency.
- Strengthen and better target the social safety net to limit adverse distributional effects.
- Climate and energy policy:
- Reinstating and increasing the carbon tax—suspended during the energy crisis—would help meet carbon neutrality targets as planned.
- Portugal’s share of renewable energy is among the highest in the euro area.
- A gradual increase in the carbon tax, combined with scaling up green investment and targeted support for the vulnerable, would help realize Portugal’s target of carbon neutrality by 2045.
Portugal Staff Concluding Statement of the 2023 Article IV Mission (May 9, 2023).