Mission Concluding Statement 

Portugal: Concluding Statement of the Fourth Post-Program Monitoring and 2016 Article IV Consultation Discussions

June 30, 2016

An International Monetary Fund (IMF) mission visited Lisbon during June 15-29, 2016, for the Fourth Post-Program Monitoring discussions—part of the IMF’s regular surveillance of countries with IMF credit outstanding above 100 percent of quota— and 2016 Article IV consultation. The Post-Program Monitoring discussions were coordinated with the European Commission and the European Central Bank.

At the end of the visit, the mission issued the following statement:

Portugal’s economic recovery has entered its fourth year, and the country enjoys favorable access to financial markets, having successfully concluded the adjustment program. The pace of growth has softened recently, as exports and investment have moderated. Increased market uncertainty in the context of heightened risk aversion following the referendum in the United Kingdom could persist for an extended period. This reinforces the importance of a credible policy framework. Further reforms are essential to improve medium-term growth prospects, together with additional steps to strengthen bank balance sheets. These measures need to be supported by sustained fiscal consolidation to reduce vulnerability from high public debt and help improve the economy’s resilience to shocks.

1. The pace of Portugal’s economic recovery has slowed since the middle of last year. While private consumption continued to expand robustly, investment and exports weakened, reflecting increased uncertainty and a sharp downturn in some markets for Portuguese goods. As a result, real GDP growth fell to 0.9 percent (year-on-year) in the first quarter of 2016 and is projected at 1.0 percent for the year as a whole. The medium-term outlook is somewhat less benign than at the time of the Third Post-Program Monitoring. Growth is expected to strengthen only gradually to around 1.2 percent as the persistent structural rigidities and the unresolved private sector debt overhang take longer to address than previously assumed. Downside risks to the outlook are elevated due to declining household savings, still subdued investor confidence and greater uncertainty in the external environment, including as a result of the U.K. referendum.

2. In light of increased uncertainty, the authorities’ recent reaffirmation of their commitment to the 2016 fiscal target is welcome. Fiscal spending has been contained so far this year, but there are risks to revenue collection in the context of slower growth, and spending pressures could emerge in the second half of the year. On account of these risks, further measures to support spending restraint will likely be needed to ensure that this year’s fiscal target of 2.2 percent of GDP is achieved. In the absence of additional steps, staff projects a deficit of close to 3 percent of GDP.

3. A credible path for medium-term fiscal consolidation is needed to put public debt on a firmly downward trajectory. This would require setting realistic targets that are underpinned by concrete measures. The authorities’ Stability Program for 2016−2020 lays out ambitious goals for medium-term fiscal adjustment, but lacks specificity which would permit an assessment of their feasibility. In staff’s view, a structural primary adjustment of 0.5 percent of GDP in both 2017 and 2018 would constitute an appropriately realistic fiscal path. This should be underpinned by permanent savings measures, with a focus on rationalization of public wages and pensions. It is regrettable, therefore, that the full rollback of public sector wage cuts has not been accompanied by a more fundamental reform of the public sector. An expenditure review encompassing all areas of the general government would help identify priority areas for generating public savings. Efforts also need to be stepped up to implement the new Budget Framework Law which aims at improving budget management and transparency. On the revenue side, a more stable and predictable tax system would help foster confidence and encourage private investment. More broadly, it is important to take advantage of the favorable financing environment facilitated by the ECB’s accommodative monetary stance to advance the fiscal adjustment effort.

4. The Portuguese banking system continues to operate in a challenging environment. Banks remain liquid, but weak asset quality, low interest margins, and sluggish lending growth remain a drag on their profitability. The process of balance sheet repair has moved slowly, with a large share of banking assets still tied up in low-productivity firms, thereby constraining economic activity. Supervisors should encourage a more ambitious approach to addressing non-performing legacy assets and corporate debt workouts to improve the resilience of the banking system, which should also be promoted by a more appropriate tax, legal, and judicial framework. This will necessitate a stronger focus by banks on profitability, underpinned by meaningful cost reduction and further efforts to strengthen internal governance. At the current juncture, removing uncertainty about the way forward for publicly-owned banks would also reinforce financial stability and improve the operating environment for all banks. Moreover, it would clarify sovereign financing requirements, with implications for both sovereign and bank funding costs.

5. Progress on structural reforms is essential to spur income convergence and job creation, particularly given rising demographic challenges. Portugal made important advances during the adjustment program in improving the flexibility and competiveness of labor and product markets; it is important to ensure that these are carried forward. A change in the direction of reforms would add to the uncertainty already weighing on investment and diminish the prospects for growth, employment and income. In particular, any unwinding of past policies that have succeeded in making hiring and collective bargaining more flexible would have adverse consequences for the competitiveness of Portuguese firms. Moreover, Portugal’s medium-term growth challenges are amplified by the aging of the population.

The mission would like to express its gratitude to the Portuguese authorities and other interlocutors, and its counterparts from the European Commission and the European Central Bank for their constructive engagement and cooperation.