Portugal: Staff Concluding Statement of the 2017 Article IV Mission

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments. The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

An International Monetary Fund (IMF) mission visited Lisbon during June 19—29, 2017, for the 2017 Article IV consultation.

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

Portugal’s near-term outlook has strengthened considerably, supported by a pick-up in investment and continued growth in exports, as the recovery in the euro area has gained momentum. Portugal has also made commendable progress in addressing near-term risks. The strong 2016 fiscal outturn has allowed Portugal to exit the Excessive Deficit Procedure, while the 2017 fiscal deficit target also appears well within reach. There has also been notable progress over the past year to stabilize the banking system, although addressing banks’ large stock of non-performing loans and dealing with the substantial corporate debt overhang remain medium-term challenges. Progress on these fronts would facilitate more effective intermediation of financing to broad-based private investment, which is essential to support strong growth over the medium-term. Sustained strong growth, together with continued public debt reduction, would reduce vulnerabilities arising from high indebtedness, particularly when monetary accommodation is reduced.

Economic activity has gained momentum in 2017, supported by continued strong growth in tourism and related construction. Tourism revenues appear on track for a fourth consecutive year of near double-digit growth, while investment in the sector has supported a marked rebound in the construction sector in the first half of 2017. There are also signs of a broad-based pickup in exports, boosted by the robust euro area recovery. Meanwhile, domestic confidence indicators have strengthened significantly and employment continues to rise. House prices have also experienced further increases in 2017, supported in part by non-resident real estate investment. As a result, real GDP growth is projected to accelerate to around 2.5 percent in 2017 and remain at 2 percent in 2018. Portugal has also made commendable progress over the past year in addressing near-term risks. The 2016 fiscal outturn was significantly better than expected, reflecting strong efforts to contain spending. This allowed Portugal to exit the Excessive Deficit Procedure that had been in place since 2009. Stability and confidence in the banking system has also improved markedly over the past year, including through the public recapitalization of Caixa Geral de Depósitos and the ongoing sale of Novo Banco. Meanwhile, BCP has received a large capital injection and BPI has been taken over by Spain’s CaixaBank. Improved market sentiment toward Portugal has contributed to a sharp narrowing in sovereign debt spreads since mid-March. The pickup in growth implies that this year’s headline fiscal deficit target of 1.5 percent of GDP is well within reach. Stronger growth, together with the authorities’ strong commitment to contain spending, should allow the headline deficit to be achieved comfortably. The favorable cyclical conditions provide an auspicious opportunity for a more ambitious reduction of public debt this year, in support of the authorities’ medium-term targets set in the Stability Program. Durable structural fiscal consolidation remains essential to ensure the sustainability of public finances, with the financing environment likely to be less benign as monetary accommodation is eventually reduced. An adjustment focused on reform to improve public spending efficiency would likely be more growth-friendly and help reinforce investors’ perceptions of the predictability of the tax regime over the investment horizon. In addition to the recent increases in capital, Portuguese banks are liquid and continue to make progress on deleveraging. Nevertheless, they face numerous challenges, including low asset quality, weak profitability and limited capital buffers. The outstanding stock of non-performing loans (NPLs) declined by 0.3 percentage points in 2016 to 17.2 percent of total loans under the European Banking Authority definition, with the weakness in asset quality particularly concentrated in the corporate sector. Banks have reduced operational costs, but this has been insufficient to offset the drag on profitability from low interest margins and higher loan loss impairments. Ambitious efforts are needed by banks to strengthen their balance sheets, which would improve financial intermediation and help raise potential growth. Recent steps to raise capital need to be accompanied by a comprehensive cleanup of banks’ balance sheets and reduction in corporate debt. This should include a credible and time-bound plan for efforts across banks to write-off, restructure or sell non-performing assets. The NPL enhanced coordination platform being developed by banks with the support of the authorities is an important initiative that could facilitate banks’ efforts in this regard. These efforts will need to be supported by strengthening banks’ business models and improving profitability, including through further cost-cutting. Banks will also need to implement the new provisioning standards and build additional buffers. Raising the economy’s growth potential will also require further structural reforms to boost investment and productivity. Ongoing initiatives along a number of fronts could help in this regard. The recent growth in investment has been in part financed through internal sources of funding by corporates. However, investment levels would need to increase substantially to raise the economy’s medium-term growth potential. This would require a more flexible labor market where wage increases are aligned with productivity, allowing Portugal to take advantage of higher-skilled entrants to the labor force while safeguarding competitiveness. Structural reforms should also focus on the bottlenecks that continue to influence investors’ perceptions of the business environment, including inefficient judicial processes and the complexity of regulations governing the operation of enterprises.

The mission would like to express its gratitude to the Portuguese authorities and other interlocutors for a close and constructive dialogue.

Portugal: Selected Economic Indicators (Year-on-year percent change, unless otherwise indicated) Projections 2016 2017 2018 Real GDP 1.4 2.5 2.0 Private consumption 2.3 2.2 1.8 Public consumption 0.5 0.6 0.5 Gross fixed capital formation 0.1 6.9 5.7 Exports 4.4 7.6 5.2 Imports 4.5 7.3 5.1 Contribution to growth (Percentage points) Total domestic demand 1.5 2.6 2.2 Foreign balance -0.1 -0.1 -0.1 Resource utilization Employment 1.2 1.6 0.9 Unemployment rate (Percent) 11.1 9.7 9.0 Prices GDP deflator 1.6 2.2 1.7 Consumer prices (Harmonized index) 0.6 1.6 2.0 Money and credit (End of period, percent change) Private sector credit -3.7 -0.5 0.1 Broad money -0.4 4.3 3.2 Fiscal indicators (Percent of GDP) General government balance -2.0 -1.5 -1.4 Primary government balance 2.2 2.6 2.7 Structural primary balance (Percent of potential GDP) 3.0 2.7 2.5 General government debt 130.4 125.8 122.6 Current account balance (Percent of GDP) 0.8 0.6 0.5 Nominal GDP (Billions of euros) 184.9 193.8 201.1 Sources: Bank of Portugal; Ministry of Finance; National Statistics Office (INE); Eurostat; and IMF staff projections.