Press Release No. 18/65

Portugal: IMF Executive Board Concludes Sixth Post-Program Monitoring

February 23, 2018

On February 21, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Sixth Post-Program Monitoring [1] of Portugal and considered and endorsed the staff appraisal on a lapse-of-time basis. [2]

Portugal’s repayment capacity is expected to be adequate under the baseline. With improved market access and sovereign outlook and ratings, as well as additional early repayments to the Fund in 2017, risks to repayment capacity have moderated significantly since the last PPM.

The Portuguese economy has strengthened. Supported by a benign external environment, job-rich growth has gathered momentum since late 2016. The headline fiscal balance continued to benefit from stronger growth, controlled budget execution, and falling interest costs, with the 2017 deficit target of 1.4 percent of GDP likely to have been met with some margin. Financial stability has also improved with various bank capital augmentations and the sale of Novo Banco in 2017 while banks have also reduced their NPLs and returned to modest profitability. Growth is projected at 2.2 percent in 2018. Downside risks in the near term are mostly external in nature and appear moderate.

Executive Board Assessment [3]

The Portuguese economy has continued to strengthen. Supported by a benign external environment, job-rich and broad-based growth has gathered momentum since late 2016, contributing to better than anticipated fiscal outcomes in 2017, including the exiting from the European Commission’s excessive deficit procedure. Financial stability also improved in the last year. Downside risks in the near term are mostly external in nature and appear moderate.

Portugal has further improved its access to financial markets. Portugal maintains prudent liquidity buffers, and its sovereign debt has become eligible for inclusion in several international bond indexes, which should help support it even as the ECB’s asset purchase program is eventually wound down. Portugal’s capacity to repay the Fund is adequate in the baseline and robust to the risk scenarios in the DSA. In fact, owing to substantial early repurchases to date, no repurchases are due until 2021.

Despite the recent positive economic developments, important crisis legacies remain. The nonfinancial private sector’s debt is large (including by European standards) and remains a source of vulnerability. The still large stock of bad loans on banks’ books constrains their ability to provide new credit for investment. Public debt, at 126 percent of GDP, is the euro area’s third largest. While the public debt ratio is expected to decline to 108 percent of GDP by 2023, this ratio would still leave Portugal vulnerable to unexpected rises in interest rates, the wind-down in the monetary stimulus of the last few years, and cyclical downturns in Portugal and its trading partners.

Favorable borrowing conditions and the economic upswing provide an auspicious opportunity for an even faster reduction of public debt. Structural consolidation in the primary fiscal balance remains essential to keep public debt on a firmly downward trajectory over the medium-term. An adjustment focused on durable expenditure reform is likely to prove more sustainable and supportive of growth. The authorities should be cautious about permanent increases in spending that might reduce the flexibility of public expenditure when cyclical conditions change. Such caution is especially important in relation to decisions that may affect the trajectory of the government wage bill in coming years.

Banks will need to continue strengthening their business models and cleaning their NPLs. Although financial stability has improved over the past year, the high level of NPLs limits banks’ internal capacity to generate stronger returns and increase their capital. Also, some upcoming regulatory changes in the euro area, although aiming to boost resilience, could affect some banks’ funding structure and costs. Banks’ improved financial results in 2017 are encouraging, as is the ongoing implementation of ECB guidance to banks on NPLs. Continued efforts in these areas, including by improving business models and cost efficiency, so banks can generate new capital from their own profits, are necessary to ensure that they remain resilient and better support the economy. New initiatives to further improve the legal framework to support the debt restructuring of viable but distressed debtors and the recovery of collateral, including through out-of-court mechanisms, need to be implemented and closely monitored. In addition, there is a need to monitor carefully developments in the housing markets. Macroprudential authorities should also stand ready to take additional macroprudential measures if needed to prevent the build-up of imbalances and to strengthen the resilience of banks and borrowers.

Raising the economy’s growth potential and resilience to shocks will also require further structural reforms and higher investment and productivity. For the economy to absorb negative shocks and adapt to new opportunities, a flexible labor market is key. Flexibility needs to be preserved even as an environment with more stable jobs is sought. Investment needs to increase substantially to raise the economy’s medium-term growth potential. Preserving external balance while raising investment requires strengthening national saving rates as well. Along with ongoing initiatives to develop human capital, structural reforms should include efforts to continue improving the business environment.