Press Release No. 18/345

IMF Executive Board Concludes 2018 Article IV Consultation with Portugal

September 12, 2018

On September 7, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Portugal.

Following robust growth in 2017, driven by investment and exports, activity is expected to moderate in 2018. Nevertheless, unemployment continues to fall on the back of sustained employment growth; and the output gap is estimated to turn positive this year. While rising energy prices have pushed up consumer prices, core inflation remains subdued. Strong import growth (linked to investment) has largely been offset by robust exports, particularly tourism, leaving the current account largely unchanged in 2017.

While the headline fiscal deficit deteriorated in 2017 owing to one-off’ bank recapitalization costs, the primary structural balance is estimated to have improved by 0.4 percent of GDP reflecting strict budget execution. The headline deficit will continue to fall in 2018, although part of the structural improvement will be reversed. On constant policies, the ratio of public debt to GDP should steadily decline in the coming years. Sovereign funding costs have declined significantly since early 2017, but saw volatility in May and June owing to spillovers from political uncertainty in Italy.

Credit growth continues to lag the recovery in economic activity, as banks repair their balance sheets. However, rising capital ratios, falling rates of non-performing loans and lower impairments meant that the resilience of banks improved significantly in 2017. Further improvement is expected in 2018. Nevertheless, no significant acceleration in credit growth is expected, and the economy should continue deleveraging its external balance sheet.

Executive Board Assessment [2]

Executive Directors agreed with the thrust of the staff appraisal. They welcomed Portugal’s strong economic performance, driven by investment and exports. This job-rich recovery has led to falling unemployment and broad-based employment creation. Directors noted that while, in the short term, growth prospects remain positive, external risks from a slowdown in trading partners’ growth and financial-market spillovers have increased. They encouraged the authorities to sustain the policy and reform momentum to ensure resilience to shocks, reduce vulnerabilities, and facilitate convergence towards the average income level of the European Union.

Directors noted that the current favorable economic conditions provide an opportunity to frontload planned fiscal consolidation. This will not only avoid pro-cyclical adjustment but will also help build policy space to deal with contingent spending needs. They emphasized that to achieve lasting consolidation, policies should focus on restraining current expenditure, including via reforms to public employment and pensions. Efforts should also be made in improving budget monitoring and control, especially in the health-care sector. Directors welcomed the authorities’ commitment to reducing public debt and bringing it back to more sustainable levels.

Directors welcomed that banking sector resilience has further improved, with higher capital and increased profitability. They noted that while progress has been made in reducing the stock of non-performing loans (NPLs), further steps are needed to strengthen the banking sector, including a concerted effort to bring down the level of NPLs. To prevent the emergence of new vulnerabilities, Directors encouraged the authorities to continue to focus on preserving credit standards, monitoring mortgage markets, and employing macro-prudential measures where necessary.

Directors emphasized the need to boost potential growth to both reduce balance sheet risks and converge to average EU levels of productivity and income. While acknowledging that the trend of improving educational attainment has the potential to offset the impact on growth of an ageing population, they recommended further structural reforms to foster investment and allow high-skilled workers to meet their potential. In this context, Directors highlighted additional gains that could be obtained by removing unnecessary regulatory barriers, lowering energy prices, better coupling wages to productivity, and further improving the debt enforcement and insolvency regime.

Directors also noted the need to avoid the reemergence of external imbalances as a byproduct of increased investment. They encouraged policies to boost private saving and increase the incentive to finance projects through non-debt-creating flows.

It is expected that the next Article IV consultation with Portugal will be held on the standard 12-month cycle.