Press Release No. 15/23

Press Release: IMF Executive Board Concludes First Post-Program Monitoring with Portugal

January 30, 2015

On January 23, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the First Post-Program Monitoring with Portugal¹.

Following a prolonged recession, the economy is estimated to have expanded by 0.8 percent in 2014 with private consumption as its main driver and investment remaining subdued. With import growth picking up in line with domestic demand, the current account balance declined marginally in 2014. As strong revenue performance helped offset the impact of adverse legal rulings during the year and other spending pressures, the budget deficit target for 2014 is within reach, with an estimated deficit of about 3.9 percent of GDP, net of one-off items. The economic recovery helped unemployment decline to 13.1 percent at the end of the third quarter of 2014, well below the crisis peak of 17.5 percent. Financial stability has been maintained despite recent challenges. Banks’ capital buffers have been strengthened with a Common Equity Tier 1 ratio of 10.6 percent and the loan-to-deposit ratio has been reduced to 114 percent from its pre-crisis peak of 140 percent. Regained policy credibility and benign market conditions have facilitated the resumption of market access at declining yields. Portugal issued close to €17 billion in debt in 2014, and the cash buffer at end-October was €10.5 billion, covering financing needs through the middle of 2015.

Looking ahead, the economy is expected to expand by 1.2 percent in 2015 and private consumption is expected to continue to be the main driver of growth. The current account surplus is expected to decline marginally. Investment is expected to pick up gradually during the course of the year. Based on current policies, the budget deficit is projected at 3.4 percent of GDP in 2015, implying a procyclical loosening of the fiscal stance (by around 0.3 percent of potential GDP in structural terms). Notwithstanding the recent sharp fall in oil prices, the risks to the outlook are mainly tilted to the downside, as significant underlying vulnerabilities, including high public and private debt and lackluster growth prospects, render the economy susceptible to a range of domestic and external shocks. With significant fiscal adjustment needs still ahead, political and legal setbacks constitute a key domestic risk. On the external front, renewed global financial volatility or bond market stress could herald the end of exceptionally favorable financing conditions. This reinforces the need to press ahead with necessary reforms to unlock higher growth while safeguarding against these risks.

Executive Board Assessment²

Executive Directors noted that Portugal ended its EU-IMF supported program in June with restored access to sovereign debt markets and a strong record of policy implementation, having initiated reforms to remove long-standing structural impediments to growth and job creation. Directors observed that the economy has emerged from a deep recession and unemployment is declining rapidly from very high levels, while substantial fiscal consolidation has been achieved and the large pre-crisis current account deficit has turned into a surplus.

Notwithstanding these commendable achievements, Directors noted that Portugal continues to face significant challenges, heightened by a sluggish external environment. They cautioned against a weakening reform momentum and called for efforts to reinvigorate structural reforms to reorient the economy towards higher investment and exports, rebuild the economy’s capital stock and absorb the significant labor slack, in order to lay the foundation for sustainable, inclusive growth.

Directors welcomed the authorities’ strong commitment to achieving the fiscal deficit target of 2.7 percent of GDP contained in the 2015 budget. They stressed the need to keep fiscal consolidation on a firm path by monitoring developments and standing ready to adjust the strategy. In this regard, Directors advised mitigating medium-term fiscal risks stemming from the Constitutional Court’s decision to nullify public wage cuts, and encouraged the implementation of further revenue and expenditure reforms, including containing the wage bill and pension costs in line with the earlier recommendations of the Public Expenditure Review. Looking ahead, they called for continued fiscal consolidation over the medium term to help foster debt sustainability and build market confidence on a durable basis, and for advancement of the fiscal structural reform agenda.

Directors emphasized the need to press ahead with structural reforms to enhance external competitiveness and boost potential growth. They called for further labor and product market reforms to help tackle key bottlenecks to high growth and durable economic rebalancing, given low inflation in Portugal’s key trading partners and the absence of an effective devaluation tool. They also advised reducing rents in the nontradeables sector, in part by improving energy sector efficiency; and adoption of a comprehensive and system-wide approach to corporate deleveraging, to free up resources for investment and job creation.

Directors considered that reducing corporate indebtedness is also central to improving the banks’ operating environment and supporting the process of balance sheet repair. They welcomed the effective resolution of the Banco Espirito Santo and creation of the bridge bank, Novo Banco, to perform the critical functions and operations of the former. Directors stressed that the subsequent restructuring and sale of Novo Banco should aim to preserve financial stability while safeguarding public finances. Following the ECB’s Comprehensive Assessment, they also encouraged efforts to continue to increase capital buffers to strengthen the resilience of the banking system. In particular, Directors underscored the need for banks to maintain robust risk management practices, and called for the reinforcement of supervisory competence by the Single Supervisory Mechanism and the national competent authority, Banco de Portugal, to help deter excessive risk-taking and/or a rise in concentration levels in response to competitive pressures within the Banking Union.