Mission Concluding Statement 

Portugal: Staff Concluding Statement of the Fifth Post-Program Monitoring Mission

December 8, 2016

An International Monetary Fund (IMF) mission visited Lisbon during November 29—December 7, 2016, for the fifth Post-Program Monitoring discussions—part of the IMF’s regular surveillance of countries with IMF credit outstanding above 200 percent of quota. The IMF mission was coordinated with the European Commission and the European Central Bank. At the end of the visit, the mission issued the following statement:

Portugal’s near-term outlook has improved, primarily on the back of an acceleration of exports seen in the third quarter of 2016. This higher-than-expected growth outturn followed relatively subdued activity in the preceding two quarters. However, a continuation of strong growth that is broad-based would be needed to conclude that a sustained shift to a faster-paced recovery is underway. The authorities’ 2016 fiscal targets are within reach, and the current account is projected to remain in a small surplus. Against the background of improved consumer confidence, the near-term risks to the macroeconomic outlook are broadly balanced. The medium-term outlook, however, remains broadly unchanged and is vulnerable to shocks, given the high stock of public and private debt, continuing banking sector weaknesses, and persistent structural rigidities. This calls for ambitious efforts to improve the resilience of the financial sector, ensure durable fiscal consolidation, and raise the economy’s growth potential.

1. Recent macroeconomic developments point to a near-term rebound from the subdued activity in the first half of the year. Real GDP grew by 1.6 percent (year-on-year) in the third quarter—up from 0.9 percent in the first half of 2016—driven primarily by net exports. The labor market has continued to strengthen, and the unemployment rate has declined to the pre-crisis level of 10.5 percent. Staff now expects economic activity to expand by 1.3 percent in both 2016 and 2017. Looking further ahead, the economy’s high level of indebtedness and persistent structural rigidities are expected to constrain growth at around 1.2 percent over the medium term.

2. Based on the latest data, staff estimates a fiscal deficit of around 2.6 percent of GDP in 2016, implying an expansion of 0.4 percent of GDP in structural primary terms. The authorities’ strong efforts at containing intermediate consumption and public investment well below budgetary allocations have mitigated the impact of a sizeable revenue underperformance on the headline deficit. Gross public debt is projected to reach 131 percent of GDP at the end of 2016.

3. The recently-approved 2017 budget aims for a further reduction in the fiscal deficit, to 1.6 percent of GDP. Based on the specified measures, staff projects a fiscal deficit of 2.1 percent of GDP—an implied primary structural tightening of 0.1 percent of GDP—with public debt remaining elevated at 130 percent of GDP. Under staff’s macroeconomic assumptions, achieving the authorities’ fiscal deficit target would require an additional structural effort of 0.4 percent of GDP. A consolidation effort based on durable expenditure reforms would be more supportive of growth than relying on compression of public investment.

4. The Portuguese banking system continues to deleverage in a challenging operating environment. Banks remain liquid, but cost-cutting measures have not offset the drag on profitability from low interest margins and weak asset quality. The deleveraging has helped banks to reduce risk-weighted assets and associated capital requirements, but balance sheet repair remains incomplete. The stock of legacy assets continues to weigh on the banking system, with provisions being insufficient to fully cover non-performing loans.

5. The authorities’ strategy to strengthen bank balance sheets is based on supervisory, legal, and judicial measures, but the banking system remains constrained by limited capital to absorb further impairment losses. A proactive approach by banks to speed up the process of disposal of legacy assets would be supported by a stepped-up focus on profitability, underpinned by additional cost reductions and increases in efficiency. This would allow banks to increase provisioning for incurred and expected losses. Lengthening the maturity of the government’s loan to the Resolution Fund has removed an important uncertainty facing the banks. Looking ahead, completing the sale process for Novo Banco and the ongoing capital augmentations in public and private banks would reinforce financial stability and improve the operating environment for all banks.

6. Raising the economy’s growth potential will require building on past structural reform efforts. Measures should focus on promoting an efficient allocation of resources in the economy, leading to employment creation and improved export competitiveness. In particular, a flexible labor market where wage increases are aligned with productivity would foster broad-based economic opportunity and allow for greater resilience and faster convergence within the currency union.