Journal Issue

Portugal: Staff Report for the 2005 Article IV Consultation

International Monetary Fund
Published Date:
October 2005
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I. Overview and Key Issues

1. Portugal has yet to emerge from the slump that followed the bursting of the euro-adoption bubble (Box 1). The euro-related drop in interest rates led to substantial increases in consumption and investment, fueled by bank credit. A rise in primary fiscal spending further fanned the flames of the expansion, and the current account deficit ballooned, reaching 10 percent of GDP in 2000-01. Domestic demand growth slowed in 2001 and turned negative in 2002-03, as firms and households sought to work off the imbalances of the boom years. The resulting sharp increase in the fiscal deficit led to a violation of the SGP ceiling in 2001 that precluded a subsequent countercyclical fiscal policy response. Cyclical difficulties have been compounded by worrying medium-term developments, as productivity and competitiveness—whose weakness was masked by the boom—have continued to slide. Per capita GDP relative to the euro-area average stands barely above its level a decade earlier.

2. The policy strategy to respond to the slowdown did not resolve underlying macroeconomic imbalances (Box 2). Substantial one-off fiscal measures were to bring the deficit within SGP limits while buying time for longer-term reforms to pay dividends. However, the measures adopted—chiefly, an increase in the VAT rate and a freeze in public sector wage increases—did not address in a sustainable manner the source of fiscal problems: the 6 percent of GDP rise in current spending, especially social transfers and wages, over the last 10 years. In addition, progress in the structural reform agenda has been slow. As a result, Portugal confronts a difficult environment, with sizable fiscal and external imbalances; a weak competitive position, especially within an enlarged EU; and high private indebtedness that clouds macroeconomic prospects.

3. Early elections in February 2005 led to the formation of the first single-party majority government in a decade. The government’s reform proposals have engendered strong opposition from some affected parties, however (particularly civil servants), and local elections in October will provide a test of its support. Shortly after the conclusion of the Article IV mission, Finance Minister Campos e Cunha resigned, and was replaced by Fernando Teixeira dos Santos.

II. Economic Developments and Outlook

4. A gradual domestic-demand driven recovery started last year, but was reversed during the second half of 2004 amid ongoing concerns about competitiveness.

  • Real GDP rose 1.2 percent last year, but contracted in Q3 and Q4 on a quarterly basis. Preliminary data show year-on-year GDP growth of 0.3 percent in the first half of 2005.

Box 1.What Accounts for the Boom and Bust?

To some extent, the adjustment witnessed in Portugal can be interpreted as an equilibrium phenomenon: a falling risk premium leads to an increase in investment and wealth, an immediate jump in consumption, and a corresponding decline in savings. The ensuing demand boom is met by higher imports and, because of rigidities and lags in the domestic economy, a widening of the current account deficit. Self-correcting forces would drive the subsequent adjustment, with domestic demand slowing and domestic supply expanding as new investments come on-line.

However, other mechanisms were also at play that aggravated the boom and bust pattern. Specifically, fiscal policy was mostly pro-cyclical in Portugal during the upswing and relative unit labor cost growth was above the euro area average. Fagan and Gaspar (2005)1 point to other factors that could be at work, including indivisibilities in investment and consumer durables that can make the initial burst in demand especially front-loaded, and rigidities in labor and product markets that can hinder the necessary adjustments of the real exchange rate and of real wages needed later in the transition process, making the “slow down” phase of the transition longer and more painful than otherwise.

In drawing lessons for new member states, Fagan and Gaspar (2005) and Constâncio (2005)2 point to the need to ensure that fiscal policy follows a counter-cyclical path during the upswing. While multipliers in a small open economy like Portugal are too small to fully smooth the cyclical path, fiscal policy should (as, for example, in Spain) at least avoid exacerbating upswings and downswings. Both studies also highlight the need for strong banking system oversight, to ensure that rising private indebtedness does not lead to financial sector weakness, and for sensible wage policies.

1/ Fagan, Gabriel and Vítor Gaspar, 2005, “Adjusting to the Euro Area: Some Issues Inspired by the Portuguese Experience,” paper presented at a Conference organized by the ECB on “What effects is EMU having on the euro area and its member countries?” in Frankfurt am Main on June 16–17, 2005.2/ Constâncio, Vítor, 2005, “European Monetary Integration and the Portuguese Case,” in Carsten Detken, Vítor Gaspar and Gilles Noblet (eds.), The New EU Member States: Convergence and Stability, Third ECB Central Banking Conference, October 21–22, 2004, Frankfurt, European Central Bank.

Figure 1.Portugal: Output, 1998–2005

Source: Bank of Portugal; National Institute of Statistics (INE); and Fund staff calculations

1/ Exports and imports represented as year-on-year percent change and net export as contribution to growth.

Box 2.Fund Policy Recommendations and Implementation

Fiscal policy. The Fund has called for fiscal consolidation through structural expenditure measures, including civil service reform. While the fiscal deficit was held below 3 percent of GDP in 2002-04, this was largely through one-off measures, and the underlying deficit remained large. The Fund has also called for strengthening budget planning and control and moving toward comprehensive multi-year budget targets. Implementation has been delayed, but the authorities plan to make progress in this area (¶16).

Population aging. The Fund has emphasized the need to proceed with further reforms of aging-related spending with a view to securing fiscal solvency. Recent reforms to health care and pensions have not prevented a steady build-up of aging-related spending.

Structural policy. The Fund has called for steps to improve general education and vocational training, and to encourage R&D. It has also stressed the need to strengthen competition and flexibility in labor markets. A fully-independent competition authority was established, but red-tape and bureaucratic impediments continue to hamper investment. Reforms have improved labor market flexibility, though there is room for progress (¶23 and ¶36).

Financial sector. The Fund has supported continued supervisory vigilance in light of historically high private indebtedness and risk concentrations. The Fund has suggested a review under the Financial Sector Assessment Program (FSAP), expected to be initiated in 2005.

  • Private consumption has proven resilient, reflecting low interest rates and lengthening tenors on bank lending, while investment and export growth remained weak.

  • A variety of indicators point to continued erosion of Portugal’s competitive position: the ULC- and CPI-based REER have appreciated steadily, the former owing both to wage growth and stagnant productivity; export shares have fallen; FDI has contracted; and employment has shifted from tradables to nontradables production. In these circumstances, the current account deficit (excluding capital transfers) widened to 7.2 percent of GDP last year.

  • The unemployment rate reached a seven-year high of 7.5 percent in 2005:Q1, falling to 7.2 percent in 2005:Q2. Due to the widening output gap—estimated by staff at about 2 percent of GDP—inflation moderated to just over 2 percent in the first half of 2005.

Figure 2.Portugal: Competitiveness Indicators

Source: AMECO database; National Institute of Statistics (INE); Eurostat; and Fund staff calculations.

5. Short-term growth prospects were viewed as poor. Weak domestic demand and continuing problems in the external sector meant that growth was unlikely to exceed ½–¾ percent this year and 1¼–1½ percent in 2006. Private consumption growth looked set to slow as households worked off high indebtedness in the period ahead: at end-2004, household debt stood at 118 percent of disposable income, about double its level of seven years ago and well above the EU average (80 percent). Fiscal adjustment measures were also likely to weigh on domestic demand growth. In addition, poor external competitiveness, concerns about the domestic economy, and a desire by firms to continue strengthening their balance sheets—indebtedness of the private nonfinancial corporate sector had largely stabilized as a percentage of GDP since 2001—would constrain investment growth. Meanwhile, the external sector would continue to contribute negatively to activity, with export growth remaining sluggish in the near term, given the extent of recent competitiveness losses.

6. Inflation in 2005-06 was expected to remain moderate. Despite an increase in the VAT rate that had come into effect on July 1—expected to increase inflation by about ¼ percentage point this year and slightly more in 2006—inflation was projected at about 2½ percent over the coming year and half, held down both by the large output gap and by the increased penetration of imports.

7. The external deficit was expected to widen this year. Excluding capital transfers, staff projected the deficit would reach just over 8 percent of GDP in 2005, reflecting lower real export growth, a terms-of-trade loss from oil prices, and still-high imports. The deficit would continue to be financed by medium- and long-term bank borrowing.

8. Staff and the authorities differed on the medium-term outlook. The authorities saw output growth accelerating relatively rapidly over the medium term, rising to 2½ percent by 2008, a full percentage point above estimated potential, and 3 percent by 2009. Staff took a more cautious line, forecasting growth at around 2 percent in 2008-09, noting that—as shown by experience elsewhere—reducing indebtedness and resolving competitiveness problems could be a lengthy process, and that fiscal adjustment would weigh on growth (see ¶14). Moderate investment growth and budget consolidation should lead to a narrowing of the current account deficit over the medium-term. Staff projections indicate, however, that these developments alone would be insufficient to stabilize the external debt to GDP ratio over next few years (Table 4). In addition to successful implementation of the deficit reduction program, therefore, some increase in private savings—which both the staff and the authorities anticipated—and an improvement in competitiveness will be necessary to prevent substantial rises in external indebtedness. Fiscal adjustment and productivity-enhancing structural reforms are therefore critical to ensuring long-term fiscal and external sustainability.

Figure 3.Portugal: Labor Market Conditions, 1999–2005

Source: Bank of Portugal; National Statistics Office (INE); and Eurostat.

1/ Data through second quarter of 2005.

2/ Proportion of total unemployed who have been unemployed for a year or more.

3/ Proportion of those 15–24 years of age who are unemployed.

Figure 4.Portugal: Monetary Conditions, Real Interest Rates, and Inflation 1998–2005 1/

Sources: Bank of Portugal; National Statistics Office (INE); and Fund staff estimates.

1/ 2005 data through June, unless otherwise noted.

2/ The index is the weighted average of real short-term interest rates and real exchange rates (based on unit labor costs); data through May.

Figure 5.Portugal: High Frequency Indicators

Source: INE, Bank of Portugal, IMF staff calculations, end of period.

1/ Seasonally-adjusted data, 3-month moving average on month-to-month growth, end of period.

2/ 3-month moving average, end of period.

3/ Year-on year growth rate (3-month moving average, seasonally adjusted). The coincident indicator is a composite indicator for economic activity published by the Bank of Portugal. It combines indicators of retail sales, heavy commercial vehicle sales, cement sales, manufacturing production, household’s financial situation, new job vacancies, and a consumer survey of Portugal’s main trade partners.

III. Report on the Discussions

9. Discussions focused on measures to ensure the sustainability of the fiscal accounts and improve competitiveness. There was broad agreement on the need for deficit reduction based on credible expenditure control measures, and for structural reforms to unlock Portugal’s growth potential.

A. Fiscal Policy

10. A mid-year audit commissioned by the new government projected a 2005 fiscal deficit of about 6½ percent of GDP, absent new measures. The significant increase in the forecast—the budget had called for a deficit of 2.8 percent—resulted in part from slower-than-budgeted growth and from the exclusion of all one-off measures (which equaled nearly 1½ percent of GDP in the budget). However, the increase also reflected more realistic estimates for certain expenditures (including health care, pensions and personnel) and nontax revenues than in the original budget, implying an increase in the structural deficit (net of one-offs) of about 1¾ percent of GDP relative to the original budget and about 1¼ percent of GDP relative to the 2004 outturn.

11. In response, the authorities had announced a series of measures, mostly on the revenue side, that are intended to reduce the deficit to 6.0 percent of GDP this year. In July, the authorities increased the top VAT rate by 2 percentage points (to 21 percent), which was expected to increase revenues by about 0.3 percent of GDP this year. Measures to reduce tax evasion were also forecast to yield revenues of about 0.3 percent of GDP this year. The authorities have also announced plans to introduce a new income tax bracket on annual incomes exceeding €60,000 (bringing the top marginal rate to 42 percent) and increase fuel and tobacco taxes, all with effect from 2006.

12. The authorities and staff agreed that these measures would not address the roots of Portugal’s fiscal difficulties. The authorities believed that previous consolidation efforts had failed because they had not targeted the underlying causes of fiscal weakness: persistent increases in spending on wages, pensions, and health care. Even when measures had focused on these spending items, they had generally been ineffective. The authorities pointed, for example, to recent public sector wage freezes, which had not prevented wage drift arising from the system of automatic promotions in force in the civil service and—because they did not apply to lower-paid workers—had contributed to increased compression of the wage scale. Similarly, past pension reforms have had limited impact on the budget because of generous grandfathering. Given the need for measures to ensure early progress in reducing the deficit and limiting the growth of the debt stock, and the fact that expenditure control measures would take time to yield benefits, the balance of adjustment measures in the short term would tilt toward the revenue side. However, these measures were not intended to substitute for more fundamental reforms on the spending side.

13. Accordingly, measures to control the growth of spending—especially on pensions and wages—would over time take on increasing prominence in the consolidation effort. The authorities’ plan—which was endorsed by the Ecofin Council of the EU—seeks to reduce the deficit to 3 percent of GDP by 2008, without one-off measures. Based on the staff’s growth projections, this would imply annual underlying adjustment of 1 percent of GDP in the next three years, somewhat front loaded in 2006 (text table). Medium-term adjustment would be based on three main pillars, though some key elements remained undefined:

(In percent of GDP)
Overall balance 1/-3.0-6.0-4.5-3.8-2.7
Structural balance 2/-2.2-4.8-3.2-2.5-1.6
Net of all one-off measures 3/-4.4-5.0-3.5-2.7-1.8
Memorandum items:
GDP growth (in percent)
One-off measures 2/
Revenues (net of one-off measures)41.341.342.242.442.6
Primary expenditures43.844.543.643.042.1
Public Sector Debt59.465.666.667.767.8

Authorities’ fiscal deficit targets.

In percent of staff’s estimate of potential GDP.

Includes asset sales and the transfer of pension funds.

  • A convergence of the rules governing public sector pensions to those for private sector workers, which are less generous. The system for public workers has been closed to new entrants, and the retirement age for public employees would be raised by six months annually over the next decade until it reached 65, the age for private workers. Pension benefits for civil servants hired before 1993, which had been exempted from a previous reform, would also be reduced.

  • Further reforms to the pension system for private sector workers to reduce costs and ensure its long-run viability. A working group had been formed to evaluate options, and its report is to be issued before end-year.

  • Reforms to enhance public sector efficiency and to modify the career path for civil servants. As a temporary measure, the authorities had frozen the system of automatic promotions, with the expectation that by end-2006 new rules would be in place that would streamline career paths, allow for greater flexibility in allocating staff, and link pay and promotions to performance. In addition, a policy of replacing only half of departing civil servants would gradually reduce the size of the workforce. The authorities were also planning to conduct ministry-level audits over the coming months that would identify measures to enhance efficiency and reduce costs.

14. The staff saw the overall pace of adjustment as broadly appropriate, but argued for greater spending restraint in 2005 and noted that additional measures might be needed in later years. Based on staff analytical work,1 deficit reductions of 1 percent of GDP annually could reduce short-term growth by as much as ¾ percent. However, staff and the authorities agreed that a rapid pace of deficit reduction would still have lower output costs than a more protracted adjustment, including through credibility effects (Box 3). Staff also concurred that the proposed adjustment path, and the front-loading of revenue measures, was a reasonable compromise between more rapid deficit reduction and the fact that pension and civil service reforms would take time to yield significant savings. The staff noted, however, that the structural deficit net of one-off measures would still increase by about ¾ percent of GDP this year, and that the authorities’ revenue projections were based on a relatively optimistic growth forecast (0.8 percent) and assume significant returns from tax administration measures whose yield is difficult to predict. The mission therefore called for greater expenditure control efforts this year, to contain the deterioration in the deficit and/or provide a cushion against possible revenue shortfalls. From a medium-term perspective, the staff argued that the program’s growth forecasts could prove optimistic, and that additional measures (of up to ¾ percent of GDP by 2008) could therefore be needed to achieve the deficit targets in later years.

15. The authorities doubted there was scope for further expenditure containment in 2005, but were prepared to take additional measures as needed to achieve their deficit targets. They believed that the expenditure ceilings in this year’s revised budget were already quite tight, limiting the room for additional spending cuts. In any case, they thought the main risk to the 2005 outcome came neither from central government spending nor from lower revenues but from higher spending by regional and local governments, particularly in light of elections scheduled for later this year. Reforming the system of local government finances—which currently relieved local governments of the political burden associated with increasing taxes and thus contained a significant inducement to spend—was therefore a high priority, although changes would not be implemented this year. Staff noted that the introduction of binding expenditure limits on local governments could be a viable reform option. The authorities agreed with the mission that achieving the program’s headline nominal deficit targets was critical to maximizing credibility, and they were therefore prepared to take additional measures should they prove necessary.

16. The mission also underscored the need to move quickly to clarify the unspecified expenditure measures needed to achieve the 2006 deficit target to enhance the credibility of the adjustment effort. About 0.9 percentage points of the targeted 1.5 percent of GDP in deficit reduction will come from revenue measures already implemented or announced, but spending cuts totaling about 0.6 percent of GDP are also called for in the program, including from the pension and public administration reforms currently under study. The authorities agreed that progress in these studies sufficient to ensure that the impact of the reforms was incorporated in the 2006 budget would be critical. They also agreed that anchoring the deficit targets in a multiyear budget framework would help strengthen fiscal discipline. As a first move, they planned to introduce with the 2006 budget spending goals for the remainder of the legislature. To protect investment in public infrastructure, they were seeking ways to increase Public-Private Partnerships in some projects. The authorities were hesitant to prejudge the findings of the pension reform commission, but the staff noted there could be scope to further reduce options for early retirement and to limit the indexation of pension benefits.

Box 3.Minimizing the Output Costs of Fiscal Adjustment

A number of studies have examined the link between the structure of fiscal adjustment and its short-term impact on growth (see WP/02/208 and the Selected Issues paper). These studies have found that so-called expansionary contractions have some common characteristics:

  • Initial conditions matter. These include a large and persistent fiscal deficit, high public debt, and difficult economic circumstances.

  • The pace and balance of measures also matter. Large and front-loaded contractions and expenditure-based adjustments are less damaging to growth than are backloaded, protracted, or revenue-based ones, as the former are more effective in altering agents’ expectations.

  • Not all spending measures have the same impact. Cuts in current spending are less damaging to growth than those to investment, in general. In particular, cuts in the public wage bill—through wage restraint or reductions in employment—can enhance external competitiveness by putting downward pressure on private sector wages.

What does this literature tell us about the likely output costs of Portugal’s fiscal adjustment? First, Portugal shares some initial conditions with countries that have experienced expansionary contractions. However, Portugal’s participation in monetary union means that two important channels, through which expansionary effects could apply—interest and exchange rates—are not operative. High levels of private indebtedness could also inhibit any expansionary effects of fiscal consolidation. On the other hand, the intended structure of the adjustment, with a focus on controlling expenditure, could help limit its output costs. In order to maximize any confidence effects, however, it is critical that the remaining elements of the adjustment package be clarified as rapidly as possible. Finally, the argument that plans to address the public sector wage bill could have a positive impact on competitiveness is supported by the strong correlation between public and private wages in Portugal.

Portugal: Government Compensation and Private Sector Labor Cost 1996–2005

Sources: Portuguese authorities, and Eurostat.

17. The authorities recognized that planned fiscal adjustments would be only the first stage of a longer process to ensure sustainability. In particular, they agreed that over the medium term a position of near budget balance was needed to create a cushion to absorb the costs associated with population aging: staff simulations show that without additional deficit reduction beyond 2009, the public debt would rise sharply over the medium term (Box 4). An additional 3 percentage points of GDP of fiscal adjustment would therefore be needed after 2008. The authorities noted, however, that some of this adjustment could come from pension reforms to be undertaken as part of their current program, reducing the need for new measures.

B. Enhancing Growth and Competitiveness

18. The authorities and mission agreed that increasing labor productivity was key to resuming income convergence and improving competitiveness. Labor utilization is relatively high, as the employment rate and hours per worker are above the euro-area average, but labor productivity has fallen to only 55 percent of that of the euro area over the last few years. Some of the decline in labor productivity growth could reflect sectoral shifts in the economy, a slowdown in capital deepening, or cyclical factors. Nonetheless, structural reforms to correct deficiencies in product markets and the business environment were recognized as being critical to restart the convergence process (Box 5).

19. The promotion of R&D and IT was the centerpiece of the authorities’ program to boost growth, but the need for more fundamental reforms was recognized. The authorities noted that spending on R&D and IT was well below European averages and believed that greater private investment in these areas could therefore stimulate growth. Staff saw more fundamental reforms to enhance human capital and the returns to innovation as a greater priority. Staff and the authorities agreed, however, that initiatives to promote technological development were in any case unlikely to yield the maximum benefits without measures to improve education, training, and the business environment.

Figure 6.Portugal: Growth Components, 1990–2004

(As percentage of the Euro Area)

Source: Ameco

Figure 7.Portugal: Structural Indicators

Source: OECD, EUROSTAT; Fund staff calculations.

1/ Average of PISA scores in reading, mathematics and science, 2003.

2/ Percent of non-residential gross fixed capital formation, total economy, 2001.

3/ Index EU15=100, 2005 (1st half).

4/ In percentage of GDP, 2002, end of period

Box 4.Fiscal Sustainability

By the staff’s estimate, even if the authorities’ current deficit-reduction targets are realized, reforms equivalent to an additional 3 percent of GDP in budgetary savings after 2008—enough to return the budget to structural balance before age-related spending begins to accelerate rapidly early in the next decade—will be required to ensure debt sustainability.

Under a baseline scenario in which the deficit is reduced to 3 percent of GDP by 2008, but with no subsequent fiscal adjustment, simulations show the debt ratio more than doubling to 140 percent of GDP over the next two decades and continuing to rise thereafter. In an alternative scenario where structural balance is achieved by 2012, following which non-age related spending is kept constant as a percentage of GDP, the debt ratio declines steadily over the next four decades before beginning to rise modestly near the end of the projection period. These scenarios do not, however, include the impact of any pension reforms to be introduced as part of the authorities’ current adjustment program.

Portugal: Long-Term Aging-Related Fiscal Projections, 2000–50

(In percent of GDP)

Sources: Portuguese authorities; and Fund staff calculations.

20. The authorities concurred that there was clear scope to increase the efficiency of education spending. Standardized test (OECD-PISA) results rank Portugal among the bottom six countries in the OECD in students’ math, science and reading literacy, even though public spending per student is above the EU average. Recent reforms had introduced new curricula, increased emphasis on technical training, and closed (and consolidated) very small schools. Reforms were also planned to increase teachers’ classroom time and to reduce teacher rotation across schools. In addition, the authorities planned to increase incentives for worker training, which is low by OECD standards.

Box 5.The Productivity Slowdown

Productivity (year-on-year percentage change)

Labor Productivity Growth (In percent)

Source: AMECO database

Since the mid-1990s productivity growth—the annual increase in output per labor hour—has trended downward. Part of this decline reflects sectoral shifts in the economy: the weight of the services sector—where productivity growth has been relatively low—has increased in recent years at the expense of the manufacturing sector, where productivity growth has been more rapid. In addition, some of the decline in labor productivity growth during the second half of the 1990s can be traced to a slowdown in capital deepening. Nevertheless, TFP growth has also slowed, eventually turning negative since 2000. The very poor productivity performance of the last few years could reflect cyclical factors, but also possibly a decline in the efficiency of investment, particularly given the rising share that has been dedicated to real estate.

21. A number of initiatives were also underway to enhance competition, as high costs in some key sectors were seen as a significant drain on the economy. The new competition authority, created in March 2003, has begun operations, although its effectiveness was constrained by Portugal’s slow legal system (see below). Introduction of the unified electricity market with Spain had been delayed, but the authorities remained committed to the project. Over time, this was expected to lead to a significant reduction in electricity costs. Portugal was granted a derogation until 2007 to implement EU directives for liberalizing the natural gas market, but the government has pledged to complete the process before this deadline. Following the substantial privatization efforts over the last two decade, the authorities saw limited room for further progress in this area.

22. Problems with Portugal’s business environment were also seen as a major impediment to investment. The World Bank’s Doing Business Indicators point to a number of shortcomings, and the Bank’s recent review of governance ranked Portugal in the bottom third of the EU in terms of both the market-friendliness of its regulatory environment and the efficiency of its public service. The authorities pointed to a number of measures that had been introduced to reduce bureaucratic impediments to investment, making it now possible to create a new firm in only one day. In addition, the costs of compliance with the corporate tax system had been reduced, including through enhanced use of the internet. Nevertheless, investors continue to report concerns about considerable delays in the granting of permits and licenses for new plants and products. The authorities acknowledged that the slow pace of Portugal’s legal system was a concern, and they were working to address this issue.

Portugal: Business Climate
PortugalFinlandEstoniaEuro-area 2/
Cost of Starting a Business (in pet of per capita GDP)
Rigidity of Employment Index 1/584441.848.2
Firing Cost (weeks of wages)982438.355
Cost of Enforcing Contracts (in pet of debt)
Cost of Foreclosing a Business (in pet of estate value)8187.4
Source: World Bank (2004) Doing Business Indicators.

An overall measure that captures rigidity of hours worked. A higher number indicates a more rigid environment.

Excludes Portugal.

23. The authorities disputed international indicators pointing to high labor market rigidities, arguing that markets displayed considerable de facto flexibility. A new labor code adopted at end-2003 allowed for more flexible working hours, facilitated the reallocation by firms of labor across regions, and revised collective bargaining procedures (with the introduction of expiry clauses, and more flexibility at the firm level with respect to rules for fixed-term contracting and dismissal). Experience with the new code was, however, too limited to allow definitive statements about its effectiveness. They stressed that while legal restrictions on individual dismissals might be relatively strict, restrictions on collective dismissals—which they felt were more important for facilitating the flow of workers to more productive sectors and achieving a restructuring of the economy—were less burdensome (though, the staff noted, still above average). Moreover, extensive use of fixed-term contracts and self-employment allowed firms to adjust employment in response to economic developments. Accordingly, further labor market flexibilization was not a priority. The staff argued, however, that fixed-term contracts and questionable self-employment were poor substitutes for fundamental reform, creating a segmented labor market and likely contributing to the low level of on-the-job training.

Figure 8.Portugal: Employment Protection Legislation (EPL) Strictness Indicators, 2003

Source: OECD Employment Outlook 2004, end of period.

C. Financial Sector Issues

24. Private sector loan growth continued to outpace income growth in 2004. While growth of bank credit to enterprises slowed, loans to households continued to expand at a rapid pace, with mortgage lending rising at double-digit rates. As a result, the private sector credit-to-GDP ratio continued to increase, reaching about 144 percent—the highest value in the EU.2 The authorities noted, however, that owing to low interest rates and the extension of tenors by banks, the debt service burden for households had remained moderate. They also emphasized that the increase in indebtedness reflected in large part improved access to mortgage credit for a growing number of households, particularly younger ones and those with lower levels of formal education.

25. The financial sector has proven resilient to the economic downturn. Bank profitability has remained solid, as the declining contribution of net interest income has been partially offset by other sources of income (such as fees and commissions) and cost-cutting. Capitalization has improved, reflecting higher growth of own funds, although the Tier I ratio is lower than elsewhere in the euro area. Liquidity has improved, with assets exceeding liabilities at tenors up to three months (on a remaining maturity basis) and gaps narrowing at other short-term maturities, owing to securitization transactions and greater reliance on international capital markets, instead of the interbank market, for funding. Despite the economic slowdown, NPLs (both as a percentage of gross loans and in levels) have remained low, due to favorable interest rates, significant write-offs, and improved risk management. Notwithstanding significant consolidation over the last decade, competition remains strong (Box 6). The financial soundness of the insurance sector has strengthened, owing to a combination of higher premiums in some categories, positive investment yields, slower growth in claims, and rationalization of personnel costs.

26. The authorities nevertheless recognized vulnerabilities arising from the high levels of corporate and household debt. In addition, a high share of loans was at floating interest rates, and loans were concentrated across sectors (real estate loans account for about 60 percent of banks’ total loan portfolio) and enterprises (about 6 percent of borrowers holds about 80 percent of bank credit). Therefore, a sharp drop in growth or rise in unemployment or interest rates could impair loan quality and hamper bank profitability.

27. Progress has been achieved in preparing the financial system for changes in accounting and prudential frameworks. The impact of the application of IFRS standards will be significant but smoothed over time. According to preliminary estimates by the Bank of Portugal, unrealized losses in the investment portfolio of the four largest banking groups, calculated by applying the IFRS rules, amounted to €445 million in 2004 (2.9 percent of their own funds). These losses, however, can in some cases be recognized for prudential purposes over a period up to 2010. In preparation for Basle II, the central bank has intensified its oversight of risk management practices by banks.

Figure 9.Portugal: Credit Developments, 1998–2005

Source: Bank of Portugal, INE and Eurostat.

1/ 2005 data refers to June.

Figure 10.Portugal: Asset Market Indicators, 1998–2005 1/

Sources: Bank of Portugal; Ministry of Finance, Monthly Note on Conjecture; Datastream; and Fund staff calculations.

1/ 2005 data through July.

2/ FTSE Eurotop 100 (in euros).

Box 6.The Portuguese Banking Sector

Portugal experienced significant bank consolidation over the last decade. Between 1995 and 2004, the number of credit institutions declined from 233 to 197, mainly due to mergers and acquisitions.1 Typical market structure indicators, such as the market share of the largest institutions or the Herfindhal-Hirshman index suggest a concentrated market structure for the Portuguese banking industry.

Yet, as discussed in a Selected Issues paper, competitive conditions in the banking sector do not seem to have been adversely affected. The Panzar and Rosse H statistic, which relates changes in a firm’s revenues to changes in input costs—shows that, although conditions of monopolistic competition prevail, there is some evidence that competition improved over 1998–2003 period. In particular, competition seems to be more intense among larger banks, as smaller ones may have been able to carve out niches for themselves. Cross-country studies suggest bank competition in Portugal compares favorably with other euro-area countries.

Portugal: H-statistics

(computed on interest revenue equation)
1/ ECB Monthly Bulletin (May 2005).

D. Other Issues

28. As a relatively small, open economy, trade issues are of considerable importance to Portugal. The textile sector has been significantly affected by the elimination of quotas under the Multi Fiber Agreement. The authorities noted, however, that liberalization had occurred in a context of a significant restructuring of the textile industry that had been ongoing for some time: between 2000 and 2004 employment in the industry had already fallen by about 70,000. The authorities stressed that putting the Doha round of trade negotiations firmly on track remained a high priority. Portugal’s official development assistance as a percentage of GNI has remained lower than in the majority of advanced economies.

29. According to the authorities, the AML/CFT legislation is consistent with EU directives and FATF recommendations. A mutual evaluation by FATF will take place in January 2006.

30. A number of innovations are underway to improve the quality of statistical data (Appendix II). Revisions of quarterly employment data are being undertaken that will facilitate the assessment of productivity developments. In addition, the authorities were in the process of rebasing the national accounts data to 2000. Improvements were also underway in the series on industrial production prices and import prices.

IV. Staff Appraisal

31. In an unfavorable context marked by large fiscal and external imbalances, slow growth, and a weak competitive position, the challenge is to create the conditions to restart Portugal’s per capita income convergence as soon as possible. Doing so will require sustainable fiscal adjustment and measures to improve product and labor markets, enhance the business environment, and strengthen human capital development. The authorities’ policy outlines in these areas point in the right direction, but early action in implementing them will be key to building confidence and credibility.

32. The authorities’ fiscal strategy correctly emphasizes medium-term expenditure containment and sets an appropriate pace of adjustment. Steady rises in the public wage bill and in pension spending in recent years are at the heart of current fiscal difficulties, and the authorities’ intention to focus on these items is well-founded. The decision largely to abandon one-off measures is also appropriate, as they have tended to obscure the true state of the public finances and to add to budget pressure in subsequent years. The planned pace of adjustment, with the deficit falling to 3 percent of GDP by 2008, strikes a balance between the need to make rapid progress in reducing the deficit and the focus on longer-term reforms. However, the authorities should seek to contain spending in 2005, both to limit the deterioration in the fiscal balance this year and to provide a cushion should revenues fall short of projected levels. Over the medium term, the growth forecasts underlying the authorities’ plans may be optimistic. The authorities’ willingness to take additional measures—ideally on the expenditure side—if needed to achieve the deficit targets, including the objective of observing the Maastricht deficit criterion by 2008, is therefore welcome.

33. Nevertheless, one consequence of the focus on medium-term measures is that adjustment in 2005 has come from revenue measures, while expenditure consolidation has yet to commence. This is true in part because a number of key elements of the authorities’ program are still being defined, including reforms of the public administration and of the retirement system for private sector workers. The definition and implementation of these bedrock spending reforms is essential to distinguish the current adjustment effort from previous, unsuccessful attempts at durable fiscal consolidation, and to maximize the credibility of the government’s program. Progress in these areas sufficient to allow them to be reflected in the 2006 budget will therefore be critical.

34. The fiscal adjustment planned for the next four years is but the first—albeit critical—stage of a longer process of deficit reduction. The looming rise in pension and health care spending from population aging underscores the need to find durable measures to improve the quality and efficiency of public expenditure. Greater use of Public-Private Partnerships could help raise spending efficiency, but care will be needed to ensure that these transactions involve an appropriate transfer of risk to the private sector, that contracts and associated liabilities are recorded transparently (including in budget documents), and that commitments to make payments over time to private partners do not unduly constrain future budget flexibility. Reforms to local government financing arrangements—possibly including binding expenditure limits—could also help reduce medium-term fiscal pressures.

35. Planned structural reforms to improve labor productivity are essential to income convergence. The impact of initiatives to promote R&D and IT spending is likely to be enhanced by ongoing and planned reforms to the education and training system, to the business environment, and to the competitive environment. In this regard, recent measures to reduce the time required to open a new business are welcome, but reducing delays in the legal system and accelerating the process of granting licenses and permits should be a high priority. There is also a need to enhance competition in key sectors like telecommunications and transportation, where relatively high costs undermine competitiveness.

36. Additional steps to raise labor market flexibility are also needed. Restrictions on collective dismissals exceed the EU average, and those on individual dismissals are the tightest in the OECD. Extensive use of temporary contracts and dubious self-employment to evade the restrictions creates a segmented labor market, with one class of workers enjoying strong employment protection and a second subject to considerable job instability. Not only do such conditions raise equity concerns, they also hamper productivity growth by slowing the movement of protected workers from low-growth sectors to higher-growth ones. They may also contribute to the low level of on-the-job training.

37. The financial sector has proven resilient to the slowdown, but high debt levels and concentrated bank lending remain a risk. Banks have remained adequately capitalized and liquid, profitability has been solid, and the quality of banks’ loan portfolios has remained broadly stable. Potential vulnerabilities arise mainly from high household and corporate debt and the concentration of loans across sectors and enterprises. The authorities should continue to monitor developments carefully. The authorities’ decision to undertake a Financial Sector Assessment Program this year is welcome, as it will afford an opportunity for a more detailed review of the financial sector.

38. Portugal is encouraged to actively support progress under the Doha round and to increase its ODA toward the UN target level.

39. It is proposed that the next Article IV consultation take place on the standard 12-month cycle.

Table 1.Portugal: Selected Economic Indicators, 2000-06(Changes in percent, except as otherwise indicated)
Domestic economy1/
Real GDP3.82.00.5-
Real domestic demand3.21.7-0.1-
Private consumption3.61.11.2-
Gross fixed investment3.51.3-5.0-10.10.6-0.62.8
Foreign sector contribution0.
Unemployment rate3.
Output gap3.43.01.5-1.3-2.0-3.0-3.3
Compensation per worker (whole economy)
Unit labor costs (whole economy)
Consumer prices (national index)
Consumer prices (harmonized index)
GDP deflator2.
External accounts
Export volume (goods)8.4-
Import volume (goods)6.11.2-0.4-
Export unit value (goods and services)
Import unit value (goods and services)8.30.2-1.9-
Trade balance (in percent of GDP) 1/-12.5-11.9-10.0-8.7-10.3-12.0-11.3
Capital transfers (net, € billions)
Current account including capital transfers (€ billions)-10.3-11.2-7.7-4.3-8.0-9.5-8.8
(in percent of GDP) 1/-8.6-8.8-5.8-3.2-5.6-6.5-5.8
Nominal effective exchange rate-
Real effective exchange rate (CPI based)-
General government finances (in percent of GDP)1/2/
Of which: capital expenditures4.
Overall balance-2.9-4.2-2.8-2.9-3.0-6.0-4.5
Structural balance, excluding asset sales-4.5-5.4-4.5-4.6-4.5-5.0-3.5
Primary balance0.3-1.20.1-0.1-0.3-3.2-1.3
Government debt, Maastricht definition51.253.656.157.759.465.666.6
Financial variables3/
National contribution to euro area M3 4/6.26.8-
Credit to the private sector 5/24.413.810.06.26.5
Interest rates (percent)
Overnight rate5.
Deposit rate, up to 2 years 6/
Loans granted to non-financial corporations 7/
Government benchmark bond5.
Sources: Bank of Portugal; Ministry of Finance; National Statistics Office (INE); and Fund staff estimates and projections.

GDP figures and ratios use revised GDP series with base year 2000

Asset sales, including UMTS receipts, the transfer of the postal pension fund and securitization are netted out for purposes of calculating structural balances.

End-of-period data.

Excludes the currency in circulation held by non-bank private sector.

Includes securitized loans. 2001 onwards it is also corrected for loan write-offs and reclassifications.

Data refer to new deposits before 2003 and to the stock of outstanding deposits thereafter. Before 2003 deposit rate with 91–180 days maturity.

Average rates on outstanding amounts of loans, denominated in Euros to residents in the Euro Area, for each sector and/or purpose, weighted by the corresponding outstanding amounts at the end of the month in each original maturity. Before 2003 lending rate with 91–180 days maturity.

Table 2.Portugal: Balance of Payments, 2000–10 1/
(In billions of euros)
Current account-12.0-12.4-9.7-7.0-10.2-11.8-11.2-10.5-10.0-9.7-9.5
Trade balance-15.0-15.3-13.4-11.8-14.6-17.4-17.0-16.5-16.2-16.0-15.8
Exports fob27.327.528.128.730.030.733.134.836.738.841.5
Imports fob42.342.841.540.644.648.250.151.352.954.857.4
Services, net2.
Of which:
Current transfers, net3.
Private remittances, net3.
Official transfers, net0.
Capital account1.
Current account (including capital transfers)-10.3-11.2-7.7-4.3-8.0-9.5-8.8-8.0-7.4-7.2-6.8
Financial account10.911.
Direct investment-
Portuguese investment abroad-8.8-7.0-0.2-6.5-5.0-1.0-1.4-1.5-1.6-1.8-1.9
Foreign investment in Portugal7.
Portfolio investment, net-
Equity securities-
Long-term debt securities-2.3-2.5-0.2-9.1-8.9-1.8-2.1-1.8-1.9-3.0-2.3
Money market instruments0.93.00.8-
Financial derivatives0.
Other investment, net14.
Of which:
Monetary financial institutions11.914.
Of which:
Reserve assets-0.4-1.0-
Errors and omissions-0.6-0.10.8-0.3-
(In percent of GDP)
Memorandum items:
Current account-9.9-9.7-7.3-5.2-7.2-8.1-7.4-6.7-6.1-5.7-5.3
Current account (including capital transfers)-8.6-8.8-5.8-3.2-5.6-6.5-5.8-5.1-4.5-4.2-3.8
Net international investment position 2/-38.0-42.1-46.5-51.4-57.2-62.2-65.7-68.2-70.0-71.2-71.9
Sources: Bank of Portugal; and Fund staff calculations.

Scenario assumes an improvement in competitiveness through structural reform, and thus differs from the constant policies scenario in Table 4.

End-of-period data.

Table 3.Portugal: General Government Accounts, 2000-06
(In millions of euros)
Total revenues49,04551,81055,97958,77561,36560,32864,211
Current receipts47,38849,63053,64155,10256,24558,15462,102
Tax revenue28,50629,59931,79632,44432,73934,71037,434
Social security contributions13,68214,73815,87216,75017,57617,90718,612
Other current revenues5,2005,2945,9725,9095,9305,5366,056
Capital revenue1,6572,1802,3383,6725,1202,1742,109
Total expenditures52,51257,22959,74162,65865,59469,06971,039
Primary current expenditures42,84546,42550,07652,76355,53659,05360,780
Interest payments3,6703,8823,8943,8083,8324,1254,892
Capital expenditures5,9976,9235,7706,0886,2265,8915,367
Overall balance-3,467-5,420-3,762-3,884-4,229-8,741-6,828
Excluding one-off measures 2/-3,866-5,420-5,583-7,141-7,280-9,073-7,281
(In percent of GDP) 2/
Total revenues40.840.641.843.343.541.542.5
Current receipts39.438.840.140.639.940.041.1
Tax revenues23.723.223.823.923.223.924.8
Social security contributions11.411.511.912.312.512.312.3
Other current revenues4.
Capital revenue1.
Total expenditures43.744.844.646.146.547.547.0
Primary current expenditure35.636.337.438.839.440.640.2
Interest payments3.
Capital expenditures5.
Overall balance-2.9-4.2-2.8-2.9-3.0-6.0-4.5
Excluding one-off measures 3/-3.2-4.2-4.2-5.3-5.2-6.2-4.8
Memorandum items:
Structural balance 4/-4.5-5.4-4.5-4.6-4.4-5.0-3.5
Primary balance0.2-1.20.1-0.1-0.3-3.2-1.3
Primary structural balance 4/-1.5-2.4-1.6-1.8-1.7-2.2-0.3
Public debt (Maastricht definition)51.253.656.157.759.465.666.6
Nominal GDP (in millions of euros)120,302127,767133,826135,822141,115145,366151,082
Change in nominal GDP (in percent)
Real GDP growth (in percent)
Sources: Ministry of Finance; and Fund staff estimates.

Staff estimates based on Authorities’ targets.

Ratios based on new GDP series with 2000 as base year.

Includes the transfer of the postal pension fund in 2003, the state enterprises pensionfunds in 2004, securitization and asset sales.

Structural balances are calculated using the staff’s estimates of potential output. Asset sales, including UMTS receipts, the transfer of pension funds and securitization are netted out for purposes of calculating structural balances.

Table 4.Portugal: External Debt Sustainability Framework, 2000–10(In percent of GDP, unless otherwise indicated)
Debt-stabilizing noninterest current account7/
1Baseline: External debt1/120.3135.5140.1147.7154.0159.1163.1166.6169.8173.0176.0-1.3
2Change in external debt20.
3Identified external debt-creating flows (4+8+9)6.15.0-5.1-6.6-0.61.5-0.4-1.1-1.3-1.2-1.1
4Current account deficit, including capital transfers and excluding interest payments4.23.41.4-
5Deficit in balance of goods and services10.
8Net nondebt creating capital inflows (negative)1.62.7-4.0-5.60.6-0.5-0.6-0.6-0.6-0.6-0.6
9Automatic debt dynamics 2/0.3-1.2-2.6-0.4-2.9-0.3-1.3-1.4-1.1-0.8-0.4
10Contribution from nominal interest rate4.
11Contribution from real GDP growth-4.2-2.3-0.61.4-1.5-0.7-1.9-1.9-1.9-1.8-1.8
12Contribution from price and exchange rate changes 3/0.2-4.2-6.3-5.6-5.2-3.7-3.8-4.2-4.0-4.1-4.0
13Residual, incl. change in gross foreign assets (2–3)13.910.29.814.
External debt-to-exports ratio (in percent)390.2454.9481.3507.2518.9537.3533.5545.5556.1564.9571.2
Gross external financing need (in billions of U.S. dollars)4/42.343.646.148.358.363.564.567.671.075.178.8
in percent of GDP38.138.136.431.433.335.035.235.535.836.536.9
Scenario with key variables at their historical averages5/159.1156.4158.3160.0161.3162.2-4.1
Key macroeconomic assumptions
Real GDP growth (in percent)
GDP deflator in U.S. dollars (change in percent)-
Nominal external interest rate (in percent)
Growth of exports (U.S. dollar terms, in percent)-1.2-
Growth of imports (U.S. dollar terms, in percent)-0.8-2.22.616.820.
Current account balance, excluding interest payments 6/-4.2-3.4-1.40.6-1.8-2.4-1.5-0.9-0.4-0.20.1
Net nondebt creating capital inflows-1.6-

Refers to gross external debt and assumes growth at historical (2000–2005) average.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+ g) + εα(1+ r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε> 0) and rising inflation (based on GDP deflator).

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Assuming no improvements in external competitiveness and priviate savings over the projection period.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and both noninterest current account and nondebt inflows in percent of GDP) remain at their levels of the last projection year.

Table 5.Portugal: Public Sector Debt Sustainability Framework, 2000–10(In percent of GDP, unless otherwise indicated)
Baseline Projections
1Public sector debt1/51.253.656.157.759.465.666.667.767.867.165.0
o/w foreign-currency denominated3.
2Change in public sector debt-
3Identified debt-creating flows (4+7+12)-
4Primary deficit-0.31.2-0.3-
5Revenue and grants40.640.241.943.143.541.542.543.
6Primary (noninterest) expenditure40.341.441.643.043.844.743.843.642.842.140.6
7Automatic debt dynamics 2/
8Contribution from interest rate/growth differential 3/-
9Of which contribution from real interest rate1.
10Of which contribution from real GDP growth-1.9-1.0-0.30.7-0.7-0.3-0.8-1.1-1.2-1.4-1.6
11Contribution from exchange rate depreciation 4/0.60.1-0.2-0.3-0.2
12Other identified debt-creating flows-2.4-
13Privatization receipts (negative)-2.4-
14Recognition of implicit or contingent liabilities0.
15Other (specify, e.g. bank recapitalization)
16Residual, including asset changes (2–3) 5/
Public sector debt-to-revenue ratio 1/126.0133.3134.2133.9136.5158.1156.7157.3157.7155.3151.1
Gross financing need6/17.018.419.521.722.326.626.325.925.424.422.6
in billions of U.S. dollars18893.821077.224621.133394.739115.848350.548244.249553.750777.251141.249758.4
Scenario with key variables at their historical averages7/65.665.466.166.967.768.5
Scenario with no policy change (constant primary balance) in 2005–201065.665.666.467.167.768.2
Key Macroeconomic and Fiscal Assumptions Underlying Baseline
Real GDP growth (in percent)
Average nominal interest rate on public debt (in percent) 8/
Average real interest rate (nominal rate minus change in GDP deflator, in percent)
Nominal appreciation (increase in US dollar value of local currency, in percent)-13.4-3.15.419.79.9
Inflation rate (GDP deflator, in percent)
Growth of real primary spending (deflated by GDP deflator, in percent)
Primary deficit-0.31.2-0.3-

The public sector refers to general government. Uses the Staff’s growth scenario for 2005–10.

Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε (1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Table 6.Portugal: Indicators of External and Financial Vulnerability, 2000-05(In percent of GDP, unless otherwise indicated)
External indicators
Exports (goods, annual percent change in U.S. dollars)-0.8-2.17.522.414.97.1May
Imports (goods, annual percent change in U.S. dollars)-0.2-2.02.317.020.912.5May
Terms of trade (goods and services, annual percent change)-
Current account balance-9.9-9.7-7.3-5.2-7.2-9.5Q1
Current account balance (including capital transfers)-8.6-8.8-5.8-3.2-5.6-8.6Q1
Capital and financial account balance10.
Of which: Inward portfolio investment (debt securities, etc.)
Inward foreign direct investment6.
Other investment liabilities (net)
Official reserves (in billions of U.S. dollars, end-of-period) 1/14.115.315.911.510.711.0March
Broad money to reserves 1/
Central Bank foreign liabilities (in billions of U.S. dollars) 1/
Foreign assets of the financial sector (in billions of U.S. dollars) 2/52.953.260.873.093.493.2May
Foreign liabilities of the financial sector (in billions of U.S. dollars) 2/73.284.3105.1121.8149.1151.3May
Official reserves in months of imports 3/
Exchange rate (per U.S. dollars, period average)
Financial market indicators
Public sector debt (Maastricht definition)51.253.656.157.759.465.6
Money market rate (period average in percent)
Money market rate (real, in percent)1.4-0.1-0.3-0.9-0.3-0.2April
Stock market index (PSI 20, 1992=3000)10,4047,8325,8256,7477,6007,699August
Share prices of financial institutions (2000=100)1009073617482August
Spread of 10-year benchmark bond with euro yield (percentage points)
Financial sector risk indicators
Foreign exchange assets (in billions of U.S. dollars) 4/
Share of foreign exchange loans in total lending (percent) 4/
Deposits in foreign exchange (in billions of U.S. dollars) 5/
Share of foreign deposits in total deposits (percent) 5/
Share of real estate sector in private credit 6/47.347.949.551.453.154.0June
Share of nonperforming loans in total loans 2/7/
Risk-based capital asset ratio 8/
Return on equity for the banking system15.114.911.713.912.8
Household Debt
In percent of disposable income 9/9197104110118
In percent of GDP6165697579
Non-financial corporate debt (in percent of GDP)8693949798
Sources: Bank of Portugal; Ministry of Finance; IMF, Balance of Payments Yearbook database; and Fund staff estimates.

Reserves and foreign liabilities refer to the Bank of Portugal.

Banks only.

Ratio of reserves to harmonized M3.

Non-euro area currencies assets vis-à-vis the resident and non-resident non monetary sector.

Deposits in non-euro area currencies by the resident non-monetary sector and liabilities in non-euro area currencies by the non-resident non-monetary sector.

Real estate defined as the sum of total credit by monetary financial institutions to individuals for housing and to nonfinancial corporations for construction; private credit defined as total domestic credit excluding the general government. Stocks adjusted for securitization operations.

NPL concern households and non-financial corporations.

Capital over risk-weighted assets. Consolidated data for the banking system.

Based on disposable income data prior to the revision of the national accounts.

Table 7.Portugal: Selected Financial Indicators of the Banking System, 2000-04
Capital Adequacy
Regulatory capital to risk-weighted assets (*)
Regulatory Tier I capital to risk-weighted assets (*)
Capital (net worth) to assets 1/
Asset composition and quality
Sectoral distribution of loans to total loans (*)
of which: Housing35.035.336.937.037.7
NPLs to gross loans (*) 2/
Specific provision to NPLs 2/67.766.862.873.083.4
NPLs net of provisions to capital (*) 2/7.98.410.57.53.6
Large exposure to capital (*) 2/
Earnings and Profitability
ROA (*)
R OE (*)15.114.911.713.912.8
Interest margin to gross income (*)62.965.865.060.058.1
Noninterest expenses to gross income (*)51.150.751.850.550.5
Personnel expenses to noninterest expenses61.859.559.359.358.6
Trading and fee income to total income29.525.526.127.729.1
Spread between reference loan and deposit rates 3/
Stock price index of bank shares 4/107.992.269.372.180.7
Liquid assets to total assets (*) 5/15.312.517.115.4
Liquid assets to total short-term liabilities (*) 5/89.185.7108.6115.2
Customer deposits to total (non-interbank) loans86.281.577.277.477.9
FX liabilities to total liabilities 6/
Sensitivity to market risk
Net open position in FX to capital (*)
Net open position in equities to capital6.07.14.7
Sources: Bank of Portugal; and Fund staff estimates.

Core Financial Sector Indicators.

On accounting basis; consolidated.

On a consolidated basis. NPLs are defined as credit to customer overdue.

Based on weighted averages of lending rates to households and to non financial corporations and of deposit interest rates for the two sectors.

PSI Financial Services (Euronext Lisbon); 01/03/2000 =100.

3-month residual maturity horizon.

FX liabilities include foreign currency deposits and deposit-like instruments of resident non-monetary sector and claims of non-resident vis-à-vis resident monetary financial institutions (excluding Bank of Portugal).

APPENDIX I: Portugal: Fund Relations

(As of July 31, 2005)

I. Membership Status: Joined March 29, 1961. Portugal accepted the obligations of Article VIII, Sections 2, 3, and 4 of the Fund’s Articles of Agreement effective September 12, 1988.

II. General Resources Account:

SDR MillionPercent Quota
Fund holdings of currency638.8673.65
Reserve position in Fund228.5526.35

III. SDR Department:

SDR MillionPercent Allocation
Net cumulative allocation53.32100.00

IV. Outstanding Purchases and Loans: None

V. Latest Financial Arrangements: None

VI. Projected Payments to Fund: None

VII. Exchange Rate Arrangements:

Portugal entered the final stage of European Economic and Monetary Union on January 1, 1999, at a rate of 200.482 Portuguese escudos per 1 euro. The official currency was changed to the euro on January 1, 2002.

Portugal maintains an exchange system free of restrictions on the making of payments and transfers for current international transactions, except for exchange restrictions with respect to: Burma/Myanmar; Mr. Milosevic and persons associated with him; certain persons and entities with a view to combating terrorism; Zimbabwe; certain persons and entities associated with Osama bin Laden, the Al-Qaida network, and the Taliban; and certain specific restrictions on economic and financial relations with Iraq, pursuant to European Council Regulations (EC) Nos. 1081/2000, 2488/2000, 2580/2001, 310/2002, 881/2002, and 1210/2003 solely for the preservation of national or international security; those restrictions have been notified to the Fund in accordance with Executive Board Decision No. 144-(52/51).

VIII. Article IV Consultation: Portugal is on a standard 12-month consultation cycle. The last Article IV consultation discussions were concluded at EBM/03/29, 03/26/03.

IX. Technical Assistance:

1998STAFinalize Metadata for DSBB9/98
1998STARevision of Monetary Statistics11/98


Standard Code AssessmentDate of IssuanceCountry Report No.
Fiscal TransparencyDecember 1, 200303/373

XI. Resident Representative: None

APPENDIX II: Portugal: Statistical Issues

1. Data provision to the Fund is adequate for surveillance purposes. Portugal subscribes to the Special Data Dissemination Standard (SDDS), and the relevant metadata have been posted on the Dissemination Standards Bulletin Board. Portugal has taken a flexibility option regarding the timeliness of reporting wages. Portugal’s publication policy is characterized by a high degree of openness and with extensive use of the Internet. The Bank of Portugal, Ministry of Finance, and National Statistics Office (INE) have several websites with long- and short-term economic indicators and data.

2. Notwithstanding some recent improvements, considerable statistical weaknesses continue to hamper an assessment of economic developments.

3. Real sector statistics were improved in the fall of 2000, when INE published a full set of national accounts based on ESA95 methodology, including quarterly GDP estimates. The authorities are in the process of rebasing national account statistics to 2000. However, statistical weaknesses remain and the Bank of Portugal continues to produce separate estimates of the annual national accounts. Shortcomings in timely and high quality monthly and quarterly data on output, employment, and total wage compensation hamper the monitoring of within-year developments in the labor market. Unemployment data also suffer from statistical problems caused, inter alia, by frequent revisions to the measurement of unemployment and sampling rotations.

4. Fiscal sector data have undergone a number of revisions during the transition to ESA95, sizably altering revenues and expenditures and hampering comparisons across years. Some progress was made and the 2001-04 budgets were presented fully consistent with recent changes in national and fiscal accounting methodology. Intra-year budget data is available only on a cash basis. In 2002 INE started to publish data for the Social Security Fund on a monthly basis with 45 days delay and in 2003 for Autonomous Funds on a quarterly basis with 75 days delay. Except for the local and general government, data broadly meet the SDDS timeliness standards. A project is underway concerning quarterly general government statistics on an accrual basis, but no firm timetable is in place for publication of the data.

5. Trade and balance of payments data are provided according to the IMF’s Fifth Edition of the Balance of Payments Manual. Although the external trade data meet the timeliness standards, frequent and sizeable revisions hamper their usefulness. The portfolio investment collection system has a simplified threshold of €500 million, which is relatively high in comparison with many EU countries. The authorities estimate however, that only about 2 percent of transactions are not captured on a monthly basis by this threshold, and that this reporting simplification does not significantly hamper the quality of the monthly balance of payments. Moreover, they indicated that all transactions below this threshold are included in the first release of the annual balance of payments data, and the monthly numbers are revised accordingly.

Portugal: Table of Common Indicators Required for SurveillanceAs of August 29, 2005
Date of Latest ObservationDate ReceivedFrequency of Data7Frequency of Reporting7Frequency of Publication7
Exchange Rates8/29/0508/05DDD
International Reserve Assets and Reserve Liabilities of the Monetary Authorities106/0508/05MMM
Reserve/Base Money06/0508/05MMM
Broad Money06/0508/05MMM
Central Bank Balance Sheet07/0508/05MMM
Consolidated Balance Sheet of the Banking System07/0508/05MMM
Interest Rates206/0508/05WWW
Consumer Price Index06/0508/05MMM
Revenue, Expenditure, Balance and Composition of Financing3 – General Government406/0508/05MMM
Revenue, Expenditure, Balance and Composition of Financing3 – Central Government06/0508/05MMM
Stocks of Central Government and Central Government-Guaranteed Debt506/0508/05MMM
External Current Account Balance2005 Q208/05QQQ
Exports and Imports of Goods and Services2005 Q207/05QQQ
GDP/GNP2005 Q107/05QQQ
Gross External Debt62005 Q107/05QQQ

Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.

Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.

Foreign, domestic bank, and domestic nonbank financing.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.

Including currency and maturity composition.

Although overall gross external debt is not available, public sector gross external debt is available on a monthly basis, with the last release for 2/05 on 3/24/05.

Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A); Irregular (I); Not Available (NA)

See the Selected Issues Paper.

At end-2004, household debt was 118 percent of disposable income, well above the EU average of 80 percent, and non-financial enterprises’ debt was 98 percent of GDP.

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