Important progress can be seen in the economic and policy environment in Portugal, but challenges remain. Firm implementation of strategy is essential to meet these challenges. It will be essential that expenditure measures move to the forefront, realizing the planned shift away from revenue-based adjustment. Fiscal adjustment will be needed to ensure long-term sustainability. A credible deficit reduction strategy is essential to raise potential growth. The financial system is sound and well supervised, but the government should continue to monitor risks closely.

Abstract

Important progress can be seen in the economic and policy environment in Portugal, but challenges remain. Firm implementation of strategy is essential to meet these challenges. It will be essential that expenditure measures move to the forefront, realizing the planned shift away from revenue-based adjustment. Fiscal adjustment will be needed to ensure long-term sustainability. A credible deficit reduction strategy is essential to raise potential growth. The financial system is sound and well supervised, but the government should continue to monitor risks closely.

1. This statement provides information that has become available since the issuance of the Staff Report for the 2006 Article IV Consultation. The new information does not change the thrust of the staff appraisal.

2. Short-term indicators are mainly positive, further supporting the assessment that a gradual recovery is underway. Export volumes rose strongly in July and industrial production grew solidly in August, as did the Bank of Portugal’s coincident indicator of economic activity. Considered alongside recent developments with oil prices, these indicators imply that the risks related to the staff’s growth forecasts for 2006-07 are tilted to the upside. Data on budget execution through September suggest that fiscal performance remains on track, although the government will of course need to continue monitoring developments closely.

3. Further progress has been made with structural reform. The authorities have signed an agreement with social partners regarding the pension reform and now expect to submit the reform to Parliament next month, behind the schedule indicated in the Staff Report but still in time for its effects to be incorporated in the 2007 budget. In addition, the government has submitted to Parliament new laws on local government financing consistent with the plans outlined in the Staff Report. It expects to submit new laws on the financing of regional governments to Parliament next month, with approval anticipated by January 2007.

4. The 2007 budget proposal submitted to Parliament on October 16 targets a deficit of 3.7 percent of GDP, in line with EDP commitments. While the staff has not had an opportunity to discuss the budget proposal with the authorities, our preliminary analysis suggests that all of the planned deficit reduction of 0.9 percent of GDP is to come from the expenditure side, consistent with the government’s medium-term strategy. About threequarters of the targeted savings would arise from reductions in the public wage bill, reflecting wage moderation, the renewed suspension of the system of automatic promotions, and staff attrition, owing in part to the impact of the public sector reorganization and civil service reforms. The budget also targets cuts in investment. Continued careful monitoring of expenditure, as well as vigorous implementation of planned reforms, will be necessary to achieve the deficit target. This is especially true as the real GDP growth forecast underlying the budget—1.8 percent next year—is somewhat more optimistic than the staff’s current baseline forecast of 1.5 percent.

Portugal: 2006 Article IV Consultation—Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Portugal
Author: International Monetary Fund