Abstract
This 2007 Article IV Consultation highlights that a modest recovery is finally under way in Portugal. Growth rose to 1.3 percent in 2006, led by strong external demand, which is driving a notable rebound in export growth. In response, corporate investment shows signs of strengthening, but overall domestic demand remains relatively weak. Real GDP growth is projected to strengthen to about 1.8 percent in 2007 and 2008. Portugal’s financial system remains sound and well supervised, and appears to have weathered the recent tensions in financial markets relatively well, though risks remain.
September 28, 2007
1. This statement provides information that has become available since the staff report was issued. The thrust of the staff appraisal remains unaltered.
2. The economy continues to show signs of modest recovery. Output growth slowed slightly to 1.6 percent year-on-year in the second quarter (1.9 percent quarter-on-quarter annualized). Domestic demand strengthened as investment rebounded after nine consecutive quarters of decline, and private consumption firmed. As expected, export growth, while remaining robust, slowed somewhat. Unemployment declined to 7.9 percent and labor costs edged up to 3.7 percent year-on-year in the second quarter. The current account deficit continued to narrow. Short-term indicators remained broadly stable; the coincident indicator of economic activity was robust in August, though industrial production slowed. Inflation (harmonized) declined to 1.9 percent year-on-year in August.
3. As envisaged by staff, the fiscal accounts continue to be buoyed by strong revenues. Preliminary data through August indicate that revenue collection remained strong, boosted primarily by corporate tax receipts. Spending remained subdued, in part due to timing issues, but is likely to pick up in the remainder of the year in line with the budget. Further progress has been made with identifying civil servants to be moved to the special mobility pool.
4. Portugal appears to have weathered the recent tensions in financial markets relatively well, though risks remain. Financial markets followed similar trends in Germany, the US and the UK; interbank rates and bank credit default spreads increased and bank equity prices fell. While the recent decline in Portuguese bank equity prices has been somewhat more pronounced, they remain above their end-2006 levels due to the sharp gains made earlier in the year. The Bank of Portugal recently surveyed banks’ liquidity and their exposure to US sub-prime mortgage markets and to asset-backed commercial paper conduits, and found their liquidity position to be comfortable and their exposure negligible. Several banks have also issued new bonds since mid-August. However, as Portuguese banks rely on significant foreign borrowing, protracted tensions in international capital markets, especially in the euro area, constitute a risk.
5. Although real sector indicators are yet to be affected, the recent market tensions have worsened the growth outlook. While the full implications of the market tensions are still being played out, current indications are that the impact on real economic activity in Portugal is likely to be modest—staff have revised down the 2008 forecast from 2 percent to 1¾ percent (with no change for 2007). In line with the greater downside risks highlighted in the current World Economic Outlook, the global growth implications could slow export growth and protracted tensions in financial markets could tighten credit conditions.