Portugal: 2022 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Portugal
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International Monetary Fund. European Dept.
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Publication Date:
30 Jun 2022
eISBN:
9798400211034
ISBN:
9798400211034
Language:
English
Keywords:
potential GDP; core inflation; GDP downgrade; financial situation; IMF staff calculation; Energy prices; Global
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1. Before the pandemic, the Portuguese economy had strengthened significantly, but productivity growth remained modest. Growth averaged 3 percent in 2017–19 and unemployment fell to a 15-year low of 6.7 percent, supported by exports and tourism. Public and private debt were on a downward path, although still elevated. The banking system had achieved a steady reduction of impaired assets and improved capital positions. However, weak productivity growth reflected a low share of skilled labor, dominance of small and low-productivity firms, an ageing population, and structurally high youth unemployment. Per-capita income remained some 30 percent below the EU average.

Abstract

1. Before the pandemic, the Portuguese economy had strengthened significantly, but productivity growth remained modest. Growth averaged 3 percent in 2017–19 and unemployment fell to a 15-year low of 6.7 percent, supported by exports and tourism. Public and private debt were on a downward path, although still elevated. The banking system had achieved a steady reduction of impaired assets and improved capital positions. However, weak productivity growth reflected a low share of skilled labor, dominance of small and low-productivity firms, an ageing population, and structurally high youth unemployment. Per-capita income remained some 30 percent below the EU average.

Context

1. Before the pandemic, the Portuguese economy had strengthened significantly, but productivity growth remained modest. Growth averaged 3 percent in 2017–19 and unemployment fell to a 15-year low of 6.7 percent, supported by exports and tourism. Public and private debt were on a downward path, although still elevated. The banking system had achieved a steady reduction of impaired assets and improved capital positions. However, weak productivity growth reflected a low share of skilled labor, dominance of small and low-productivity firms, an ageing population, and structurally high youth unemployment. Per-capita income remained some 30 percent below the EU average.

uA001fig01

Nominal GDP Per Capita

(Euros)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF WEO.

2. After being harder hit by the pandemic than the EA, the economy has been on a sustained recovery. Reflecting its reliance on tourism, GDP fell 8.4 percent in 2020 (EA: -6.5 percent). Growth rebounded to 4.9 percent in 2021, helped by unprecedented policy support and an impressive vaccination drive (95 percent of the population is fully vaccinated). The effects of Omicron were relatively muted (Figure 1). Activity restrictions were lifted in early-2022 and the economy strengthened sharply in Q1.

Figure 1.
Figure 1.

Portugal: Covid-19 Developments, March 2020-May 2022

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: Bloomberg; Google Mobility: European Centre for Disease Prevention and Control; Banco de Portugal; and Our World in Data.
uA001fig02

Negative Correlation between Output Losses and Share of Tourism, 2021Q4

(Percentage Point)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: IMF WEO; and WTTC.

3. The war in Ukraine poses new headwinds. Direct exposures to Russia and Ukraine are limited, and Russian energy imports comprise less than 10 percent of total energy supply (Figure 2). However, Portugal will be hit by sharp increases in energy and food prices (oil and gas account for 70 percent of energy use), and lower European trading partners’ demand. Refugee inflows from Ukraine have increased steadily since the start of the war, exceeding 36 thousand in early May.

Figure 2.
Figure 2.

Portugal: Exposure to Spillovers from the War in Ukraine

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

4. The center left socialist party that led a minority government during 2015–2021 emerged with an outright majority in the January 2022 elections. The new government has recommitted to a timely implementation of the NRRP financed by the Next Generation EU (NGEU) funds, public debt reduction, and structural reforms, which featured prominently in previous Article IV recommendations (Annex I).

Recent Developments

5. A gradual, but uneven, recovery continued through early 2022 (Figures 4–5). Growth rebounded to 4.9 percent (y/y) in 2021, reflecting strong private consumption and NGEU investment, while tourism improved faster from 2021:H2. Private consumption growth eased with the Omicron wave and supply-chain bottlenecks hampered manufacturing activity starting in late 2021. However, the recovery regained momentum in 2022:Q1, when GDP rose by 2.6 percent q/q (one of the highest in the EA) and surpassed the pre-pandemic level.

Figure 3.
Figure 3.

Portugal: Private Sector Leverage and Credit, 2008–2021

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: Eurostat and Haver Analytics.
Figure 4.
Figure 4.

Portugal: Covid-19 Pandemic and its Economic Impact, 2020–2022

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: IMF WEO; Eurostat; Bloomberg; Oxford University; and Banco de Portugal.
Figure 5.
Figure 5.

Portugal: Labor Market Indicators, 2017–2021

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: IMF WEO; Eurostat; INE; Haver Analytics; and IMF staff calculations.

6. Inflation pressures, induced by commodity prices, have become broad-based (Figure 6). The Harmonized Index of Consumer Prices (HICP) inflation stood at 7.4 percent (y/y) in April 2022 (EA: 7.4 percent), mostly due to fuel, transport, and food prices. Core inflation (HICP excluding energy and unprocessed food) has also risen to 5.3 percent (y/y) in April 2022 (EA: 3.9 percent) reflecting broadening inflation pressures into other components, specifically, housing and utilities, transportation, and hotels and restaurants. Energy prices increased by 27 percent (y/y) in April (EA: 38 percent) reflecting policies that allow a slower passthrough to retail prices.1 However, wage inflation—measured by growth in compensation per employee—(2.9 percent (y/y) 2021 :Q4) is still contained and below the EA average (3.5 percent (y/y) 2021 :Q4).2

Figure 6.
Figure 6.

Portugal: Inflation Developments, 2020–2022

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: Eurostat; Haver Analytics; and IMF Staff Calculations.
uA001fig03

Portugal and Euro Area: Contribution to Inflation

(Percent)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Eurostat.

7. The policy response to the pandemic was timely and comprehensive (Figure 7, Annex II):

  • Above the line cumulative measures in 2020–21 included discretionary measures (6.1 percent of GDP) and automatic stabilizers (2¾ percent of GDP). This included higher health spending, job retention and wage subsidy programs and expanded social safety nets.

  • Below the line and other measures comprised 4.5 percent of GDP in 2020–21 to contain NFCs’ liquidity stress mainly via state-guaranteed credit lines for the most-affected firms (covering 12 percent of NFC loans at end-September 2021).

  • A large public moratorium was extended several times until September 2021, covered 18.7 percent of total loans at the peak (September 2020) but falling under 0.1 percent at end-2021.3 Bankruptcy filing obligations remain suspended.

  • The EU’s NGEU (mainly RRF and REACT-EU) of 8 percent of GDP in grants over 2021–26 provides sizeable funding for economic transformation. The government intends to use only some 1½ percent of GDP in loans (out of 7 percent of 2020 GDP available). SURE loans provided 2.9 percent of GDP against unemployment risk.

  • Fiscal room was boosted by ECB policies. The Eurosystem holdings rose from 18 percent of sovereign debt in 2019 to 29½ percent in 2021. Despite high public debt (127.4 percent of GDP in 2021), sovereign spreads remain compressed. While long-term bond yields have risen by 125 basis points (bp) since mid-2021, spreads to German bunds have risen by much less (40 bp).

Figure 7.
Figure 7.

Portugal: Fiscal Sector Indicators

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: IMF WEO; Haver Analytics; ECB; OECD; European Commission; and IMF staff calculations.

Discretionary Fiscal Support Measures

(In Percent of GDP)

article image
Source: Portuguese authorities and IMF staff estimates.

Excludes tax deferrals.

Scheme for the temporary interruption of work.

uA001fig04

Discretionary Fiscal Response: 2020–21

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF Fiscal Monitor Database (October 2021).

8. Pandemic policy support is estimated to have saved about one-third of jobs and one-fifth of NFC output (Selected Issues Paper, SIP I). During 2020, about 40 percent of Portuguese firms experienced an increase in leverage, while the share of firms in financial difficulty (with leverage ratio above 7.5) rose from 20 to 28 percent. A Resilience and Capitalization Fund was created (¾ percent of GDP) to support debt reduction and recapitalization of viable corporates with equity and quasi-equity instruments. The authorities also launched a program to incentivize distressed but viable firms to restructure bank loans supported with a partial government guarantee, but received limited take up, partly reflecting difficult-to-meet qualifications criteria, and perceived better alternatives, including an European Investment Bank (EIB) Group credit guarantee operations.

uA001fig05

Portugal: Share of Firms by Financial Situation (2020–2019)

(percent of reporting continuing firms financial difficulty is if debt-to-equity is 7.5)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: Orbis and IMF staff calculations.Note: D E= debt-to- equity ratio measures as ratio of current and non-current liabilities to shareholders funds.

9. Several measures have been taken in response to surging energy prices. Support (0.6 percent of GDP) extends October 2021 measures (reduction in excise duties on oil products, monthly subsidies for fuel prices at the pump) until at least June 2022 and introduces new temporary measures for this year (freezing carbon taxes, oil tax reduction for agriculture, augmentation of subsidies to firms, flexibility in tax payments’ regime, spending on refugees). Liquidity support has been granted to the hardest-hit sectors (transport, agriculture).

Portugal and Spain were granted an exception by the European Commission to set maximum price ceilings for gas in the Iberian market to control electricity inflation. The authorities are also awaiting the EC’s approval for a temporary lowering of fuel VAT rates, and pending this decision, have temporarily reduced oil taxes (equivalent to a 10-pp cut on fuel VAT).

Fiscal Measures to Mitigate the Impact of the War in Ukraine

article image
Source: Portuguese authorities and IMF staff estimates.

10. The unemployment rate rose only ½ percentage point (pp) and has since recovered, while mirroring the divergence in output recovery. Employment and labor force participation in 2021 already surpassed the 2019 level and unemployment reached 5.9 percent by March 2022. Total hours worked in 2022:Q1 stood around 1 per cent above the 2019 level, but employment indicators lag for contact-intensive sectors (Figure 5). The young, low-skilled, and workers with temporary contracts—disproportionately hired in the contact-intensive sector—were worse affected. At the same time, many sectors are faced with labor shortages (in high and low skills), partly reflecting early retirement during the pandemic and lower foreign workers inflow

uA001fig06

Portugal: Unfilled Job Vacancies by Sector

(Numbers)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Eurostat

11. In contrast to previous crises, private credit held up and residential real estate prices surged (Figure 3). As in other EA countries, residential real estate prices have increased sharply, gaining 20 pp in real terms and relative to rents, and suggesting overvaluation of 8–17 percent (Annex III). While housing credit was not a factor behind the rise in house prices and has picked up only recently (averaging 4 percent y/y growth in 2021:H2–2022:Q1),4 the stock of housing credit has been rising. Housing affordability concerns have also risen.

12. The banking sector has been resilient so far, but a potential credit deterioration has yet to fully materialize.5 Financial health improved in 2021 though capital and asset quality remained weaker than EA averages. The drop in NPLs reflected policy support, NPL sales to investors, and write-offs. While staff estimates suggest that the banking system, on average, should be fairly resilient to adverse shocks, including from the war impacts, there is considerable variation across banks.6 A few legacy domestic banks are still to complete their restructuring process. Moreover, the share of stage 2 loans is 13 percent in total loans (Figure 8).

Figure 8.
Figure 8.

Portugal: Bank Loans Under Moratoria

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: Eurostat; Banco de Portugal; and European Banking Authority.
uA001fig07

Banking Sector: Profitability, Capitalization, Liquidity and Nonperforming Loans

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: EBA Risk Dashboard; and IMF staff calculations.Note: The whiskers correspond to the 25th and 75th percentiles. Sample comprises EBA-reporting institutions.

13. The 2021 external position is assessed to be broadly in line with medium-term fundamentals and desirable policies (Annex IV). As tourism receipts collapsed at the onset of the pandemic, the current account recorded its first deficit since 2011 at -1.1 percent of GDP in 2020 (Figure 9). The deficit remained broadly similar in 2021, as higher imports—reflecting rebounding consumption and investment and worsening terms-of-trade—offset improving exports, the latter limited by supply-chain bottlenecks and slower tourism recovery.

Figure 9.
Figure 9.

Portugal: External Sector Indicators

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: Eurostat; Haver Analytics; and IMF staff calculations.

Outlook and Risks

14. Growth is projected to average 5.8 percent in 2022 and 1.9 percent in 2023. The pickup in 2022 growth reflects the strong bounce-back in tourism and domestic demand in Q1. However, activity in the rest of the year is expected to be impacted by negative spillovers from trading partners’ demand, adverse terms-of-trade, higher energy and materials costs, and lower confidence. Factoring in the Q1 growth outturn, this entails a 2022 GDP downgrade of some 1–1½ percent relative to pre-war.7 The baseline projections assume: no escalation of the war; softening in commodity price growth in 2023; gradually rising interest rates; and fiscal policy supportive in 2022 and neutral in 2023. Growth will be driven by private consumption—as household saving rates fall to pre-pandemic levels faster— net exports, and NGEU-backed investment. Tourism is expected to reach its 2019 level in 2023 (SIP II).

uA001fig08

Contribution to Real GDP Growth

(Percentage points, year-on-year)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: IMF WEO; and IMF Staff Forecasts.

15. Medium-term growth is expected to converge to below 2 percent with some scarring. NRRP investments and reforms are expected to raise output by 2 percent over the medium term (Annex V), without which scarring would be higher. Staff estimates suggest that the share of tourism in GVA could stay some ½-2 percentage points below its pre-pandemic trend, offset by higher shares of sectors such as ICT (SIP II). However, if risks from heightened NFC leverage and zombification are unresolved, or get amplified further by war-related shocks, medium-term TFP growth could be weakened materially due to allocative efficiency and productivity losses (SIP I). The output gap is expected to close gradually over the medium term and GDP to remain some ½ percent below the pre-pandemic trend.

uA001fig09

Real Output Loss

(2019=100)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: Portuguese Authorities and IMF staff estimates.

16. Inflation is projected to average 6.1 percent in 2022 and start receding in 2023 as energy price growth softens and supply-side disruptions ease (Figure 6). Core inflation is expected to average 4.5 percent in 2022 and decline slowly over the forecast horizon, reflecting the broad-based nature of inflation pressures. However, second-round effects are expected to remain broadly contained and inflation expectations anchored, allowing inflation to decelerate towards 2 percent in the medium term.

17. The current account deficit is expected to widen significantly in 2022, before narrowing over the medium term, as terms-of-trade normalize, and exports and tourism receipts recover. Similarly, the negative NIIP position is projected to decline over the medium term as the current account deficit narrows and the fiscal balance improves.8

18. Risks remain tilted to the downside amid high uncertainty (Annex VI). Besides potentially new virus waves, the main risk stems from the war in Ukraine. A faster normalization of ECB monetary policy and tighter financial conditions could hurt growth and the fiscal position. The end of loan moratoria could eventually expose higher insolvencies, lowering investment and bank capital. Slower use of NGEU funds could weaken the recovery. Moreover, despite its projected decline, public debt will remain high and vulnerable to downside risks, potentially aggravated by sovereign-bank-corporate linkages, while rising real estate prices pose additional risks. More protracted supply-side bottlenecks, higher commodity prices, and wage pressures could lead to persistently higher inflation and weaken prospects further. On the upside, a stronger tourism recovery, continued strength in pent-up demand and higher payoffs from NGEU investments would brighten the outlook.

Authorities’ Views

19. The authorities broadly agreed with staff’s assessment of the outlook and risks but expected annual growth in 2022 to be stronger, reflecting carryover effects from 2022:Q1. They noted that labor market employment and participation rates were already above pre-pandemic levels. They agreed that inflation will likely peak this year, although the broad-based nature in inflation and likely persistence may imply inflation converging to a slightly higher than pre-pandemic level. The views on risks were broadly aligned, although the authorities noted that a stronger bounce-back in tourism and manufacturing exports presented important upsides. They concurred with staff’s external sector assessment and that a significant reduction of the NIIP to more prudent levels would require a sustained current account surplus over the medium term.

Policy Discussions

A. Fiscal Policy

20. The fiscal deficit fell to 2.8 percent of GDP in 2021, beating budget projections. VAT and PIT overperformed and capital allocations were underspent. The overall fiscal position was appropriately supportive. However, some 2 percent of GDP of the 2020–21 fiscal measures relative to 2019 are expected to be permanent—¾ of the 1 percent GDP increase in wage bill reflected trend increases in public wage and employment growth; reference increases in pensions and other social spending will also add to recurrent spending.

uA001fig10

Fiscal Balance and Primary Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF WEO.

21. The 2022 fiscal position is expected to remain suitably accommodative with a structural primary balance broadly similar to 2021.9 The fiscal deficit is expected to narrow to 2.2 percent of GDP, largely reflecting the boost from the recovery and unwinding of the remaining temporary Covid-19 measures, despite additional measures in response to higher energy prices. NGEU grant-financed spending will provide additional support (1.5 percentage points).

22. However, some fiscal measures should be better targeted. The planned outlays on expanding ALMPs, social housing, education and public sector digitalization, and NFC solvency support are welcome. However, plans for general tax relief, including for the youth, and expanded family support allowance should be better targeted. The projected expansion in current spending should be offset with equal measures over time. Similarly, the broad-based measures on energy price relief, caps on wholesale electricity prices, and energy tax cuts should preferably be replaced with more targeted and temporary support for vulnerable households and the most affected and viable firms, while preserving price signals for most users to facilitate energy savings.

23. Contingency measures may be needed under severe downside risks. Automatic stabilizers should be fully deployed if growth disappoints. For potentially new pandemic waves that entail extensive activity restrictions and severe downturns, extension of existing short-term work schemes, social benefits, and turnover loss compensation grants could be considered, balancing cautiously near-term macro-stabilization with medium-term debt sustainability priorities.

24. Starting 2023, a gradual and steady growth-friendly fiscal adjustment is needed to rebuild policy space, improve expenditure composition, address longer-term fiscal pressures and alleviate public debt risks.

Motivation. Under the baseline assumption of unchanged policies, public debt is projected to steadily decline to below 100 percent of GDP, driven by favorable (r-g) dynamics, but remain high and more market-reliant as ECB support normalizes. Despite rising nominal yields, the extended maturity profile—with maturing debt being rolled over at lower rates than rates at which they were originally contracted—and low effective interest rates over the medium term offer comfort. Nevertheless, risk perceptions may change abruptly. Portugal remains susceptible to a faster-than-projected normalization of ECB monetary policy and spillovers from negative events in the rest of the EA, through co-movement of market risk perceptions (2019 Article IV staff report).10 Contingent liabilities related to the credit guarantees and a potentially larger-than-expected impact of the end of moratoria on firms and banks as well worsening financial health of SOEs since the pandemic also add risks (Annex VII). RRF-backed spending provides a window to rationalize current spending, rebuild room for ageing-related spending and avoid cliff effects on public investment at the end of the RRF. Early identification and announcement of fiscal measures would anchor the fiscal path.

Pace. A sustained and gradual discretionary consolidation—averaging annually 0.5 percent of GDP in the structural fiscal balance during 2023–26 is advisable (relative to the authorities Stability Program, which assumes no policy change), with flexibility to respond to shocks. The pace of consolidation should be data dependent, with more ambitious fiscal savings under fiscal overperformance, and full operation of automatic stabilizers under downside scenarios.

Measures. The following measures provide scope for the recommended consolidation.

  • Tax reforms should aim at greater efficiency, remove distortions, and broaden the tax base. There is scope for institutional reform to strengthen tax policy and tax expenditure analysis, reduce proliferation of tax incentives, and revisit reduced VAT rates.11’12 Increasing property taxes would also raise revenue and improve the tax mix.13’14

  • Rationalizing current spending. The estimated increase in ageing-related fiscal outlays of ¾ percent of GDP is a key medium-term headwind. Spending reforms should include bolstering pension sustainability. Key reforms include simplification of non-contributory benefits regimes, including eliminating duplication, strengthening contributory working period incentives of minimum pensions, extending the link between increases in the retirement age and life expectancy gains to the minimum age of early retirement, and abolishing special (early) retirement ages for specific subgroups,15 (see 2019 IMF Staff Report and OECD Pensions report 2021); strengthening financial management and spending rationalization in the NHS; improving social benefits targeting, spending reviews; and improving SOEs’ financial sustainability and governance. Containing the public wage bill over the medium term will require a comprehensive review of the public employment and compensation structure.

  • Composition. Over the last decade, public investment has fallen from high levels to below EU peers. The NRRP can reverse this trend, with significant investment in R&D spending, digital and climate transitions. Transparent planning and budgeting, implementation, and oversight will be key for timely and effective absorption of the EU funds.

Potential Revenue Measures

(In percent of GDP)

article image
Source: GTAP, European Commission, and IMF staff estimates.

Direct cross-country comparisons of the value of tax expenditures need to be interpreted with caution. Tax expenditures are departures from country-specific benchmark tax systems and their aggregation can result in over- or underestimation.

Revenue lost to VAT fraud and evasion, VAT avoidance and optimisation practices, bankruptcies and financial insolvencies, as well as miscalculations and administrative errors.

uA001fig11

Public Gross Fixed Capital Formation

(percent of GDP)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Eurostat.

25. Addressing growing distributional challenges will also be key. The Covid-19 crisis reinforced existing social challenges in regional inequality of opportunity, poverty, social exclusion and housing affordability. Some 21.1 percent of the population was still at risk of poverty or social exclusion in 2019. While this has steadily fallen in recent years, workers with short-term contracts, rural areas residents, and children remain at risk. Strengthening social assistance will require streamlining complex regulations and requirements that determine entitlement (OECD, 2021).

26. Completing ongoing structural fiscal reforms would strengthen fiscal sustainability. Efforts to centralize integrated reporting of Covid-19 spending and the RRP implementation on the national Transparency Portal seek to improve accountability and transparency of public expenditure. Amendments to the Budgetary Framework Law approved in April will strengthen the ex-post evaluation of macroeconomic forecasts, and the role of the Public Finance Council but further reforms are needed to: (i) fully implement the 2015 Budgetary Framework Law (BFL) to upgrade budgetary processes and integration of annual budgets within a medium-term budgetary framework, expenditure controls, and cost efficiency; (ii) reinvigorate NHS reforms to enhance governance, resolve planning and management control weaknesses, and do away with the recurrent arrears; and (iii) timely, transparent, and comprehensive monitoring of the financial situation and performance (enhanced management contracts, strategic management plans) of state-owned enterprises (SOEs), and structural reforms to improve pension sustainability (OECD, 2021, IMF Staff Report 2019).

Authorities’ Views

27. The authorities were confident that fiscal performance would improve significantly in 2022, despite the new energy crisis measures. The strong recovery was boding well for the revenue outlook. Also, unwinding of Covid-19 emergency measures would more than compensate discretionary energy-related expenditure. These factors would allow the headline deficit to fall to 1.9 percent of GDP. On the economic fallout from the war in Ukraine, they noted that the new measures focused on ameliorating the effects of heightened energy prices on overall inflation, vulnerable households, and energy-intensive sectors. They cautioned that downside risks may require some measures to be maintained for longer and stressed the importance of the prompt adoption of a joint European strategy for coping with these challenges.

28. The authorities reiterated commitment to fiscal discipline, underscoring their strong track record of fiscal overperformance. They stressed that political stability in the parliament was conducive for policy continuity and thereby implementing the RRP, promoting potential growth while maintaining sound public finances. They noted that past pension reforms had mitigated the fiscal effects of an ageing population, but more effort would be needed in the coming years. They plan to create a working group to explore options to strengthen pension system sustainability. They highlighted the April-2022 amendments to the Budgetary Framework Law strengthened fiscal policy evaluation and oversight. In parallel, efforts will continue on improving efficiency of public investment and strengthening governance and financial performance of SOEs.

B. Corporate and Financial Policies

29. Despite policy support, NFCs’ solvency needs are estimated to have increased by some 2¼ percent of GDP (SIP I).16 Firms impacted include both, the micro and small firms, with lower capital needs but higher employment base, and medium and large firms, particularly in the transport sector, with systemic economic presence. Moreover, the share of zombie or low-productivity firms is expected to rise, which would depress productivity and investment, unless addressed promptly. Additional vulnerabilities due to the war in Ukraine, cost-push pressures, supply-chain disruptions and higher interest rates could elevate insolvency risks.

30. Leveraging banking sector technical expertise for NFC viability assessments is essential in providing timely support to viable firms. Prompt recapitalization will also help viable firms better handle the energy crisis. Relatedly, the newly established state-owned development bank, Banco Portugues de Fomento (BPF), is managing the capitalization fund. The two solvency support programs—Strategic Recapitalization Program and Consolidar—have efficient features such as viability requirements but may need (size and instrument) augmentation. The BPF should draw on commercial banks’ expertise in assessing borrowers’ viability. The BPF’s mandate should be clearly defined to increase accountability and its activities, not introduce market distortions.

31. Strong restructuring and insolvency regimes would facilitate effective reorganization and exit of businesses and optimizing resource reallocation without overwhelming the financial system. Clear communication and a short deadline on the lifting of the duty to file for insolvency will allow corporate debtors to prepare for the reintroduction of the rule. Moreover, the low uptake of the November 2020 pandemic insolvency reforms points to need for further steps to simplify and strengthen the effectiveness of the restructuring and insolvency law, and establishing clear guidelines for the participation of public creditors (tax, social security and other public administrations) in all procedures (2018 Staff Report and Selected Issues Paper); and streamlining liquidation procedures by addressing bottlenecks in the verification of claims and asset sales. Building on recent efforts to strengthen insolvency statistics would enable better analysis of the effectiveness and efficiency of current insolvency systems (see Garrido and others, 2019). Also, while the recent implementation of the EU Restructuring Directive is welcome, a broader reform that rationalizes the insolvency regime, effectively coordinating all procedures, should be considered.17

32. Close monitoring of banks’ credit quality after the end of the moratoria and in light of new risks from the housing market continues to be essential (Figure 9). Bank capital buffers and asset quality have steadily improved but remain below EA averages (see 119). Forward-looking assessments of bank financial soundness should be a priority, given the uncertain effects of the two overlapping exogenous shocks in the context of sovereign-bank-corporate-housing market linkages.

  • Banks should continue to apply well-defined strategies for adequate loan classification, managing NPLs, and maintaining adequate provisioning levels, in order to mitigate the potential increase in NPLs over time. Continued strong supervisory pressure by prudential authorities should ensure banks act preventatively against credit quality deterioration. Where needed, particularly in a few relatively weaker domestic banks, capital buffers should be gradually rebuilt. Given uncertainties on banks’ capital needs, and in light of the new economic shocks, caution is needed in dividend distributions and share buybacks.

  • Banks should value their exposures to restructuring funds at market or fair values and their deferred tax assets should follow prudent valuations.

  • Risks from rising real estate prices remain contained (Annex II and ESRB 2021). Macroprudential policy measures are already relatively tight and have helped in containing leverage ratios (Banco de Portugal, December 2021 Financial Stability Report). Additional guidance was issued in April 2022 to reduce the average maturity of housing loans. However, given the dominant share of variable rate mortgages (three-quarters with rate fixation of up to one year, with an average interest rate of 0.8 percent on all outstanding mortgages) and long maturity (average 35 years), these risks should be closely monitored. For instance, an interest rate increase of 100bps would raise the average per-capita interest burden from 3¼ to 7¼ percent of gross disposable incomes. Once the recovery is well established, the BdP could consider introducing a positive rated CCyB or a sectoral systemic risk buffer (SRyB), in line with the CRDV and following EBA Guidelines, to contain macro-financial risks from banks’ real-estate exposures. Such buffers would bolster banking system strength gradually, increasing resilience to housing market risks while avoiding the distributional costs of tighter macroprudential measures.18

33. Policies to address potential money laundering risks should be focused on their cross-border dimension. Portugal is a transit country for financial flows and provides incentives to attract foreign investment through the Golden Visa Program and the Madeira Free Trade Zone (FTZ) with a potential impact on non-resident banking-sector deposits and house prices. Close monitoring of cross-border flows and accounting for the relevant transnational money laundering (ML) and terrorist financing (TF) threats is essential in Portugal’s national risk assessments and AML/CFT policy priorities. Portugal’s Financial Intelligence Unit’s priorities should be aimed at collecting and disseminating financial intelligence related to suspicious cross border flows. AML/CFT risk-based supervision of banks and real estate agents could also be strengthened commensurate with these risks. The establishment of the Central Registry of Beneficial Ownership (RCBE), which applies to legal entities including foreign trusts authorized to trade in the Madeira FTZ, is welcome, and next steps would be to ensure that the RCBE contains complete, accurate and up-to-date data on all relevant legal entities, including foreign trusts operating in the Madeira FTZ. Portugal should ensure that its AML/CFT framework provides for regulation of virtual assets sector in line with international standards.

Authorities’ Views

34. The authorities noted that while the corporate sector had handled the pandemic well, solvency risks may take time to materialize. They assessed that even sectors that were disproportionately affected by both overlapping shocks (Covid-19, energy price increase) had held up well so far, but the situation warranted continued close monitoring. They agreed with the mission on the importance of a prompt recapitalization of viable firms. They shared the importance to resume the duty to file for insolvency to support market forces to allow a smooth exit of non-viable firms and normalization in corporate sector activity.

35. The authorities broadly agreed with the mission’s recommended priorities for the financial sector. They continue to closely monitor banks’ credit quality and adequacy of loan loss provisions, especially for NFC exposures that benefited from credit moratoria and that show higher deterioration than average. Supervisory efforts have focused on strengthening bank capitalization, particularly for institutions with weaker-than-average capitalization and profitability. While the authorities also concurred with the mission’s diagnosis that housing market risks were increasing, they noted that important risk mitigants are in place, notably those related to the borrower-based macroprudential measure, which had been effective in lowering the risk level of new mortgages, the borrowers’ leverage ratios and related macro-financial risks. Targeted measures to build banks’ systemic resilience could be assessed in due course when risks for economic recovery subside. On AML/CFT, the authorities noted that they continue to integrate the cross-border dimension into their AML/CFT supervisory risk assessment and that the risk factors remain relatively stable. Risks related to exposures to the Madeira FTZ were not considered material and those related to the Golden Visa Program were strictly monitored.

C. Structural Reforms

36. The NRRP focuses on key long-term challenges of the Portuguese economy (Annex IV). The structural reforms to raise skill levels and increase competitiveness, steps to strengthen NFC health, and measures for a greener and more digitized economy would underpin stronger medium-term saving and investment rates and growth without generating external imbalances.

37. The lack of skilled labor remains a longstanding obstacle to productivity although the situation is set to improve gradually. The share of low-skilled workers is still among the highest (35 percent versus 18 percent for EA average), which in turn is rooted in long-standing issues in the Portuguese education system. However, earlier reforms have begun to bear fruit, helping reduce the share of young low-skilled to 20 percent of all employees. Also, the NRRP presents reforms to (i) reinforce vocational and educational training; (ii) strengthen cooperation between higher education, public administration and enterprises; (iii) strengthen teachers’ digital skills; and (iv) improve the digital infrastructure of schools. If implemented well, these reforms should address skill shortages and labor supply over time.

uA001fig12

Worker Characteristics: Temporary and Low-skilled Employment, 2021Q4

(Percent)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Eurostat.

38. High youth unemployment and labor market duality also need to be tackled. Further efforts at improving vocational and on-the-job training—including for the older cohorts—steps to ease immigration, and training incentives will be important (OECD, 2022). Measures to alleviate costs from employment protection for permanent contracts will also be essential to reduce labor duality. Indeed, some 17 percent of all workers —predominantly young—are employed on a temporary basis (3–4 percentage points above the EA-EU averages) with lower access to training opportunities and higher job insecurity. Allowing permanent contracts to be more flexible, combined with ALMPs (as planned under the RRP) and a stronger social safety net will increase labor market efficiency while limiting adverse distributional effects.

uA001fig13

Strictness of Employment Protection – Individual and Collective Dismissals, 2019

(Index)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: OECD.

39. The NRRP includes ambitious milestones to reduce digital skill gaps which will contribute to raising productivity. In 2021, some 51 percent (60 percent EA/EU average) of Portuguese companies had basic digital intensity. Low digitalization of SMEs and low investment in human capital are key factors behind sluggish productivity growth. The national priority to advance digital transformation is welcome. Under its Digital Transition pillar, the NRRP envisages several measures to improve Portugal’s digital position including: (i) tax credits for companies’ digital transition; (ii) digitalization of public administration, including the judicial system; and the educational system; and (iii) digital skill training to SMEs to help a holistic digital transition of the economy.

Authorities’ Views

40. The authorities highlighted that the broad set of growth-enhancing reforms and investment goals in the NRRP with focus on climate transition, digitalization, education, and governance were conducive to raising growth potential durably. They stressed that Portugal was among the first countries to receive pre-financing and the first regular payment under the NRRP. Introduction of simplified procedures for recruitment and public spending processes would allow smooth implementation of the NRRP. On labor market duality, the draft Decent Work agenda being discussed with social partners aims to improve prospects for young, long-term unemployed, and inactive labor. They stressed the importance of permanent job contracts in improving job stability, and higher statutory minimum wages in raising living standards. They agreed with the importance of ALMPs and reforming the vocational training system to reduce structural unemployment and facilitate sectoral reallocation.

Transition Towards Carbon Neutrality

41. The authorities have set ambitious targets and policies to address climate change challenges. With per capita GHG emissions below EU average, Portugal’s contribution to global emissions remains limited. In 2016, Portugal was among the first to announce its target to become carbon neutral by 2050, implying a reduction of emissions of 85–90 percent relative to 2005. The long-term strategy for low GHG emissions were formulated in a Roadmap for Carbon Neutrality 2050 (RCN) and set out in the National Energy and Climate Plan (NECP). The authorities are committed to an overall investment of 3 percent of GDP by 2030 to support climate-related research and innovation. The NRRP also proposes relevant reforms for energy transition with funding for sustainable mobility, energy efficiency, renewables, decarbonization and the bioeconomy. Tackling energy poverty—with some 15 percent of the population without proper access to heating—is also a key national objective.

uA001fig14

Target Emission Reduction by 2030

(Percent)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Sources: Eurostat/UNFCCC, and IMF staff calculations.

42. More effort would be required for Portugal to achieve carbon neutrality by 2050 (SIP, III). Driven by improvements in energy efficiency, total GHG emissions—which peaked in 2005—are now close to 1990 level. With some three-quarters of total electricity supply from renewable sources and the last coal-based power plant closed in 2021, emissions from electricity generation are expected to decline further. Nonetheless, under unchanged current policies, staff estimate GHG emissions to increase by about 5 percent between 2022 and 2030. A gradual increase of carbon price to $100 per ton of C02e, accompanied with the elimination of energy subsidies and a broader coverage of the carbon tax could reduce GHG emissions by about 15 percent by 2030—on a path towards reaching carbon neutrality by 2050—while also gradually raising revenues. Nonetheless, to achieve carbon neutrality in 2050, other measures outlined in NECP and RNC, such as: (i) investment in public transportation infrastructure and urban planning; (ii) renewable-based power generation; (iii) introducing or raising efficiency standards; (iv) water, land and forest management; and (v) investment in R&D initiatives will be critically important.

uA001fig15

Portugal: GHG Emissions Over Time, 1990–2030

(in tons of C02 equivalent)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: UNFCCC GHG Data Interface and IMF staff calculations.

43. However, carbon pricing would weigh on vulnerable households. Reforms will need to be complemented with transfers to offset the regressive nature of the carbon tax on the most vulnerable households. Measures to promote sustainable mobility, energy efficiency, higher share of renewable energy sources, and low-carbon products and services—including developing financial devices to reduce the risk-weighted capital costs of low-carbon technologies and projects will also be needed. To address the impact of extreme weather events (floods, coastal erosion, droughts, heat waves, and forest fires) investments in risk prevention and preparedness, and climate change adaptation may also be needed (SIP III).

Authorities’ Views

44. The authorities highlighted that the energy crisis is an opportunity and a call for Portugal to accelerate energy transition. They noted that the country is well positioned to comply with the Fit for 55 targets. A revised NECP, which will be submitted to the EC in July 2023, will include plans to contain the impact from the current energy crisis and strengthen energy risk preparedness. The ultimate goal over the long term is to tax all carbon production, but given present circumstances, it is difficult to ascertain the timing of such a move. They noted that the energy transition could be further accelerated thanks to Portugal’s strong legal framework and regulatory environment and strengthened by available EU funding. They also noted that a National Strategy to Tackle Energy Poverty focusing on strengthening access to energy, reduction of energy costs, and improving energy performance of households is expected to be approved soon.

Staff Appraisal

45. The recovery is expected to continue despite adverse spillovers from the war in Ukraine. Near-term growth, while remaining strong, is expected to be affected by second-round effects from the war in Ukraine. The effects of two consecutive shocks will likely result in scarring. Inflation is expected to increase in 2022 before receding in 2023, reflecting surging energy prices, but also broader pressures.

46. Risks are to the downside. Key risks stem from the war and the pandemic. Furthermore, tighter financial conditions could hurt growth and the fiscal position. The end of loan moratoria could expose higher insolvencies, lowering investment and bank capital, and amplifying fiscal strains. On the upside, a stronger tourism recovery, pickup in pent-up demand and higher-than-projected payoffs from the NRRP would brighten the outlook.

47. Fiscal policy should remain appropriately accommodative in the near term, with support measures carefully designed to be temporary and well-targeted. Broad-based tax cuts and price measures to alleviate the energy shock could be preferably replaced with more targeted support for vulnerable households and the most affected and viable firms. Policies need to be flexible to provide more support should severe downside risks materialize. Fiscal overperformance should be saved.

48. A growth-friendly fiscal consolidation from 2023 is key to rebuilding fiscal space, preparing for long-term fiscal pressures, and alleviating risks from high public debt. While public debt is projected to remain on a solid downward trajectory, it will remain exposed to shocks. A stronger consolidation path—centered on reducing tax expenditures, bolstering pension sustainability, and stronger financial management—would rebuild fiscal space for much-needed investment even after NGEU funds end, while helping offset longer-term ageing and health spending pressures.

49. Timely adjustments in the corporate sector are key to a smooth reallocation of resources. The ultimate effect of the pandemic on corporate, bank, and public sector balance sheets remains uncertain, potentially amplified by war-related strains. Prompt recapitalization of viable firms to leverage private funds and expertise will help mitigate debt overhang, productivity losses, and better handle the energy crisis. Further improvements in the insolvency regime with active labor market policies are needed to smooth exit for unviable businesses, reallocation, and limit scarring.

50. Vigilance on financial sector health with continued efforts to rebuild weak balance sheets is critical in the context of the roll back of Covid-19 measures. The banking system has held up well so far, and, on average, should be resilient to adverse shocks. Nonetheless, capital and asset quality still lag behind the EA and a few domestic banks are yet to complete their restructuring. Continued close monitoring of banks’ credit quality is essential given downside risks to the outlook.

51. Advancing structural reforms on multiple fronts—anchored by the NRRP—are essential to raise growth potential durably. The NRRP reforms and investments appropriately focus on addressing Portugal’s structural challenges and facilitating the climate and digital transition. Efficient planning, budgeting, implementation, and oversight will be key to maintain strong investment absorption capacity. Reforms to strengthen insolvency regimes and reduce labor market fragmentation are also important. To achieve Portugal’s ambitious climate targets, the authorities may consider further adjustment of the carbon price when uncertainty surrounding the energy crisis subsides, combined with measures further improving energy efficiency and offsetting the impact on the most vulnerable households.

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

Table 1.

Portugal: Selected Economic Indicators

(Year-on-year percent change, unless otherwise indicated)

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Sources: Bank of Portugal; Ministry of Finance; National Statistics Office (INE); Eurostat; and IMF staff projections.

National Accounts concept. Differences between the savings-investment balance and the current account in the balance of payments arise from a set of factors, including a different statistical treatment given to special purpose entities in the national accounts and the balance of payments.

Table 2a.

Portugal: General Government Accounts 1/

(Billions of euros)

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Sources: INE; Bank of Portugal; and IMF staff projections.

GFSM 2001 presentation.

Table 2b.

Portugal: General Government Accounts 1/

(Percent of GDP, unless otherwise noted)

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Sources: INE; Bank of Portugal; and IMF staff projections.

GFSM2001 presentation.

Table 3a.

Portugal: Balance of Payments 1/

(Billions of euros)

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Sources: Bank of Portugal; and IMF staff projections.

End-of-period data.

Table 3b.

Portugal: Balance of Payments 1/

(Percent of GDP, unless otherwise noted)

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Sources: Bank of Portugal; and IMF staff projections.

End-of-period data.

Table 4.

Portugal: Selected Financial Indicators of the Banking System 1/

(Percent of GDP, unless otherwise noted)

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Sources: Bank of Portugal; and IMF Financial Soundness Indicator Database. 2020 2017 2018 2021

On accounting basis; consolidated.

Data reflects the information from Instruction No 13/2009 of Banco de Portugal until 2015:Q3, which was adapted to be comparable with the latter data from ITS reporting framework (from 2015:Q4 onwards). This fact implied a slight change in the reporting universe of institutions.

Data reflects the information from Instruction No 23/2004 of Banco de Portugal (until 2015:Q3). From 2015:Q4, data is based on the ITS reporting framework.

Includes foreign currency deposits and deposit-like instruments of resident nonmonetary sector and claims of nonresident vis-à-vis resident monetary financial institutions (excluding Bank of

Annex I. Status of Past Article IV Recommendations

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Annex II. Key Policy Measures in Response to Covid-19, 2020–2021

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Annex III. Residential Housing and Mortgage Market Development

1. Since 2015, Portuguese house price growth outpaced the EA average by almost 30 percentage points. This pace was sustained throughout the pandemic, with residential real estate prices gaining nearly 20 percentage points in real terms and relative to rents.

uA001fig16

Real Estate Prices Index

(Index, 2015 = 100)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Eurostat and National Statistical Institute (INE).
uA001fig17

Real House Price Index, 2021Q3

(Index, 2015 = 100)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: OECD.

2. Available estimates suggest overvaluation of residential real estate. Based on indicators developed by the ECB, Banco de Portugal estimates point to an over-valuation of 8 to 16.5 percent (see Banco de Portugal, December 2021 Financial Stability Report). IMF model-based estimates of house price misalignments relative to fundamentals point to an overvaluation of 7 percent as of mid-2021. However, since mid-2021 house prices increased by 5.7 percent by end-2021. Price-to-rent and price-to-income ratios have reached the highest levels since 2000.

uA001fig18

House Price Misalignment

(In percent, 2021Q2)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF staff calculations.
uA001fig19

House Price-to-income and Price-to-Rent Ratios

(Index, 2010=100)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: OECD.

3. Domestic bank credit has not been a key driver of house prices yet. Even before the pandemic, Portugal had become one of EA’s most dynamic real estate markets partly reflecting tax incentives for foreigners and the Golden Visa program, whereby non-resident flows contributed to drive up housing prices.1 With households deleveraging since 2012–13, outstanding house credit to disposable incomes declined by 100 pp between 2014 and 2019. Housing credit growth turned positive only from 2019, driven by improved consumer confidence and low interest rates. While credit it still below historical averages, some estimates suggest small but positive credit gaps emerging in recent years. Housing supply shortages also played a role in boosting prices, with relatively subdued construction activity in the pre-pandemic years, although the construction sector remained resilient throughout the pandemic. Some cities (e.g., Lisbon) also saw a compression in price variation, with lower-end prices seeing steep gains.

uA001fig20

House Purchase Transactions and New Housing Loans

(In billion euros)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Banco de Portugal.
uA001fig21

Housing Credit Outstanding

(Percent of gross disposable income (GDI) per capita)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Haver Analytics and IMF staff calculations.Note: GDI is not adjusted for in-kind transfers and is on per capita as opposes to per household basis.

4. Although aggregate housing debt service as a share of disposable income was declining before the pandemic, this trend has slowed. On a per capita basis, average mortgage payments correspond to about 1/5th of household gross disposable income, marginally lower than the peak during the 2012–13 sovereign debt crisis. Also, mortgage interest payments declined from about 12 percent of disposable income in 2012H1 to about 3 percent in 2021. Principal repayments dipped temporarily due to moratoria.

5. With house lending relying predominantly on variable rate mortgages, a significant increase in interest rates would quickly erode household incomes. Three quarters of housing loans have rate fixation of up to one year, with Euribor as the benchmark, while only a small fraction has fixed rates for longer than 10 years. Compared to early 2021, 2-year swap rates have widened by over 150 basis points reflecting expectations of ECB monetary tightening. With historic and euro-area’s lowest mortgage interest rates as of 2021Q4 – 0.7 percent for new mortgages and 0.8 percent for all outstanding -a 1 pp higher rate could raise household interest payments from 3.2 percent to about 7.2 percent of average household income, potentially also impacting aggregate demand.2 As per BdP’s borrower-based macroprudential policy measures, banks are recommended to consider a 300 basis point interest rate shock in the calculations of DSTIs for new mortgages.

uA001fig22

Housing Credit Payments

(Percent of gross disposable income (GDI) per capita)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Haver Analytics and IMF staff calculations.Note: GDI is not adjusted for in-kind transfers and is on per capita as opposes to per household basis.
uA001fig23

Loans for house purchase, end-2021

(In percent of total loans for house purchase)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: ECB Risk Assessment Indicators Database.Note: Variable rate loans includes only loans with up to 1 year interest rate fix; average interest rate is volume-weigheted for all loans for house purchase.
uA001fig24

3-month EURIBOR Swap Curve

(Percent)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Bloomberg L.P.

6. The Bank of Portugal expanded its macroprudential toolkit in 2018, including measures on new credit agreements relating to residential property and consumer credit (also see Neugebauer and others 2021, Banco de Portugal Financial Stability Report, December 2021. Supervisory data indicate that borrower profiles improved in 2019, partly reflected in the increase in the share of mortgage credit granted to borrowers with net income above median. Nonetheless, the average maturity of new loans has not undergone gradual convergence towards 30 years, which prompted new macroprudential guidance from April 2022 on limits to maximum maturities. As regards the interest rate risk, and as mentioned above, the measures stipulate that banks should take into account the impact of higher interest rates in the calculations of DSTI, which is a mitigating factor.3 More generally, risks need to be closely monitored and consideration should be given on further strengthening capital positions, in accordance with the ESRB guidance, should vulnerabilities from the residential real estate sector continue increasing.

uA001fig25

Share of housing loans in total bank credit to residents

(in percent)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: ECB Risk Assessment Indicators Database.

7. In view of rising house prices and limited social housing, housing affordability has also been a growing concern. House prices to disposable income are high among EA countries. Social housing is also limited, at about 2 percent of the total housing stock compared to EA average of 7.5 percent. In this context, the NGEU financed NRRP provides an opportunity for such investments to increase the stock of affordable rental housing for low-income families, which can also facilitate job mobility.

uA001fig26

Social Housing Stock, 2020 or latest

(In paercent, social rental dwellings as a share of the total number of dwellings)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: OECD affordable housing database.

Annex IV. External Sector Assessment, 2021

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EBA REER models are based on CPI-based REER.

Based on the 0.36 model elasticity, the REER gap obtained from the staff-assessed CA gap is assessed to be in the range of -3.4 to 2.1 percent, with a midpoint at -0.7 percent.

Annex V. The National Recovery and Resilience Plan (NRRP)

1. The Next Generation EU (NGEU) package of 9 percent of 2020 GDP—of which 7 percent of GDP is for the NRRP—provides a unique opportunity to transform the economy.1 Portugal is receiving €13.9bn (7 percent of 2020 GDP) in grants. Another €14.2 bn (7 percent of 2020 GDP) is available in loans, although the government plans on utilizing only (1½ percent of GDP) of the latter during 2021–26. The government has set up three key pillars in its NRRP: (i) Economic Resilience (€11.13 bn); (ii) Climate Transition (€3.06 bn), and (iii) Digital transition (€2.46 bn). The three major areas are themselves divided into twenty components. The authorities have set up a well-designed portal to report its execution of these milestones (Resiliencia – Recuperar Portugal).

2. The NRRP identifies reforms that could address many long-standing gaps in the Portuguese economy. To address longstanding labor market issues, the plan envisages reforms to improve vocational education and training, strengthen cooperation between higher education and companies, remove restrictions in highly regulated sectors and reduce gender inequality. The NRRP aims at raising exports to 53 percent of GDP and R&D investment to 3 percent of GDP by 2030. It envisages sizable green investment for energy efficiency of residential and administrative buildings and increasing the share of renewable sources of energy. Investments are also planned for affordable social housing and student accommodation, to support integration of disadvantaged communities and more inclusive growth. Beyond the resolute implementation of structural reforms, strong governance and spending accountability will be key.

3. If implemented in an efficient and in a timely manner, these underlying investments and reforms are likely to deliver a sizeable temporary growth boost and contribute to reduce scarring. Assuming frontloaded deployment of NGEU funds over 2021–26 and a public investment multiplier of 0.8 and 0.4 respectively in the first two years and a public consumption multiplier of 0.3 and 0.1, respectively, staff estimates the GDP impact at 2 percent by 2025, which would close almost 40 percent of the gap between the projected 2026 GDP relative to its pre-pandemic projected level. The authorities’ estimates are more optimistic projecting to raise real GDP level by 3.5 percent by 2025.

4. Potential growth may also be boosted depending on the quality of the projects and speed of absorption of the funds. However, structural bottlenecks (ageing, low share of skilled labor and typically low investment absorption capacity, and risks to productivity), coupled with global supply-side bottlenecks public investment and reforms may result in a longer lag before potential growth bears fruit. On the upside, an efficient absorption of EU funds in public investment complemented with well-sequenced structural reforms could additionally boost potential growth.

Recovery and Resilience Plan: Investments Areas and Reforms to be Financed by Grants

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Annex VI. Risk Assessment Matrix1

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Annex VII. Public Debt Sustainability Analysis (DSA)

The economic contraction due to Covid-19 and the fiscal response led to a sizable increase in Portugal’s public debt from an already high level, thereby increasing debt sustainability risks. Nevertheless, under the baseline, the debt-to-GDP ratio is projected to resume its downward trajectory and decline to 97 percent of GDP by 2027, benefiting from sustained strong growth, still-low interest rates, and primary fiscal surpluses. The materialization of a growth shock or combined shock to public finances and growth could, however, add close to 20 pp of GDP to public debt over the medium term. Contingent liabilities, emanating from Covid-19 state-backed credit guarantees, could also impact debt. An interest rate shock would not lead to significant deviations of the debt during the forecasting horizon due to improved debt maturity profile. Stronger consolidation plans should be put in place to reduce the high public debt while creating space for much-needed investment and addressing longer-term ageing and health spending pressures.

A. Background

1. Prior to the pandemic, Portugal’s public debt, while high, was on a declining trend. The debt-to-GDP ratio declined from its pre-pandemic peak of 132.9 percent in 2014 to 116.6 percent at the end of 2019, although it was still well above the pre-GFC level of 75 percent of GDP. Fiscal consolidation was a cornerstone of Portugal debt reduction, with structural primary surpluses averaging 3¾ percent of GDP during 2014–19. With sustained market access and low yields, Portugal extended the maturity profile of outstanding marketable debt from 5 to 7 years over 2014–19. The benchmark bond yield (10-year) declined from about 5½ percent in early 2014 to 0.4 percent at the end of 2019. As a result, the interest bill declined from 5 to 3 percent of GDP over the same period. Based on staff’s pre-pandemic baseline projections, the debt level was projected to decline to about 100 percent of GDP by 2024

B. Baseline Scenario

2. Portugal’s debt is projected to decline by an average of about 5 percent of GDP during 2022–27 a year, driven by the economic recovery and a gradual return to primary surpluses. The sharp recession and fiscal response in 2020 caused the debt-to-GDP ratio to rise by 18.6 pp to 135.2 percent of GDP in 2020. Nonetheless, the debt-to-GDP ratio declined to 127.4 percent in 2021 driven by real GDP growth of 4.9 percent. As well, 2021 primary deficit narrowed to 0.5 percent of GDP from 3.1 percent of GDP in 2020 and is expected to return to a surplus of about 1.0 percent of GDP by 2023. GDP is projected to grow by 5.8 percent 2022 and average 2 percent during 2023–2027.

uA001fig28

Projected Change in Debt, 2022–2027

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF staff estimates.

3. Baseline projections: The debt-to-GDP ratio is projected to decrease by 30.4 pp over the six-year forecast period—with 25.5 pp accounted by interest-growth dynamics, and primary deficit contributing 4.2 pp to increase in debt over the forecast horizon. The real interest rate is projected to reduce the public debt ratio by 5.1 pp in 2022 and by a further 3.3 pp over 2023–27. Specifically,

  • GDP growth. Under the baseline, medium-term growth is expected to converge to below 2 percent, helped by investments and reforms under the NRRP (see Annex V). However, medium-term TFP growth could weaken materially in the event of materialization of the risks from corporate vulnerabilities, zombification, or further amplification of these risks from war-related shocks.

  • Fiscal deficit. Staff projects the primary fiscal balance to improve from -0.5 percent of GDP in 2021 to 1.0 percent of GDP in 2023 and stay at an average of around 0.8 percent of GDP in 2024–27. The improvement in the primary balance over the near term is underpinned by: (i) the expiration of exceptional Covid-19 stimulus measures, such as job retention schemes and turnover loss compensation programs, and (ii) the winding down of support via automatic stabilizers with the output gap narrowing from about 2.5 percent of potential GDP in 2021 to 0.1 percent by 2024. The baseline scenario is based on the current policy framework (draft 2022 Budget, 2022 Stability Program, and NRRP), and no additional consolidation effort is assumed during the forecasting horizon in the baseline. The structural primary balance is assumed to deteriorate (¾ of a percentage point) over the forecast horizon from 1.6 percent of potential GDP in 2021 to about 0.9 percent in 2027 driven by the rise of demographic ageing-related social spending.

  • Interest rates and gross financing needs. Under the baseline, the gross financing needs of the government would decline from a recent peak of 16.5 percent of GDP in 2020 to 11.5 percent in 2027. Long-term interest rates on Portuguese sovereign bonds and spreads to German bunds are projected to gradually increase over the projection horizon from current levels. Specifically, the Portuguese 10-year yield is assumed to rise from the average of 0.3 percent in 2021 to an average of 2.2 percent in 2022 and further to 3.5 percent in 2027. The effective interest rate is projected to decline from 2.3 percent in 2020 to 1.9 percent in 2025, as maturing debt would continue to be refinanced at lower rates, and then gradually pick up to 2.4 percent in 2027

C. Risk Assessment

4. Public debt would remain high despite the downward momentum under the baseline. Over the past decade, Portugal has experienced two deep recessions (real GDP cumulative decline of 6.5 percent during 2011–13 and an 8.4 percent drop in 2020) accompanied by a sharp fall in inflation (which is now being reversed), as well as spikes in borrowing costs in the face of elevated financing needs. Near-term reoccurrences of such shocks would translate into a spike in the debt ratio.1 In addition, a high share of public debt2 held by non-residents generates vulnerabilities from foreign risk appetite and financial conditions but does not bear foreign exchange rate risk. While still-low interest rates and the extended maturity profile offer comfort, risk perceptions may change abruptly. Risks related to the sharp increase in contingent liabilities, such as calling of state guarantees on bank lending extended during the pandemic or capital support needs stemming from larger-than-expected impacts of the end of moratoria on firms and banks, could translate into fiscal costs through higher primary deficit and drag on growth.

5. Mitigating factors. While risks from elevated debt and its external financing profile under the baseline are deemed to be high, important mitigating factors include: (i) the ECB’s accommodative monetary stance is expected to keep Portugal’s funding costs low for some time, even after the ending of the APP and commencement of policy rate hikes; (ii) the financing from the EU; (iii) the negligible share of foreign currency debt; and (iv) comfortable cash buffers, currently about 6 percent of GDP, and the availability of NGEU loans that are not currently envisaged to be utilized would reduce rollover risks during temporary market pressure episodes. A comfortable cash position remains relevant, in anticipation of a lumpy redemption schedule in 2022. Moreover, the composition of debt—with a high average residual maturity of 7.7 years3 and a considerable share of official debt (19.8 percent)4—offer comfort. Lastly, the projected return to primary surpluses together with the extended maturity profile mean that gross financing needs remain below the relevant benchmark of 20 percent of GDP.

6. The authorities’ fiscal strategy under the Stability Program 2022–2026 entails a stronger medium-term growth than staff’s baseline. The authorities foresee a stronger improvement in the primary balance and real GDP growth in the medium term compared to staff’s baseline projection: 2026 primary balance of 2.0 percent of GDP vs. 0.7 percent of GDP, and GDP growth of 2.5 percent vs 1.9 percent, respectively. Staff projection for 2022 nominal GDP growth at 12.2 percent exceeds Stability Program’s 7.4 percent (as of April-2022) and hence implies an additional impact of automatic debt dynamics, close to 4½ pp, on the 2022 debt ratio. Nonetheless, debt-to-GDP reach is projected to reach a similar level of close to 100 percent under both the authorities’ and staff’s baseline scenario.

7. Realism of baseline projections. The median forecast error for real GDP growth during 2012–20 is 0.15 suggesting a downward bias in staff projections for growth. This is associated with median forecast errors of -1.42 percent for the primary balance and 0.19 percent for inflation, respectively. The size of the forecast error for the primary balance is explained by the two economic crises, namely the sovereign debt and the Covid-19 pandemic, in the reference sample.

8. Projected fiscal adjustment. The three-year adjustment of the cyclically-adjusted primary balance (CAPB) put Portugal around the median, with the percentile rank of 57 percent, the projected fiscal adjustment remains feasible as pandemic-related emergency responses are expected to unwind by 2022 and GDP growth is expected to remain strong in 2022.

9. Heat map and fan chart. Risks from the debt level are deemed high, given that Portugal is above the threshold of 85 percent of GDP under the baseline and all stress scenarios. The high share of public and private (mainly banks) debt held by non-residents also results in high external financing requirements. The fan chart analysis with no restriction on the distribution of shocks indicates a 50 percent probability of debt reaching between 87.7 and 107.9 percent of GDP by 2027. When upside risks are constrained, the analysis indicates a 50 percent probability of debt being between 94.3 and 111.6 percent of GDP by 2027.

D. Shocks and Stress Tests

10. Portugal’s debt dynamics would worsen significantly under the growth shocks:

  • Growth shock. Under this scenario, real output growth rates in 2023–24 are assumed to be lower than in the baseline by one standard deviation (2011–2020: 4.0 pp). The assumed declined in growth leads to lower inflation (0.25 percent per 1 pp decrease in GDP growth) and the interest rate is assumed to increase by 25 basis points for every 1 percent of GDP worsening in the primary balance. Public debt would rise to 124.5 percent of GDP in 2024 and decline towards 114.4 percent of GDP by 2027 under this scenario. Gross financing needs would peak at 17.0 percent of GDP in 2024 before declining to about 13.7 percent of GDP in 2027.

  • Financial contingent liabilities shock. This scenario assumes ½ percent of GDP in bank recapitalization needs5 and a 3 percent of GDP in Covid-19 guarantees being called (representing approximately ¾ of the guaranteed credit lines)6. The total magnitude of the contingent liability shocks is equal to about 3½ percent of GDP. Real growth is also assumed to be 2 pp (0.5 standard deviation) lower than in the baseline. Under this scenario, debt rises to around 118.6 percent of GDP in 2023, but then declines steadily towards 106.8 percent of GDP in 2027.

  • Interest rate shock would not lead to significant deviation of the debt path or entail a spike in gross financing needs to above 20 percent threshold during the forecasting horizon. In the stress scenario, the interest rate is increased by 560 basis points, which is the difference between the average effective real interest rate level over the projection period and the maximum historical level of 4.5 percent experienced during the sovereign debt crisis. However, the impact of the shock would be backloaded—the deterioration of public debt and gross financing needs—as old debt matures gradually and new debt is contracted at higher rates. By 2027, the effective interest rate would rise from 1.9 percent in the baseline to 3.9 percent, still below the peak of 4.2 percent reached in 2012 owing to much lower gross financing needs (average of 26 percent during 2012–14 vs. average of about 13 percent during 2025–27). The gross financing needs to GDP ratio, despite the rise by 3 pp from 2023, would remain below the 20 percent of GDP threshold.

  • The combined macro-fiscal shock would result in debt peaking at 125 percent of GDP in 2024 and declining to 119.3 percent of GDP by 2027. GFNs would peak at 17.6 percent of GDP. The combined macro-fiscal shock also incorporates the interest rate shock as calibrated above, allowing for a feedback loop between higher interest rates and increased financing need. The effective interest rate would rise to 4.2 percent by 2027, which is 0.3 p.p. higher than under the interest rate shock on account of higher gross financing needs. Such a scenario would significantly raise concerns over debt sustainability. The main driver of the macro-fiscal component of this scenario is the growth shock, described above.

  • The other standardized macro shocks. The primary balance shock and the real exchange rate shock would not lead to significant deviations from the baseline debt path over the forecast horizon.

uA001fig29

10-Year Sovereign Bond Yields

(In percent)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: Bloomberg LP.

Portugal: Sovereign Risk and Debt Sustainability Analysis1

The Box presents an assessment of the sovereign risk using the tools of the new Sovereign Risk and Debt Sustainability Framework for Market Access Countries under a preliminary calibration:

Portugal: SRDSF Tools Assessment

article image
Source: IMF staff estimates.

Medium-term risks (up to 5-years ahead) are assessed as moderate. This reflects the results from: (i) the financing risk module to analyze rollover risks, considering creditor composition, and (i) a debt fan chart to probabilistically assess prospects for debt stabilization.

The analysis suggests that Portugal’s financing risks are moderate. Gross financing needs under the baseline are moderate (averaging 12 percent of GDP over the 2022–27 period), while initial bank claims on government are low (around 9.6 percent of banking sector assets). The large size of the banking sector relative to the economy (assets at 210 percent of GDP) and the negligible share of foreign currency debt are key risk mitigating factors, along with the composition of holders (the Eurosystem2 at 29½ percent and foreign official creditors at 20.5 percent).3 The domestic banking sector may have to provide an additional 3 percent of bank assets to provide residual absorption of sovereign debt in case of a stress scenario, which appears manageable. This analysis currently assumes that the Eurosystem’s holdings of sovereign debt, which have risen in recent years to 29½ percent of total debt, act as shock absorbers. However, as ECB support normalizes over time and financing becomes more market reliant, the impact of these mitigating factors will weaken over time. That said, overall risks may be relatively stable given the strengths discussed above.

Figure 1.
Figure 1.

Portugal: Gross Financing Needs Module

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

The fan chart module assesses Portugal at moderate risk of medium-term sovereign stress. The main factors contributing to the fan chart risk index are the fan’s width (a measure of uncertainty) at 51.1 percent of GDP and the debt level indicator (median debt level interacted with the institutional quality index)—a proxy of debt carrying capacity—projected for 2027 at 123 percent of GDP. Nonetheless, there is a high probability (93 percent) of debt stabilization.

Figure 2.
Figure 2.

Portugal: Fan Chart Module

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

1 See Review of The Debt Sustainability Framework for Market Access Countries, IMF Policy Paper 2021/003. 2 The Eurosystem comprises the ECB and the national central banks of those countries that have adopted the euro. 3 Official loans include EFSF and EFSM loans under Economic and Financial Assistance Program, as well as SURE and RRF loans.
Figure 1.
Figure 1.

Portugal: Public DSA Risk Assessment

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 85% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 20% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 400 and 600 basis points for bond spreads; 17 and 25 percent of GDP for external financing requirement; 1 and 1.5 percent for change in the share of short-term debt; 30 and 45 percent for the public debt held by non-residents.4/ Long-term bond spread over German bonds, an average over the last 3 months, 09-Feb-22 through 10-May-22.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
Figure 2.
Figure 2.

Portugal: Public DSA—Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF Staff.1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Not applicable for Portugal, as it meets neither the positive output gap criterion nor the private credit growth criterion.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.
Figure 3.
Figure 3.

Portugal: Public Sector DSA—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF staff.1/ Public sector is defined as general government and includes public guarantees, defined as COVID19 guarantees.2/ Based on available data.3/ Long-term bond spread over German bonds.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = 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).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1 +g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1 +r).8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure 4.
Figure 4.

Portugal: Public DSA—Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF staff.
Figure 5.
Figure 5.

Portugal: Public DSA—Stress Tests

Citation: IMF Staff Country Reports 2022, 203; 10.5089/9798400211034.002.A001

Source: IMF staff.
1

About 12 percent of Portuguese households benefit from means-tested social tariffs for electricity (33.8 percent discount). Also, regulated tariff regime covers about 11 percent of low-voltage consumption, and consumers are allowed to switch. The regulated market tariff reduces volatility and helps guide the liberalized market price. The price of electricity for households on the regulated market increased on April 1, 2022, by an average of 3.0 percent following quarterly regulatory review. The surge in the wholesale Iberian Electricity Market price (MIBEL) will be mitigated by (i) the lower payment to renewables, which in 2022 is expected to provide a figure in the order of 0.8billion euros in consumers’ favor, (ii) lower network tariffs (508 million euros, such as from EU-ETS revenues transfer), particularly for the Very High, High and Medium Voltage consumers, (iii) further EU-ETS revenue transfer (150 million euros) towards network tariff reduction, and (iv) temporary gas price cap in the wholesale electricity market.

2

Gross monthly earnings per employee, which grew by 3.4 percent in 2021, decelerated to 2.2 percent in 2022:Q1.

3

Public moratoria were also matched by private moratoria offered by financial institutions to HHs and NFCs with loans that were not eligible under the public moratoria for a shorter period, most of which expired in March 2021. With the amendment to the public moratoria in March 2021, private moratoria beneficiaries were also eligible for a six-month extension under the public moratoria.

4

The share of residential real estate transactions financed by domestic credit, at 55 percent, is still some 20 p.p. lower than prior to the sovereign debt crisis. Nonresidents have reportedly played an increasing role in the housing market. More generally, the tightening of macroprudential measures by the BdP in 2018 is assessed to have reduced the probability of default of this market segment during the pandemic (see Macroprudential Recommendation on new credit agreements for consumers – progress report, Banco de Portugal, March 2021).

5

There is considerable heterogeneity in the six largest banking groups; however, with a few relatively weaker banks. The non-bank financial sector is relatively much smaller and growing moderately.

6

See S. Aiyar, M. Chi Dao, A. Jobst, A. Mineshima, S. Mitra, M. Pradhan (2021). The June 2021 EBA/SSM stress tests, which cover only three of the larger domestic banks, highlights somewhat higher risks for these banks. Banks’ direct linkages to Russian banks, based on BIS data, total around 0.1 percent of banking system assets).

7

As a member of the European Union, Portugal joined the sanctions adopted at the EU level in response to Russia’s invasion of Ukraine.

8

The SDR allocation amounted to about 1.1 percent of GDP. A possible voluntary channeling is under consideration.

9

The structural primary balance corresponds to cyclically adjusted primary balance excluding one-off and temporary measures, and hence is subject to uncertainty associated with cyclical assessment, stability of the output gap elasticities, and judgement involved in treatment of Covid-19 discretionary policy measures as temporary.

10

While holdings of EA public debt by the Portuguese banking sector also induces financial sector risks, bank holdings of Portuguese government debt declined from 8 percent of total bank assets during 2019–20 to 7 percent in 2021 and holdings of other EA sovereign debt is also limited (see Banco de Portugal, Financial Stability Report, December 2021).

11

The MoF has a fiscal policy department, but no tax policy division. Tax policy is currently developed through informal collaboration of relevant parties such as the group of advisers in the Cabinet of the Secretary of State of Tax Affairs in the MoF.

12

A 2021 Fund technical assistance mission estimated that tax expenditure has been on the rise, reaching more than 7 percent of GDP in 2020. Moreover, the number of tax deviations has increased by 40 percent over the past decade. The single most important item among current expenditures is the set of reduced rates for the VAT, which accounts for 52 percent of total estimated revenue forgone. In addition, the investment law offers some of the most generous incentives, including the non-regular resident scheme (a reduced PIT rate of 20 percent, for a period of 10 years, for a set of high value-added activities, costing about 0.4 percent of GDP annually).

13

Property tax revenues and rates, ranging from 0.3 percent to 0.45 percent for urban areas, are below OECD peers.

14

Efficiencies could also be gained by leveraging the anti-money laundering framework to enhance tax compliance and better tackle tax evasion.

15

Portugal has one of the most generous pension systems in the OECD (net pension replacement rate for average wage workers at 90 percent of pre-retirement earnings). In line with past IMF advice, authorities should make further efforts over the medium term to enhance the equity of the pension system by reducing accrual rates for the largest earning brackets to make average gross replacement rates in the public pension schemes gradually converge to EU average levels.

16

The change in equity gap is for continuing firms (balance sheets data available in both 2019 and 2020), and hence is lower than change in aggregate solvency gap (1 percent of GDP) due to survivorship bias (non-reporting of 2020 balance sheets by firms with solvency gap in 2019).

17

Portuguese law includes several restructuring procedures (PER and RERE). In addition, PEVE was introduced as a provisional hybrid restructuring procedure to address the impact of the pandemic, but it expired by end 2021. PER is the generally applicable restructuring procedure. RERE is an out-of-court restructuring procedure designed for illiquid but solvent companies, with viability prospects. Differences in treatment may lead debtors to choose one procedure over another. Previous Fund work also calls for improvements in Portugal’s legal framework to facilitate in-court and out-of-court proceedings, debt recovery processes and collateral enforcement and to eliminate tax disincentives to impairment and write-offs.

18

More broadly, longer-term imbalances in the housing market may need to be addressed through stronger property taxes (see section on Fiscal Policy). The Golden Visa provides salient tax incentives. However, the program was terminated in three key areas—Lisbon, Porto and Algarve—in December 2021.

1

Portugal grants a 5-year residency perm it to non-EU citizens who buya minimum of €500,000 worth of property, allowing holders to work or study, and travel to Schengen countries. They can apply for permanent residency after five years. Since the program started in 2012, it has accounted for 40 percent of the FDI in the real estate sector, bringing in over 5 billion euros. The Golden Visa for residential real estate was ended in Lisbon, Porto, and Algarve from January 2022.

2

Despite the low interest rates, borrowers in Portugal pay one of the highest annual percentage rates to cover their mortgage loan charges in the EU (apart from the interest payments, these charges also include maintenance costs for the accounts required to conclude the credit agreement and, more importantly, insurance costs required to obtain the loan).

3

The Mortgage Credit Directive requires creditors to create two illustrative examples for variable rate mortgages, including a warning that the variability could affect the actual level of the annual percentage rate of charge. For mortgage loans, Banco de Portugal recommends a 300 basis point illustrative scenario in the setting of the DSTI. Nonetheless, no warning is foreseen that there is no maximum limit of the borrowing rate. Portuguese loans are full recourse, although isolated judicial rulings have limited borrower liability when liquidation sale value fell significantly below bank’s appraisal furnished at the mortgage contract stage.

1

The remaining 2 percent funds the reforms under REACT-EU.

1

As of April 2022. The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staffs subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

1

The severity of the last decade’s two deep recessions implies that a historical scenario based on 10-year average values of real GDP growth of 0.5 percent as well as primary balance of -0.1 percent of GDP would entail a smaller decline in debt-to-GDP from 127.4 percent in 2021 to 111.4 percent of GDP in 2026.

2

At the end of 2020, 43.5 percent of outstanding general government debt securities were held by non-resident investors. Non-euro area holders comprise about 16 percent of total public debt.

3

Average residual maturity of debt excluding loans from European institutions is 7 years as of March-2022.

4

Official loans include EFSF and EFSM loans under Economic and Financial Assistance Program, as well as SURE and RRF loans.

5

Based on MDA shortfall, with the NPLs increase to about 12 pp, doubling from the end 2019 level, to about 2/3 of the peak 17.9 percent in mid-2016 (for underlying methodology, see Aiyar, S, C. Mai, A. Jobst, A. Mineshima, S. Mitra, M. Pradhan, “Covid-19: How Will European Banks Fare?”, IMF Departmental Paper No. 2021/008).

6

The assumption on the share of called loans represents an adverse scenario compared to: (i) authorities estimate of the low fiscal risk from state guarantees to NFCs with expected cumulative multiannual fiscal cost of about 0.2 percent of GDP, and (ii) the share of guaranteed loans classified under IFRS stage 2 and 3 at 18 percent of total guaranteed loans as of end-2021.

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Cover IMF Staff Country Reports
Portugal: 2022 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Portugal
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2022: Issue 203
Publisher:
International Monetary Fund
ISBN:
9798400211034
ISSN:
1934-7685
Pages:
75
DOI:
https://doi.org/10.5089/9798400211034.002

Nominal GDP Per Capita

(Euros)
Figure 1.

Portugal: Covid-19 Developments, March 2020-May 2022

Negative Correlation between Output Losses and Share of Tourism, 2021Q4

(Percentage Point)
Figure 2.

Portugal: Exposure to Spillovers from the War in Ukraine
Figure 3.

Portugal: Private Sector Leverage and Credit, 2008–2021
Figure 4.

Portugal: Covid-19 Pandemic and its Economic Impact, 2020–2022
Figure 5.

Portugal: Labor Market Indicators, 2017–2021
Figure 6.

Portugal: Inflation Developments, 2020–2022

Portugal and Euro Area: Contribution to Inflation

(Percent)
Figure 7.

Portugal: Fiscal Sector Indicators

Discretionary Fiscal Response: 2020–21

(Percent of GDP)

Portugal: Share of Firms by Financial Situation (2020–2019)

(percent of reporting continuing firms financial difficulty is if debt-to-equity is 7.5)

Portugal: Unfilled Job Vacancies by Sector

(Numbers)
Figure 8.

Portugal: Bank Loans Under Moratoria

Banking Sector: Profitability, Capitalization, Liquidity and Nonperforming Loans
Figure 9.

Portugal: External Sector Indicators

Contribution to Real GDP Growth

(Percentage points, year-on-year)

Real Output Loss

(2019=100)

Fiscal Balance and Primary Balance

(Percent of GDP)

Public Gross Fixed Capital Formation

(percent of GDP)

Worker Characteristics: Temporary and Low-skilled Employment, 2021Q4

(Percent)

Strictness of Employment Protection – Individual and Collective Dismissals, 2019

(Index)

Target Emission Reduction by 2030

(Percent)

Portugal: GHG Emissions Over Time, 1990–2030

(in tons of C02 equivalent)

Real Estate Prices Index

(Index, 2015 = 100)

Real House Price Index, 2021Q3

(Index, 2015 = 100)

House Price Misalignment

(In percent, 2021Q2)

House Price-to-income and Price-to-Rent Ratios

(Index, 2010=100)

House Purchase Transactions and New Housing Loans

(In billion euros)

Housing Credit Outstanding

(Percent of gross disposable income (GDI) per capita)

Housing Credit Payments

(Percent of gross disposable income (GDI) per capita)

Loans for house purchase, end-2021

(In percent of total loans for house purchase)

3-month EURIBOR Swap Curve

(Percent)

Share of housing loans in total bank credit to residents

(in percent)

Social Housing Stock, 2020 or latest

(In paercent, social rental dwellings as a share of the total number of dwellings)

Projected Change in Debt, 2022–2027

(Percent of GDP)

10-Year Sovereign Bond Yields

(In percent)
Figure 1.

Portugal: Gross Financing Needs Module
Figure 2.

Portugal: Fan Chart Module
Figure 1.

Portugal: Public DSA Risk Assessment
Figure 2.

Portugal: Public DSA—Realism of Baseline Assumptions
Figure 3.

Portugal: Public Sector DSA—Baseline Scenario

(In percent of GDP unless otherwise indicated)
Figure 4.

Portugal: Public DSA—Composition of Public Debt and Alternative Scenarios
Figure 5.

Portugal: Public DSA—Stress Tests