Abstract
The Portuguese authorities thank staff for the fruitful and engaging Article IV consultation discussions. The Portuguese economy entered the pandemic on a strong footing, benefitting from the reforms and hard-won adjustment that followed the Global-Financial and Sovereign-Debt crises. Public debt had been declining since 2016, the external position had been improving steadily, unemployment had reached a decade low, and the banking sector had significantly strengthened. When the pandemic hit, the authorities deployed a timely, comprehensive, and well-coordinated package of policy support, that sustained employment and incomes by providing liquidity to both households and firms. These policy measures, coupled with a strong vaccination drive, laid down the conditions for a swift recovery. The protracted pandemic and Russia’s invasion of Ukraine have posed new major challenges, including an increase in inflation, but all sectors of the Portuguese economy have proven resilient. Moving forward, we agree with staff’s recommendation of balancing policies to address short-term challenges with policies to promote, in the long-term, competitiveness, economic growth and social cohesion, together with sound public finances.
The Portuguese authorities thank staff for the fruitful and engaging Article IV consultation discussions. The Portuguese economy entered the pandemic on a strong footing, benefitting from the reforms and hard-won adjustment that followed the Global-Financial and Sovereign-Debt crises. Public debt had been declining since 2016, the external position had been improving steadily, unemployment had reached a decade low, and the banking sector had significantly strengthened. When the pandemic hit, the authorities deployed a timely, comprehensive, and well-coordinated package of policy support, that sustained employment and incomes by providing liquidity to both households and firms. These policy measures, coupled with a strong vaccination drive, laid down the conditions for a swift recovery. The protracted pandemic and Russia’s invasion of Ukraine have posed new major challenges, including an increase in inflation, but all sectors of the Portuguese economy have proven resilient. Moving forward, we agree with staff’s recommendation of balancing policies to address short-term challenges with policies to promote, in the long-term, competitiveness, economic growth and social cohesion, together with sound public finances.
Economic activity and outlook
Staff rightly stresses that the Portuguese economy has been on a path of sustained recovery. Data for 2022Q1 and a strong carry-over effect point to higher growth in 2022 than the 4.9 percent registered in 2021; even if the impact of the war and rising energy prices have clouded the outlook for the rest of the year. An acceleration of private consumption and a rebound in tourism are driving growth. The labor market continues to show remarkable resilience. Overall employment returned to pre-pandemic levels already in 2021Q2 and is now close to 2019 levels even in the most affected sectors by the pandemic. The unemployment rate (5.8 percent in April 2022) is at a historically low level. There has been a recent increase in inflation mainly driven by energy prices, but without second round effects.
Inflation is expected to peak at around 5.9 percent in 2022 and to go back to 2 percent over the medium-term. Nonetheless, the 12-month average HICP in May 2022 stood at 3.3 per cent, still considerably below the euro area average of 4.9 per cent.
We agree that, despite the recovery in economic activity, global uncertainty about the effects of Russia’s invasion of Ukraine is high. Monetary and financial conditions in the euro area may become less favorable, as evidenced by the rise of the EURIBOR rate to positive levels for the first time in several years. The Portuguese authorities will continue to implement their economic reform plans and take adequate measures to deal with the challenges posed by a deteriorating global outlook.
Fiscal Policy
We welcome staff’s acknowledgement of Portugal’s strong fiscal performance. Fiscal outturn was better than projected with the deficit below the 3 percent threshold in 2021 (2.8 percent of GDP). We expect the headline deficit to decrease even further in 2022, despite the additional temporary measures taken to mitigate the impact of higher energy prices. Staff also rightly recognizes that the debt-to-GDP ratio has resumed its steep downward trajectory, with a drop of 7.8 percentage points of GDP in 2021; a major step towards bringing it below 100 percent by 2026!
Portugal will continue implementing policies that on the one hand support the economic recovery and on the other hand enhance public finances’ sustainability by reducing public debt. This strategy aims at maintaining external credibility and access to financial markets at favorable conditions. To this end, we plan a consolidation effort of 0.3 percent of GDP on average each year over the 2023–2025 period, which will allow us to reach the Medium-Term budgetary Objective (MTO) of a 0.5 structural deficit (in percentage of GDP) by 2023 and a balanced structural position by 20251. This consolidation path is somewhat slower than the one recommended by staff, but we believe it is adequate to continue the steady downward trajectory of the public debt-to-GDP ratio. Under our consolidation plans, public debt-to-GDP will reach its pre-pandemic level already in 2023, and at the same time leave space to deal with long-term challenges, such as ageing, inequalities and the climate and digital transitions.
Corporates and financial sector policies
Portuguese corporates were still embarking on a deleveraging process when the pandemic hit. Supported by policy measures, the sector has held up well, but vulnerabilities have increased. To address these vulnerabilities, the authorities created Banco Portugues de Fomento (BPF) that is responsible for the Capitalization and Resilience Fund, and developed two solvency support programs in the amount of 650 M€, to, among other things, help recapitalize viable corporates particularly impacted by the pandemic, to strengthen start-ups and to facilitate corporates’ access to equity instruments.
After strengthening their capital levels and balance sheets following the global financial crisis, banks have now become part of the solution to address the pandemic, showing resilience during the crisis. Capital ratios increased throughout 2020, remaining stable in 2021, contributing to banks’ ability to absorb losses and finance the economy. Indeed, credit continued to flow smoothly to the economy in 2020 and 2021. Non-Performing Loans (NPLs) ratios have kept their downward trend since June 2016, with the ratio of NPLs to gross loans, net of impairments, standing at 1.7 percent in December 2021. While we observe some signs of deterioration in credit quality for loans that benefitted from moratoria, currently available information points to quite limited risks, in line with the economic recovery, and better than feared at the beginning of the pandemic.
Going forward, the full impact from the pandemic and the consequences from the invasion of Ukraine on asset quality remain uncertain because of possible second-round or indirect effects. Nevertheless, the already well-defined and proven strategies for adequate loan classification, managing NPLs, and raising provisioning to mitigate the potential increase in NPLs over time will continue to play their important role in risk mitigation.
Cyclical systemic risk may increase in the future because of developments in the residential real estate market. However, we see several mitigating factors. First, the evidence gathered since the introduction of the macroprudential borrower-based measure points to an increase in the resilience of the banking system to shocks in real estate prices. Indeed, 92 percent of mortgage loans in banks’ balance sheet have a Loan-to-Value below 80 percent, leaving leeway to accommodate a correction in house prices in the banking sector. Second, the credit risk profile of new mortgage loans has improved. Third, domestic bank credit has not been a driver of increases in house prices. Finally, monetary policy normalization, depending on its pace and scale, will also help reducing the level of vulnerabilities and should not be ignored from a macroprudential perspective. In case we conclude that risks associated with the real estate market should be addressed by macroprudential policy in the future, we favor more targeted/sectoral capital instruments.
At this point in time, with risks well contained, and a backdrop of high global uncertainty, downside risks to growth and upside risks to inflation that can impact households’ real disposable income and non-financial corporations profit margins, we want to avoid introducing a macroprudential measure that could have procyclical effects, magnifying the adverse impact of a materialization of risks.
Structural Reforms
The Portuguese authorities structural reform agenda is wide and ambitious. The 5-Pillar2 National Reform Program (NRP) is updated yearly; it sets the authorities’ main priorities with timeline and quantitative benchmarks to assess progress in its implementation. In turn, the Portuguese Recovery and Resilience Plan (RRP) will implement a set of reforms and investments based on three dimensions: Resilience, Climate Change and Digital Transition, aiming at restoring sustained economic growth and supporting the goal of convergence with Europe over the next decade. The authorities are strongly committed to a steadfast implementation of the RRP, which can lift growth in the medium-term and further reduce the chance of scarring from the pandemic. We highlight some recent or upcoming initiatives on (i) the judicial system; (ii) workers’ skills and the labor market, and (iii) the green transition; that speak to some of the recommendations by staff.
Judicial system. The authorities have recently revised the legal framework for the insolvency and recovery of companies and the legal regime to encourage the extinction of proceedings by judicial and extrajudicial agreements to facilitate reorganization and exit of businesses.
Workers’ skills and the labor market. Staff rightly recognizes that reforms in the education system have begun to bear fruit in Portugal. Indeed, Portugal registered considerable progress in qualifications of the youth, with younger cohorts having much higher education levels than older cohorts. The authorities have also promoted adult education and training. Nevertheless, Portugal still lags European averages in terms of skills. Hence, the authorities are prioritizing additional initiatives to enhance qualifications, notably in the areas of digitalization, trying to align qualifications with demands of the labor market. The RRP devotes 22 percent of its funds to digitalization initiatives, including to promote students’ and workers’ digital competences, which will help promote inclusion and foster productivity. The aim is to promote continuous professional training and lifelong learning, as well as combating the segregation of occupations between women and men. The authorities also continue to implement Active Labor Market Policies, namely, to support the insertion of young people and long-term unemployed in the labor market, to convert traineeships into permanent employment, to provide direct hiring incentives and to promote entrepreneurship. The authorities are strongly committed to push ahead with their Agenda for Decent Work and appreciation of Young People in the Labor Market that, among other things, tries to decrease incentives for excessive use of temporary contracts.
Climate transition. Portugal has set ambitious national targets and is well placed to comply with the new Fit-for-55 targets and the RRP will be the financial cornerstone of the strategy. The fact that Portugal allocated 38 percent of RRP funds to the climate transition is a testament to the priority Portugal attributes to climate change adaptation and mitigation.
Portugal’s strategy for climate change mitigation revolves around renewable energy sources. The authorities approved exceptional measures to simplify energy production procedures from renewable sources in the context of the current crisis. They will increase the production of biomethane and renewable hydrogen, the deployment of solar and wind energy, the deployment of innovative solutions based on hydrogen and electricity from renewable sources at competitive costs in industrial sectors and simplify and reduce deadlines for licensing procedures. The authorities have also considered new measures to combat energy poverty through a draft of the National Strategy to Tackle Energy Poverty to: (i) increase the energy performance of households; (ii) strengthen the conditions of access to energy services; (iii) reduce energy consumption costs; and (iv) strengthen knowledge and access to information on energy.
The authorities welcome the Special Issues Paper on reducing Greenhouse Gas Emissions in Portugal and its policy recommendations. They consider that a combination of policy measures is needed to fight climate change. In this context, they recognize that carbon pricing tools are important to mitigate climate change and would envision a gradual increase in carbon taxing. However, the pressures on energy prices make it difficult to implement at this juncture. Other fiscal measures, such as cutting back on fossil fuel subsidies, are also part of a medium-term strategy. The authorities consider that financial policies should also have a complementary role. These should be designed to induce an adequate pricing of climate risk by financial institutions and to facilitate the re-orientation of lending towards greener activities. The authorities are working toward these goals within the Eurosystem context, for instance by upgrading the financial stability and prudential frameworks to incorporate climate-related financial risks.
Conclusion
The authorities will continue to strengthen public finances, implement structural reforms and investments to foster resilience and higher productivity levels, in the context of the Portuguese Recovery and Resilience Plan and of the Portugal 2030 programming period. The goal is to promote sustainable, green and inclusive growth, while reaping the benefits of the digital transition.
The authorities look forward to the next Article IV Consultation in 2023, which will constitute another excellent opportunity to continue closely working with the Fund, deepening our dialogue, and promoting an ever-closer mutual understanding.
The MTO is part of the European Union’s fiscal framework and is currently set as a structural deficit of 0.5 per cent for Portugal.
The five pillars of the NRP are: (i) macroeconomic context and structural reforms’ impact; (ii) a better demographic balance, further inclusion and less disparities; (iii) digitalization, innovation and qualifications as drivers of devebpment; (iv) an externally competitive and internally cohesive country; (v) and sustainable development.