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Country report Portugal

Country Report

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Portugal returned to growth in 2014 and exited the EU/IMF bailout package, which signals a substantial increase of economic and financial stability. However, the net international investment position is very negative and high public and private debt leave the country vulnerable to sudden shifts in risk perception.

Strengths (+) and weaknesses (-)

(+) Political stability

Portugal is not facing politically destabilising populist and extremist trends despite its high unemployment and considerable reform and austerity effort in the past few years.

(-) Excessive bureaucracy and overburdened court system

Portugal has excessive bureaucratic procedures and a slow administrative process coupled with an overburdened court system, which have a negative impact on the business climate.

(-) Structurally low economic growth

Portugal is characterized by a structural lack of robust economic growth, which has negative implications for welfare, unemployment and debt sustainability.

(-) Worrying state of public finances

Amid the very high public debt level a robust budgetary effort will be necessary for many years to come, while a scenario of debt becoming unsustainable cannot be excluded.

Key developments

1. Return to growth amidst bleak prospects

Portugal returned to GDP growth (0.9%) in 2014 on the back of strengthening domestic demand. Consumer and producer confidence have shown a marked and continued improvement since mid-2013, signaling a further strengthening of domestic demand going forward. This improvement has boosted consumption and investment, which both posted solid yearly growth rates of (2.1% and 2.4% respectively). As a result, imports increased faster than exports (5.9% versus 3.8% respectively). This means the necessary improvement of the current account has been is stalling. The current account is expected to show a modest surplus of 1.2% of GDP in 2015, while the net international investment position is still -119% of GDP. With heavy reliance on portfolio investment and relatively little FDI this poses a risk to macro-economic stability. Domestically, Portugal is also dealing with high indebtedness of the private sector (figure 3), even as deleveraging has been substantial with both household and corporate debt declining by 6% and 7% respectively in the last two years. However, deleveraging could inhibit new lending to productive sectors.

Figure 1: GDP growth in components
Figure 1: GDP growth in componentsSource: Macrobond
Figure 2: Current account
Figure 2: Current accountSource: Macrobond

Employment growth was 1.6 percent in 2014, but this still left unemployment at 13.6% at the end of the same year. What is more, the employment growth figure overstates real job creation, as a significant part of the growth in private sector jobs takes the form of state sponsored traineeships, provoking sharp criticism from the Portuguese Central Bank. Looking forward, the IMF states that current policies are insufficient to substantially reduce labour slack, particularly for lower-skilled workers. Low employment growth will also leave poverty and income inequality at elevated levels. While Portugal started with ambitious reform and privatization programs to qualify for EU/IMF support, political support is waning. The OECD publishes an indicator that shows to what extent a country is implementing suggested reforms. For Portugal, his indicator has declined in 2013-2014, which does not bode well for a further reduction of unemployment, which is expected to stay above 12% in 2015 and 2016.

Figure 3: Private debt
Figure 3: Private debtSource: Macrobond
Figure 4: Public finances
Figure 4: Public financesSource: Macrobond

2. Over-optimistic pre-election budget

The state of public finances continues to pose problems for Portugal. Although the government has worked quite persistently to meet the criteria of the EU/IMF bail-out programme which it exited on May 17th 2014, the public debt and deficit remain high and it looks like the perceived urgency for consolidation has waned. The 2015 budget was widely criticized by both the central bank and the European Commission. On the revenue side, the forecasted tax revenue growth is deemed quite optimistic as most of the low-hanging fruit has already been picked. On the revenue side, the proposed measures are judged to be rather limited. For now Portugal will benefit from low(er) bond yields as a result of quantitative easing by the ECB, contributing to debt sustainability. However current levels of public debt are unsustainable and should come down over the medium term.

3. Political fragmentation could make it more difficult to implement new reforms

Portugal will go to the ballot box in October this year. The country remains politically stable with little susceptibility for extremist parties or populist movements that we have seen in other crisis-stricken countries. However, like in many other countries, the political scene is likely to become more fragmented in Portugal. Neither of the two large parties is likely to win an absolute majority in the upcoming election. This will make it necessary to form a coalition government. The opposition has severely criticized the austerity and reform packages implemented to fit the terms of the IMF/EFSF bailout package. With sovereign spreads in calmer waters, the reform effort has slowed in recent years. The political situation does not bode well for the much needed structural reforms.

Factsheet of Portugal
Factsheet of PortugalSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Partly due to the period of structurally low economic growth that began in the 1990s, Portugal has the lowest GDP per capita of the larger eurozone countries. This period of low growth can be explained by several structural weaknesses in comparison to its European peers: a low level of domestic competition, an inflexible labour market, an inefficient government and a poor business climate. After the financial crisis Portugal entered several years of severe economic contraction, driven by a large austerity effort, private sector deleveraging and weak external demand. This contraction has improved the external balance, but came at the cost of a very large output gap. It should be noted that this rebalancing is driven largely by an import contraction and only to a smaller extent by export growth. In November 2011, the Portuguese government received a rescue package from Europe and the IMF, worth EUR 78bn. Considerable progress has been made under this bailout program, especially in the fields of structural reform and budgetary consolidation. However, the self-defeating character of recession and austerity led to a rapid rise of Portugal’s unemployment rate, which peaked at 17.5% January 2013, and has led to increasing public dissatisfaction with the policies demanded by Portugal’s creditors. Since the large public protests in September 2012, there have been several disputes between the current coalition partners, fuelled by stiff pressure from the opposition and by the decision by the Constitutional Court to reject several austerity measures. Although the fragmentation of Portugal’s political landscape has so far remained limited this could change after the October election. Since the democratic reforms after the dictatorship ended in 1974 it has been dominated by two parties but cracks in the two-party system are starting to appear. Political fragmentation will make it difficult to continue with necessary structural reforms.

Economic indicators of Portugal
Economic indicators of PortugalSource: EIU
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Author(s)
Jurriaan Kalf
RaboResearch Netherlands Rabobank KEO
+31 (0)30 21 62666

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