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Portugal: weak reform momentum threatens feeble growth

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Portugal continued to grow in 2015, after exiting the EU/IMF bailout programme in 2014, 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 levels leave the country vulnerable to adverse shocks.  

Strengths (+) and weaknesses (-)

(+) Political stability

Portuguese political parties share a willingness to keep the political system stable to guarantee conditions for economic growth and good relationships with creditors.

(-) 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. Growth holds up but remains feeble, reform momentum is rapidly fading

Portugal continued to grow in 2015 at 1.5% on the back of strengthening domestic demand (see figure 1), in turn boosted by employment growth. While this is consistent with pent-up demand after the program years of 2011-2013, growth of private consumption higher than disposable income since early 2015 raises concerns about the durability of the domestic demand growth. As a result of the increasing consumption, imports increased faster than exports, leading to a negative net contribution of exports. This means that strengthening of the current account surplus is stalling (see figure 2). The current account is expected to show a modest surplus of 0.9% of GDP in 2016, while the net international investment position is still -103.3% 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 though deleveraging has been substantial, with both household and corporate debt steadily declining in the past three years. The high level of private and fiscal debt weigh on the financial sector, resulting in low profitability and high shares of NPLs (over 11% in 2014). 

Figure 1: GDP growth driven by domestic demand
Figure 1: GDP growth driven by domestic demandSource: Eurostat
Figure 2: Current account balance stabilising
Figure 2: Current account balance stabilisingSource; ECB 

The lack of structural reforms since the IMF/EC bailout program ended in spring 2014 leaves Portugal with substantial macroeconomic vulnerabilities. There are still significant rigidities in labour and product markets. Especially network industries (telecoms, electricity, ports, energy) remain closed industries, resulting in high rents in these sectors and an uneven distribution of economic surpluses among different groups. Current reforms implemented or planned are not comprehensive and mainly aim at implementing already agreed measures resulting from the program. 

Figure 3: Private debt is declining further
Figure 3: Private debt is declining furtherSource: Eurostat
Figure 4: Public debt consolidation is stagnating
Figure 4: Public debt consolidation is stagnatingSource: EC, Eurostat 

2. New government spells end of unanimity and may lead to gridlock

In October 2015, the Portuguese went to the ballot box delivering no clearly mandated government. The more mainstream socialist party (PS) led by prime minister Da Costa is in power, but because his party has no majority in parliament, he has to rely on radical left-wing parties, which are adamantly opposed to austerity. This severely limits the government’s room for manoeuvre on fiscal issues. Now the prime minister is performing a difficult balancing act between the European Commission and financial markets, who demand Portugal sticks to the original direction of especially fiscal policy, and his fractious partners. This bodes ill for the already lacklustre reform progress where, under pressure from the Communist party, many planned reforms are shelved or even reversed. To appease the Eurogroup, however, the government has come up with several ‘contingency’ measures in case of fiscal slippage. This also signals that the government has no appetite to drive relations over the edge, which could result in increased surveillance by the Commission or even a new programme. 

3. Public debt is problematic in the medium and long term

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 in 2014, the public debt and deficit remain high and it looks like the perceived urgency for consolidation has waned. The 2016 budget was widely criticized by the European Commission, which lead to a confrontation with the Eurogroup in February 2016. The budget was approved in spite of a deviation from the EU’s fiscal adjustment requirements. The left has vowed to reject any reduction in public spending so the vast majority of corrective measures are on the revenue side, further burdening the economy with tax increases. 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 over the medium term and a reduction of public debt is therefore key. 

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 was 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% in 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 had thus far remained limited, it increased markedly after the October 2015 elections failed to yield a clearly mandated government. Since the democratic reforms after the dictatorship ended in 1974, the political system is 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)
Daniel van Schoot
RaboResearch Netherlands Rabobank KEO
+31 30 21 62666

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