RaboResearch - Economic Research

Portugal: Back from the brink but not without lingering risks

Economic Update

  • Portugal’s growth outperformed the euro zone average in recent years, on the back of strong labor market recovery
  • But growth is expected to decelerate as catch-up opportunities diminish and the tough external environment impacts exports 
  • Despite falling public debt, at 121% of GDP Portugal still has the third highest public debt ratio in the euro zone, after Greece and Italy
  • The center-left coalition has successfully juggled re-igniting Portuguese growth and improving the budget balance with lower taxes and higher wages and pensions
  • This makes it likely that Socialist leader Costa will be re-elected prime minister in October

Portugal has Outperformed Euro Zone Average

Figure 1: Portuguese Output has Recovered to Pre-Crisis Levels
Figure 1: Portuguese Output has Recovered to Pre-Crisis LevelsSource: Macrobond

Portugal has come out of the euro crisis better than some of its (southern) European peers (Figure 1). It outperformed the euro zone average in recent years and output recovered to pre-crisis levels, due to strong GDP growth in 2017 and 2018. Private consumption has been the most important driver of output growth, thanks to rapid improvements in Portugal’s labor market, which brought a sharp fall in youth- and broader unemployment metrics.

Going forward, we expect that domestic demand will continue to drive growth despite a tough environment for external demand. We do expect growth to slow in the coming years, as the opportunities for catch-up growth diminish, labor market recovery slows, and exports suffer from declining global economic growth and international trade tensions. Risks are clearly to the downside, with potential for Portugal’s exports to take a hit from a full escalation of US-China trade tensions, a hard Brexit, and Trump shifting his trade-war focus to Europe. Moreover, renewed tensions between Brussels and Rome, or even a debt crisis in Italy (from a medium to longer term perspective) could push up financing costs for other peripheral euro zone countries. This includes Portugal where the public debt ratio remains high.

Portuguese debt Levels are Down but Still Pose Risks

Although Portugal’s public debt went down in recent years (due to improvements in the budget balance, low interest rates and strong output growth) at 121% of GDP, Portugal still has the third highest debt ratio in the euro zone (Figure 2). Private sector debt is also falling and currently stands at 168% of GDP. Yet European Central Bank (ECB) data indicates that over 80% of these private sector loans are subject to variable interest rates, making Portuguese households and non-financial corporations vulnerable to an increase in interest rates. Nevertheless, we do not see any imminent problems in that respect: interest rates are more likely to continue on their way down following fresh ECB stimulus signals, which are also reflected in recent declines in government bond yields (Figure 3).

Figure 2: Debt Ratio is Among the Highest in Euro Zone
Figure 2: Debt Ratio is Among the Highest in Euro ZoneSource: Macrobond
Figure 3: 10-year Yields Have Come Down
Figure 3: 10-year Yields Have Come DownSource: Macrobond

Centre-left Coalition Still has Popular Support but Faces Challenges Ahead

Prime Minister Antonio Costa, who has been in office since November 2015, enjoys strong support among the general public. With the Socialists enjoying a comfortable lead in the polls ahead of general elections scheduled for October, Costa looks set for another term in office.

The Socialists are given the credit for a swift reduction of unemployment, for re-igniting economic growth after Portugal suffered heavily during the European debt crisis, and for ending EU-imposed austerity. This would not have been possible without Portugal’s skillful (Socialist) Minister of Finance, Mario Centeno. He also managed to improve public finances while cutting taxes and  raising pensions, minimum wages and public sector wages. While it reversed some of the previous harsh austerity measures, the administration is, broadly speaking, seen as pro-Europe and supportive of the market economy.

Nevertheless, the Socialists still face substantial challenges ahead. For starters, at more than 20%, youth unemployment is still high (although this had been a feature of the labor market well before the sovereign debt crisis). Added to this, the Portuguese people have become increasingly vocal in demanding a share in the spoils of economic recovery. Public sector workers have staged strikes for higher wages, which makes life harder for Centeno as he tries to reduce the public debt ratio. Meanwhile, Portugal’s household saving ratio is among the lowest in the euro zone: it has declined sharply since 2013, making consumer spending more sensitive to future setbacks in income growth.

The Portuguese banks still require attention too, given the substantial amount of non-performing loans (NPL) on their balance sheets (Figure 4). Despite declines in recent years, the NPL ratio remains high, making it harder for banks to support investments, which are still 15% below pre-crisis levels. Nonetheless, the Portuguese people seem confident they have the right government to address these problems.

Figure 4: Asset Quality Portuguese Banks Remains Relatively Weak
Figure 4: Asset Quality Portuguese Banks Remains Relatively WeakSource: European Banking Authority (EBA)
Table 1: Selection of Macroeconomic Aggregates
Table 1: Selection of Macroeconomic AggregatesNote: (f) forecast, * forecasts are from European Commission 
Source: Rabobank, Macrobond


Michiel van der Veen
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO

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