The chal­lenges for Por­tuguese pub­lic fi­nances

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Por­tu­gal has pre­sented a bud­get for 2016 that in­di­cates political com­mit­ment to fur­ther fis­cal con­sol­i­da­tion. A re­vised bud­get is tar­get­ing a fis­cal deficit of 2.2% of GDP. As back­ground, af­ter a de­lay of more than three months, brought about by the for­ma­tion of a new govern­ment at the end of last year, the Por­tuguese govern­ment sub­mit­ted its Draft Bud­getary Plan to the Euro­pean Com­mis­sion at the end of Jan­uary. Un­der this plan, the head­line deficit tar­get for the year was set at 2.6% of GDP, lower than the 2.8% pre­sented in the eco­nomic pro­gramme in De­cem­ber; and the struc­tural deficit tar­get was ex­pected to fall to 1.1% of GDP. A real GDP growth rate of 2.1% in 2016 was also as­sumed, which may be op­ti­mistic. How­ever, the im­prove­ment in the struc­tural deficit was mainly the re­sult of the clas­si­fi­ca­tion of some mea­sures as one-offs in 2015 and 2016, im­ply­ing that there was in fact no im­prove­ment but in­stead a de­te­ri­o­ra­tion in the struc­tural bal­ance.

Fol­low­ing talks with the Euro­pean Com­mis­sion, the Por­tuguese govern­ment adopted ad­di­tional fis­cal con­sol­i­da­tion mea­sures at the be­gin­ning of Fe­bru­ary, and agreed on the clas­si­fi­ca­tion of one-off mea­sures. As a re­sult, the Com­mis­sion has es­ti­mated that the fis­cal ef­fort at be­tween 0.1% and 0.2% of GDP. While still below the rec­om­mended 0.6% of GDP, the de­vi­a­tion was not con­sid­ered sig­nif­i­cant and the Com­mis­sion de­cided not to re­quest a re­vised bud­get from the Por­tuguese govern­ment. How­ever, the Com­mis­sion still deems the bud­get to be at risk of non-com­pli­ance with the Sta­bil­ity and Growth Pact, and thus ad­di­tional mea­sures might be needed. A re­assess­ment of com­pli­ance with the EU fis­cal rules planned for May, af­ter Por­tu­gal’s Sta­bil­ity Pro­gramme and the Euro­pean Com­mis­sion Spring Eco­nomic Fore­cast are pre­sented, will be an im­por­tant bench­mark.

Un­der the 2016 bud­get cur­rently un­der dis­cus­sion in the Por­tuguese par­lia­ment, the govern­ment is tar­get­ing an am­bi­tious fis­cal deficit of 2.2% of GDP. This com­pares to an es­ti­mated 3.0% in 2015 (ex­clud­ing one-offs op­er­a­tions) and 3.4% in 2014. The bud­get mea­sures con­tain the re­ver­sal of the cuts in pub­lic sec­tor wages and the sur­charge on per­sonal in­come tax, as well as a re­straint on pub­lic in­ter­me­di­ate con­sump­tion ex­pen­di­ture. Ad­di­tional mea­sures on the rev­enue side in­clude taxes on car pur­chases, fuel and to­bacco, and higher taxes on bank con­tri­bu­tions to the Por­tuguese res­o­lu­tion fund. Ad­di­tional mea­sures on the ex­pen­di­ture side in­clude re­stric­tions on hir­ing civil ser­vants and con­trols on so­cial se­cu­rity. How­ever, there are some risks to the im­ple­men­ta­tion of th­ese mea­sures. First, the re­duc­tion in ex­pen­di­ture could be chal­leng­ing, es­pe­cially in the ab­sence of bind­ing and clear ex­pen­di­ture ceil­ings. Se­cond, a fur­ther im­prove­ment in the per­for­mance of state-owned en­ter­prises is also planned, but the re­sults are un­cer­tain. Third, there is a risk that the gov­ern­ing So­cial­ist Party, the Left Bloc and the Com­mu­nists could dis­agree over the mea­sures. DBRS would be con­cerned if fis­cal slip­page be­came per­sis­tent.

Por­tu­gal has un­der­gone a sig­nif­i­cant fis­cal ef­fort, and this is al­ready re­flected in DBRS’s rat­ings at BBB (low). Be­tween 2010 and 2015, the re­duc­tion in the struc­tural bal­ance amounted to 6.2 per­cent­age points of GDP, sim­i­lar to that of Ire­land. How­ever, pub­lic debt re­mains high. Af­ter peak­ing at 130.2% of GDP in 2014, gen­eral govern­ment debt is es­ti­mated to have de­clined to 128.7% of GDP in 2015, the third high­est ra­tio in the Euro area. The 2016 bud­get en­vis­ages the govern­ment debt ra­tio to fall fur­ther, to 127.7% of GDP in 2016. Over the medium term, DBRS ex­pects a grad­ual re­duc­tion in govern­ment debt, re­flect­ing mod­er­ate struc­tural fis­cal ad­just­ment and mod­est growth prospects. The sale of Novo Banco should con­trib­ute to the re­duc­tion of debt, but the tim­ing of the sale re­mains un­cer­tain.

An im­proved debt re­pay­ment pro­file, with ex­tended debt ma­tu­ri­ties, partly mit­i­gates some of the risks stem­ming from high debt. How­ever, the high level of pub­lic debt leaves Por­tu­gal ex­posed to sev­eral shocks. Debt dy­nam­ics are par­tic­u­larly sus­cep­ti­ble to a neg­a­tive growth shock and a pri­mary deficit shock. A rise in bor­row­ing costs could also have a neg­a­tive im­pact on the tra­jec­tory of debt-to-GDP. Al­though the risk from con­tin­gent li­a­bil­i­ties has mod­er­ated fol­low­ing the re­struc­tur­ing of most state-owned en­ter­prises since 2013 and the strength­en­ing in banks’ cap­i­tal ra­tios, con­tin­gent li­a­bil­ity risks per­sist. With the struc­tural ad­just­ment ex­pected to be mod­er­ate and given the risks of slip­page, stronger growth could play a more i mpor­tant role in the re­duc­tion of debt. How­ever, growth prospects look mod­est. DBRS would be con­cerned if durable growth fails to ma­te­ri­alise.

Por­tu­gal’s eco­nomic re­cov­ery has been grad­ual and the prospects look mod­est. Af­ter grow­ing by 0.9% in 2014, real GDP is es­ti­mated to have grown by 1.5% in 2015. Th­ese out­comes were broadly in line with the Euro area av­er­age, but below growth of 1.4% and 3.2% in Spain in 2014 and 2015, re­spec­tively. Un­der the 2016 bud­get, the govern­ment re­vised down­wards its as­sump­tion for growth to 1.8% this year. While less op­ti­mistic than un­der the Draft Bud­getary Plan, it is still above the Euro­pean Com­mis­sion’s lat­est fore­cast for the Por­tuguese econ­omy of 1.6% and the IMF fore­cast of 1.4%, which were pub­lished at the be­gin­ning of Fe­bru­ary. Growth is ex­pected to re­main sup­ported by pri­vate con­sump­tion, while in­vest­ment re­mains sub­dued and net ex­ports are set to de­tract from growth.

Down­side risks to the out­look in­clude re­newed un­cer­tainty over eco­nomic poli­cies, the political sit­u­a­tion and the bank­ing sec­tor. Po­ten­tial un­cer­tainty could af­fect eco­nomic sen­ti­ment and lead house­holds to in­crease their sav­ings, af­fect­ing pri­vate con­sump­tion. Weaker-thanex­pected ex­ter­nal de­mand from the Euro area, par­tic­u­larly from Spain, could also pose risks to the out­look.

Lift­ing Por­tu­gal’s growth po­ten­tial re­mains a ma­jor chal­lenge for the coun­try. Al­though sev­eral struc­tural re­forms have been im­ple­mented over the past five years, Por­tu­gal’s po­ten­tial growth re­mains low. This largely re­flects low lev­els of in­vest­ment, in­suf­fi­cient com­pe­ti­tion in the non­trad­able sec­tor and rigidi­ties in the labour mar­ket. As a re­sult, the con­tin­ued im­ple­men­ta­tion of struc­tural re­forms re­mains im­por­tant.

To con­clude, Por­tu­gal has al­ready un­der­gone an im­por­tant fis­cal ef­fort and seems com­mit­ted to fur­ther ad­just­ment. How­ever, fis­cal slip­page re­mains a risk. More im­por­tantly, govern­ment debt re­mains high and is ex­pected to de­cline only grad­u­ally, leav­ing the coun­try ex­posed to shocks. In the longer term, mod­est fis­cal struc­tural ad­just­ment and the ab­sence of durable eco­nomic growth could pose a risk to the sus­tained im­prove­ment in pub­lic fi­nances.

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