Portugal’s economy continued growing, with some deceleration stemming mostly from the external sector. Domestic demand was the main driver of growth supported by improvements in the labour market. By the end of 2018, fiscal targets were met, supporting reductions in high public debt. This downward debt trajectory remains susceptible, however, to lower-than-expected growth dynamics and to a drag on public finances from an ageing population. The health of the banking system improved, but vulnerabilities remain, such as NPLs above the euro area average and weak profitability.
GDP growth moderated to 2.1% in 2018 from 2.8% in 2017 due to weaker global and euro area growth. Gross capital formation and private consumption were the primary drivers of growth. Net exports’ positive contribution was interrupted in 2018; import growth outweighed that of exports, given a weaker contribution from tourism. Labour market developments were positive with unemployment stabilising at 6.6% by the end of 2018. Growth is expected to decelerate gradually between 2019 and 2021, caused by a moderate slowdown of private consumption and business investment. Trade disputes and Brexit could also impact future economic developments.
The general government budget deficit reached 0.5% of GDP in 2018, improving beyond the 0.7% target, following revenue outperformance and contained expenditure growth. Both current revenues and primary spending grew in line with the annual targets. The public debt level declined further to 121.5% of GDP in 2018 from 124.8% of GDP in 2017 in response to improvements in the primary balance. Moreover, fiscal performance and good market access allowed Portugal to repay early and in full its IMF loan and further smooth its debt maturity profile, taking advantage of the current low rates. Portugal has also committed to an early repayment of the EFSF loan by up to €2 billion from 2020 to 2023 subject to market conditions and the impact on debt sustainability as assessed at the time.
In 2018, Moody’s was the last of the major rating agencies to upgrade Portugal’s rating to investment grade taking into account positive economic developments. The 10-year government bond yield returned to the 1.5%-2% range in the second half of 2018, close to the historical lows after the end of its programme, following some temporary volatility in the first half of the year. The spread to Germany has also been broadly stable around 150 basis points.
Economic growth, higher real estate prices, and heightened investor interest supported the banking sector’s continued recovery in 2018. The sector’s profitability improved clearly in 2018 compared to previous years. The NPL ratio dropped significantly by 3.9 percentage points during 2018 to 9.4%. NPL sales and cures have driven the fall in the NPL stock. The total capital ratio remained constant at 15.2% of risk-weighted assets, while the common equity tier 1 ratio decreased slightly to 13.2%. The resolution fund is liable for future losses of Novo Banco through a capital contingent mechanism until 2025. In 2018, Novo Banco made use of it and received its first payments from the resolution fund, which were partially funded by a state loan.
The continued assessment of Portugal’s repayment capacity suggests no short-term repayment risk of the outstanding EFSF loan. Portugal’s high public debt burden, however, remains an important vulnerability and its downward trajectory remains fragile due to weaker growth, fiscal fatigue, and the ageing population. Prudent fiscal policies and structural reforms should, therefore, be pursued to boost long-term growth and increase resilience to shocks. The impact of expansionary policies, such as the resumption of civil servant promotions and the respective salary increases or minimum wage increases, needs to be carefully monitored. While on a consistent downward trend, the still high level of NPLs in the banking sector and weak profitability represent the main challenges in the financial sector looking forward.
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