The International Monetary Fund (IMF) published the results of its Sixth Post-Program Monitoring of Portugal at the end of February. From 2011 to 2014, the IMF dispersed €26.3 billion in loans to Portugal as part of a larger €78 billion bailout package with the European Union. The country exited the bailout program in May 2014 and the following month the IMF Executive Board initiated a supervisory program to ensure Portugal’s economic progress remained on track and the outstanding loans were repaid. The February report concluded that Portugal’s repayment capacity has improved since its last consultation, citing several positive improvements in key economic indicators. Nevertheless, the IMF struck a cautionary tone, suggesting that there are still areas of vulnerability that could undermine Portugal’s economic recovery.
On the surface, Portugal’s economic recovery appears impressively robust. The country grew at 2.6% last year, a significant increase from 1.5% in 2016. While the government deficit and stock of debt stood at 2% and 130.1% in 2016, the IMF’s report anticipates that these figures will fall to 0.9% and 118.9% by 2019. Moreover, last year consumer and business confidence reached their highest levels in more than a decade.
What accounts for this remarkable economic turnaround? Exports and investment are the two most important drivers of Portugal’s recent growth. Investment in exports doubled in 2017, contributing exports’ share of GDP rising from 30% in 2009 to 42% last year. According to AICEP, an independent government agency focused on trade and investment, Portugal’s export sector attracted €1.9 billion in 2017, with an additional €2.4 billion worth of projects in the pipeline for 2018.
Tourism is the primary driver behind Portugal’s surge in exports. In 2016 the industry accounted for 25.6% of all exports. During the first half of 2017, tourism revenue grew by 21% compared with the previous year, bringing in around €6.1 billion. Going forward, the government hopes to expand the contribution tourism makes to the Portuguese economy. Two years ago, it launched Estraté- gia Turismo 2027, with the goal of increasing tourism revenue to €26 billion in 2027. The program focuses on a myriad of challenges facing the tourism industry including reducing seasonality and regional disparities, attracting investment, supporting sustainable practices, and the simplification of legislation.
However, there are reasons to be skeptical about the continued growth of Portugal’s export sector. One of the main areas for concern identified by the IMF report is the persistently high level of non-performing loans (NPLs) on banks’ balance sheets. NPLs make up 15.5% of all gross loans in Portugal, which constrains the ability of the banks to lend. This is especially problematic for the export sector as younger businesses are more likely to have a global outlook and require financial assistance. Without a strong banking sector that can provide credit to small and medium enterprises (SMEs), it is questionable whether the export sector in general, and tourism in particular, will continue to experience such high growth rates.
It should be noted that Portugal’s three biggest banks agreed in September to create a jointly managed platform to tackle their bad loans. Millennium BCP, Novo Banco and state-owned Caixa Geral de Depósitos believe the platform will help coordinate and increase the speed of debt restructuring by enabling them to negotiate as a single entity with creditors. However, the IMF’s report suggests that there is scope for government action as well. Specifically, the IMF recommends that Portugal improve its legal framework in order to facilitate debt restructuring of distressed but viable debtors, and the recovery of collateral.
The IMF also identified the tightening of global financial conditions as a potential risk to Portugal’s recovery. While a stronger U.S. dollar could increase demand for Portugal’s exports, any benefits may be offset by a reduction in the European Central Bank’s bond-buying program. The latter event would precipitate a rise in interest rates, thereby increasing the cost of borrowing for Portuguese firms. In such circumstances, it is unlikely that Portugal’s export sector would be able to sustain its current growth rate.
The necessity for higher investment to help propel productivity growth is another concern highlighted in the IMF report. While investment has increased, it is not yet high enough to offset Portugal’s sluggish productivity growth. In Portugal’s Country Report published in June 2017, the IMF determined that the growth rate of investment would need to increase to 8.5% per year if total factor productivity did not improve. This is a particularly tall order given that investment is currently projected to grow at 4.9%.
In recognition of this weakness, Portugal has undertaken numerous reforms in order to attract international capital. Back in 2009, the government introduced a series of tax breaks for both EU and non-EU citizens in order to make acquiring residency status in the country less onerous. Last year Portugal also altered the terms of its Residence Permit for Investment. Foreigners who invest 350,000 in Portuguese companies or 250,000 in companies that are undergoing a recovery or revitalisation are now eligible for the so-called “Golden Visa”. However, the efficacy of this policy is questionable. Some observers argue that investment has been excessively concentrated in the property sector, causing house prices to rise precipitously. As of January 2018, investments associated with this program decreased 29% year-on-year, illustrating the limitations of a more relaxed residency policy to attract long-term investment.
Perhaps more promising is the announcement in October 2017 that the government would create “free zones” to allow for the testing of drones and self-driving vehicles. This policy was introduced in order to attract cutting edge technology companies as well as larger firms like Tesla. In recent years, a budding start-up scene has emerged in Portugal, and progressive policies like this are likely to support its expansion. Most recently, Google announced plans to open an office in Oeiras, a tech hub outside Lisbon where HP and Cisco also have offices. While the creation of “free zones” didn’t directly influence Google’s decision, the policy does signal to businesses that Portugal is keen to support innovative, technology-driven companies. This in turn can help attract both start-ups and more mature companies looking for a friendly regulatory environment in which to operate.
Portugal has made significant economic strides since it exited the IMF’s bail-out program nearly four years ago. According to Mário Centeno, Portugal’s minister of finance, the country is experiencing “the period of greatest growth this century”. However, the IMF’s Sixth Post-Program Monitoring report provides more circumspect assessment of the economy’s future prospects. While growth has been strong up until now, the government will need to move more aggressively to address NPLs and introduce policies that encourage investment and drive productivity growth if the economy is to live up to its potential.