EN Official Journal of the European Union C 73/6

COUNCIL OPINION

of 4 March 2008

on the updated stability programme of Portugal, 2007-2011

(2008/C 73/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular Article 5(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 4 March 2008, the Council examined the updated stability programme of Portugal, which covers the period 2007 to 2011.

(2) From a phase of high economic growth in the second half of the nineties, the Portuguese economy moved to a situation of sluggish GDP growth after 2000, accompanied by rising unemployment, which all added to budgetary fragilities. This marked change in economic performance was rooted in the accumulation of large external and budgetary deficits, with pro-cyclical fiscal policies compounding the imbalances of the private sector and feeding uncertainty. At the beginning of this decade, private domestic demand moderated considerably reflecting the adjustment of spending to levels more in line with income patterns. At the same time, public primary expenditure had to slow down from previous unsustainable trends, while the competitive position has remained vulnerable reflecting a lasting misalignment between wages and productivity growth. Whereas recent economic growth has been led by the external sector, accompanied by considerable restructuring in some industries in the face of increased external competition, weaknesses of a more structural nature stand in the way of a lasting improvement in economic performance. In particular, overall productivity is low, mainly due to relatively low levels of human capital, and the efficiency and effectiveness of the public sector needs particular attention. In recent years, significant progress has been achieved to overcome this situation, in particular in containing public finances imbalances. In all, continuing fiscal consolidation, improving the quality of public finances, and proceeding with structural reforms with a view to improving potential GDP growth remain major challenges to put back the Portuguese economy on a sustainable and dynamic catching-up path.

(3) The macroeconomic scenario underlying the programme envisages a continuation of the upswing in economic activity, with real GDP growth picking up from 1,8 % in 2007 to 2,2 % in 2008 and further to 2,8 % in 2009 and 3 % in 2010 and 2011. Assessed against currently available information (2), the economic outlook after 2008 appears to be based on favourable growth assumptions. In particular, growth rates for private demand components seem to be on the high side, especially for investment. The programme expects the labour market to improve gradually over the programme period, but the employment outlook appears optimistic. The projections for consumer inflation may be on the low side in the light of the recent surge in food and oil prices in world markets. The economy's competitiveness position is expected to improve in the coming years, with unit labour costs growing more slowly than in most of its trading partners. The programme envisages a marked decline of the sizable external deficit, from 8,8 % of GDP in 2006 and an estimated 7 % of GDP in 2007 to 4,7 % of GDP in 2011. Assessed against current information, however, the underlying improvement of the deficit in the balance of current transfers and primary income projected in the update might be difficult to achieve.

(4) For 2007, the general government deficit is estimated at 3 % of GDP in the updated programme and in the Commission services' autumn 2007 forecasts, against a target of 3,7 % of GDP set in the previous update of the stability programme. More recent and preliminary data on budgetary execution suggest that the 2007 deficit outturn is likely to be lower than 3 % of GDP. This development is in line with and goes beyond the invitation in the Council opinion of 27 February 2007 on the previous update to implement measures so as to correct the excessive deficit by 2008 (3). As the better-than-expected outcome in 2006 was used to pursue a more ambitious target in 2007, the Council notes that it is also consistent with the April 2007 Eurogroup orientations for budgetary policies.

(5) The update of the stability programme aims at further fiscal consolidation over the medium term, notably to achieve the medium-term objective (MTO) of a structural deficit, i.e. cyclically-adjusted deficit net of one-off and other temporary measures, of 0,5 % of GDP by 2010. The headline general government deficit is targeted to decline gradually from 3 % of GDP in 2007 to 2,4 % of GDP in 2008, 1,5 % in 2009, 0,4 % in 2010 and eventually 0,2 % of GDP in 2011. The path for the primary balance is similar, improving from a slight deficit to a surplus of 2,5 % of GDP in 2011. The structural deficit calculated according to the commonly agreed methodology is projected to narrow by around 0,5 percentage point of GDP per year on average until 2010 and to broadly stabilise at around 0,5 % of GDP in 2011. The planned fiscal consolidation is to be achieved by continued expenditure moderation thanks to corrective measures to contain the cost of public employment (in the broader context of public administration reform) and to a lesser extent social transfers. A rise in the revenue ratio is expected to also contribute to fiscal consolidation. Building on the better-than-budgeted deficit outturns in 2006 and 2007, the programme largely confirms the planned structural adjustment path outlined in the December 2006 update of the stability programme against a little changed macroeconomic scenario. Government gross debt, estimated at 64,4 % of GDP in 2007, is projected to accelerate its decline, which would amount to almost 8 percentage points of GDP over the period, falling below the 60 % of GDP Treaty reference value in 2010.

(6) The budgetary outcomes could be worse than projected in the programme update. In particular, as noted above, the macroeconomic scenario appears to be based on favourable GDP growth assumptions for the outer years. Also, the expenditure savings that can be generated over the medium term from recently implemented measures are still subject to some degree of uncertainty. However, some of these risks could be partially offset if the better-than-estimated outcome for 2007 is confirmed, which would create a benign base effect for 2008. In view of the negative risks to the budgetary targets, the evolution of the debt ratio could also be less favourable than projected in the programme.

(7) In view of this risk assessment, the budgetary stance in the programme seems consistent with a durable correction of the excessive deficit by no later than 2008 as recommended by the Council. Following the reductions in 2006 and 2007, the update targets a reduction of the structural deficit of 0,5 percentage point of GDP in 2008. The Council notes that this is consistent with the April 2007 Eurogroup orientations for budgetary policies. According to the programme, a sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations would be reached in 2009. However, in view of the risks to the budgetary targets, it might not be provided before 2010. In addition, the budgetary stance in the programme may not be sufficient to ensure that the MTO is achieved by 2010, as envisaged in the programme. Although the planned pace of consolidation towards the MTO is in line with the Stability and Growth Pact, the adjustment may require additional efforts in view of the risks mentioned above. Finally, taking into account the risks to the debt projections highlight before, the debt ratio may be sufficiently diminishing towards the reference value at the end of the programme period.

(8) The reforms of old-age pension schemes adopted by Portugal in 2006 and 2007 contribute markedly to containing the increase in age-related expenditure and allow an improvement in the rating of risks to the sustainability of public finances from high to medium risk, bringing the long-term budgetary impact of ageing in Portugal close to the EU average. However, the current level of gross debt is above the Treaty reference value. At the same time, the budgetary position in 2007 as estimated in the programme, albeit clearly improved compared with the starting position in the previous update, still constitutes a risk to sustainable public finances even before the long-term budgetary impact of an ageing population is considered. Further budgetary consolidation, as planned in the programme, would contribute to reducing risks to the sustainability of public finances.

(9) The stability programme is fully consistent with the October 2007 implementation report of the national reform programme. In particular, the medium-term fiscal consolidation plans have been included in the national reform programme, which considered budgetary consolidation, together with improving sustainability of public finances, as a key priority. In parallel, the stability programme elaborates on progress achieved in implementing some of the national reform programme measures and on their impact on public finances and the broader economic outlook. Indeed, the two programmes provide complementary and consistent information on common policy measures.

(10) The budgetary strategy in the programme is broadly consistent with the country-specific broad economic policy guidelines included in the integrated guidelines and the guidelines for euro area Member States in the area of budgetary policies issued in the context of the Lisbon strategy.

(11) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme provides all required and most of the optional data (4).

The overall conclusion is that the programme is consistent with a correction of the excessive deficit no later than 2008. If the better than expected budgetary execution is confirmed, the deficit outturn will be below 3 % of GDP already in 2007. The programme aims at further fiscal consolidation over the medium term, including the achievement of the MTO by 2010, and foresees a declining path for the government debt ratio over the entire programme period. However, achieving these objectives is subject to an effective implementation of the measures announced in the programme and may require additional efforts, notably in the light of the risk of lower-than-projected economic growth.

Further progress with fiscal consolidation, as planned, could also help to address the external imbalances and improve the prospect of the long-term sustainability of public finances, for which Portugal is considered to be at medium risk, after the significant reform of the pension system. Finally, envisaged improvements in the quality and efficiency of public expenditure, including the public administration and the budgetary framework, can have a favourable impact on potential GDP growth and thereby help resume the catching-up process.

In view of the above assessment, and also in the light of the recommendation under Article 104(7) of 20 September 2005, Portugal is invited to:

(i) implement with determination the fiscal consolidation envisaged in the programme so as to secure the correction of the excessive deficit;

(ii) carry out the planned adjustment towards the MTO, backing it up with reinforced measures if necessary; and, also in view of the risks to the sustainability of public finances, ensure a rapid reduction in the debt-to-GDP ratio, notably by continuing to allocate any better-than-expected budgetary results to deficit reduction;

(iii) maintain expenditure moderation in a permanent way and enhance the quality of public expenditure, also by pursuing the ongoing reform of public administration and further improving the budgetary framework as outlined in the programme.

The Council also notes that such actions would be consistent with the April 2007 Eurogroup orientations for fiscal policies.

Comparison of key macroeconomic and budgetary projections

2006 2007 2008 2009 2010 2011 Real GDP (% change) SP Dec 2007 1,3 1,8 2,2 2,8 3,0 3,0 COM Nov 2007 1,3 1,8 2,0 2,1 n.a. n.a. SP Dec 2006 1,4 1,8 2,4 3,0 3,0 n.a. HICP inflation (8) (%) SP Dec 2007 3,0 2,3 2,1 2,1 2,1 2,1 COM Nov 2007 3,0 2,4 2,4 2,3 n.a. n.a. SP Dec 2006 3,2 2,2 2,2 2,1 2,1 n.a. Output gap (5) (% of potential GDP) SP Dec 2007 – 2,4 – 2,2 – 1,8 – 1,1 – 0,2 0,5 COM Nov 2007 (6) – 2,1 – 1,7 – 1,2 – 0,8 n.a. n.a. SP Dec 2006 – 2,6 – 2,4 – 1,8 – 0,7 0,2 n.a. Net lending/borrowing vis-à-vis the rest of the world (% of GDP) SP Dec 2007 – 8,8 – 7,0 – 5,8 – 5,6 – 4,9 – 4,7 COM Nov 2007 – 8,8 – 7,9 – 7,7 – 7,7 n.a. n.a. SP Dec 2006 – 7,5 – 7,3 – 6,9 – 6,3 – 6,0 n.a. General government balance (% of GDP) SP Dec 2007 – 3,9 – 3,0 – 2,4 – 1,5 – 0,4 – 0,2 COM Nov 2007 – 3,9 – 3,0 – 2,6 – 2,4 n.a. n.a. SP Dec 2006 – 4,6 – 3,7 – 2,6 – 1,5 – 0,4 n.a. Primary balance (% of GDP) SP Dec 2007 – 1,1 – 0,1 0,5 1,3 2,2 2,5 COM Nov 2007 – 1,1 – 0,1 0,3 0,5 n.a. n.a. SP Dec 2006 – 1,7 – 0,7 0,4 1,5 2,5 n.a. Cyclically-adjusted balance (5) (% of GDP) SP Dec 2007 – 2,8 – 2,0 – 1,6 – 1,0 – 0,3 – 0,4 COM Nov 2007 – 2,9 – 2,2 – 2,1 – 2,1 n.a. n.a. SP Dec 2006 – 3,4 – 2,6 – 1,8 – 1,2 – 0,5 n.a. Structural balance (7) (% of GDP) SP Dec 2007 – 2,8 – 2,1 – 1,6 – 1,0 – 0,3 – 0,4 COM Nov 2007 – 2,9 – 2,3 – 2,1 – 2,1 n.a. n.a. SP Dec 2006 – 3,4 – 2,6 – 1,8 – 1,2 – 0,5 n.a. Government gross debt (% of GDP) SP Dec 2007 64,8 64,4 64,1 62,5 59,7 56,7 COM Nov 2007 64,8 64,4 64,7 64,5 n.a. n.a. SP Dec 2006 67,4 68,0 67,3 65,2 62,2 n.a. Stability programme (SP); Commission services' autumn 2007 economic forecasts (COM); Commission services' calculations.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The documents referred to in this text can be found at the following website:

http://ec.europa.eu/economy_finance/about/activities/sgp/main_en.htm

(2) The assessment takes into account notably the Commission services' autumn forecasts and the Commission assessment of the October 2007 implementation report of the national reform programme.

(3) OJ C 71, 28.3.2007, p. 5.

(4) In particular, the data on public consumption and investment deflators are not provided.

(5) Output gaps and cyclically-adjusted balances from the programmes as recalculated by Commission services on the basis of the information in the programmes.

(6) Based on estimated potential growth of 1,5 %, 1,5 %, 1,6 % and 1,6 % respectively in the period 2006-2009.

(7) Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary measures are 0,1 % of GDP in 2007 (deficit-reducing) according to the most recent programme and the Commission services' autumn forecasts.

(8) Private consumption deflator for the December 2006 update of the stability programme.

Sources:

Stability programme (SP); Commission services' autumn 2007 economic forecasts (COM); Commission services' calculations.