[pic] | COMMISSION OF THE EUROPEAN COMMUNITIES |

Brussels, 20.7.2005

SEC(2005) 991 final

COMMISSION OPINION

on the existence of an excessive deficit in Portugal – Application of Article 104(5) of the Treaty establishing the European Community

EXPLANATORY MEMORANDUM

On 9 June 2005, Portugal submitted the most recent update of its stability programme covering the period 2005-2009. This update reveals the plans for a general government deficit in excess of the 3% of GDP reference value of the Treaty for the years from 2005 to 2007. Specifically, after a reported deficit outturn of 2.9% in 2004[1], Portugal plans to record a government deficit of 6.2% of GDP for 2005, which is to be reduced to 4.8% in 2006, 3.9% in 2007 and 2.8% of GDP in 2008. Over the same years, the debt-to-GDP ratio is projected to further increase from a reported figure of 61.9% in 2004 to a peak of 67.8% of GDP in 2007.

The application of the excessive deficit procedure (EDP) is governed by Article 104 of the Treaty and by Council Regulation (EC) No 1467/97 “on speeding up and clarifying the implementation of the excessive deficit procedure”, which is part of the Stability and Growth Pact.[2] In its assessment, the Commission has taken due account of the 20 March 2005 Ecofin Report to the European Council on ‘Improving the implementation of the Stability and Growth Pact’, endorsed by the latter on 22 March 2005[3].

The Commission report according to Article 104(3) of the Treaty assessed the fulfilment of the Treaty requirements concerning the deficit and the debt criteria.

The planned government deficit in 2005, revealed in the June 2005 update of the Portuguese stability programme, is in excess of the 3% of GDP reference value and not close to it. In addition, the excess over the reference value is not exceptional and temporary in the sense of the Treaty and the Stability and Growth Pact. While the rate of GDP growth has declined sharply since 2000, the economy returned to positive economic growth in 2004 and, according to the Commission services Spring 2005 forecasts and the June 2005 updated stability programme, it is expected to remain on a gradual, even if moderate, upward trend for the years to come. Moreover, although the negative output gap is sizeable and not expected to narrow significantly in the coming years, the deterioration of the government balance is out of proportion with the recent widening of the output gap. Therefore, the excess over the reference value cannot be considered as resulting from a severe economic downturn. Nor can the excess over the reference value be considered temporary because, according to Commission services Spring 2005 forecast, the government deficit ratio is projected to exceed its Treaty reference value by a large margin also in 2006, when the recovery of the economy is expected to gradually take hold. In fact, the June 2005 update of the Portuguese stability programme foresees the government deficit to narrow over the coming years, but to exceed the reference value until 2007. This suggests that the Treaty requirement concerning the deficit criterion is not fulfilled.

The debt-to-GDP ratio breached the 60% of GDP reference value of the Treaty in 2003, reaching 61.9% in 2004, an increase of some 8.5 percentage points of GDP since 2000. The increase in the debt ratio can be explained by a very low primary surplus – even a primary deficit in some years –, the existence of a sizeable stock-flow adjustment, where debt-increasing below-the-line operations more than offset significant privatisation proceeds in most years, and also by the low nominal GDP growth. The debt targets for the years 2005 to 2007 contained in the June 2005 stability programme update, and largely in line with the debt projections of the Commission services Spring 2005 forecast, suggest a further sharp increase in the debt ratio and up to a peak of just below 68% in 2007. This conflicts with the Treaty requirement that, in the event of an excess over the 60% of GDP reference value, the “debt ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace”. This suggests that the Treaty requirement concerning the debt criterion is not fulfilled.

In its report in accordance to Article 104(3), the Commission also analysed relevant factors pertaining to the medium-term economic and budgetary positions, as well as others that appeared relevant to the assessment of public finances in Portugal.

In its report of 20 March, the Council underlined that taking into account other relevant factors in the steps leading to the decision on the existence of an excessive deficit, thus including the Economic and Financial Committee opinion in accordance with Article 104(4), the Commission opinion in accordance with Article 104(5) and the Council decision in accordance with Article 104(6), “must be fully conditional on the overarching principle that – before other relevant factors are taken into account – the excess of the reference value is temporary and the deficit remains close to the reference value”. In the case of Portugal, this condition is not met: the planned deficit for 2005 is not close to the reference value and the excess over the reference value cannot be considered temporary, since the government deficit is projected to be above 3% of GDP for three years. Therefore, for the purpose of the Commission opinion in accordance with Article 104(5) and the Council decision in accordance with Article 104(6), other relevant factors are not taken into account in the case of Portugal.

Article 104(4) of the Treaty states that “the Committee provided for in Article 114 (i.e. the Economic and Financial Committee) shall formulate an opinion on the report of the Commission”. The Committee issued its opinion on 4 July 2005, which is consistent with the assessment made by the Commission in its report. In particular, the Committee concluded “that the planned budgetary developments in Portugal in 2005 are such that both criteria in the second paragraph of Article 104 are not respected”. The Committee considered that deficit planned for 2005 is not close to the 3% of GDP reference value, and its excess over the reference value cannot be considered exceptional and temporary. Government debt exceeds the 60% of GDP reference value and is planned to rise further in percentage of GDP over the next two years. The Committee also noted that economic prospects for the next two to three years remain subdued and expressed concern about the high level and the trend of the structural deficit. The Economic and Financial Committee examined all other relevant factors, but it concluded that these factors would not be taken into account in its assessment.

The Commission, having taken into account its report and having regard to the opinion of the Committee, is of the opinion that an excessive deficit exists in Portugal. This opinion, adopted by the Commission on 20 July 2005, is herewith addressed to the Council, according to Article 104(5) of the Treaty. The Commission is recommending that the Council shall decide accordingly, in conformity with Article 104(6). In addition, the Commission is submitting to the Council a recommendation for a Council recommendation to be addressed to Portugal with a view to bringing the situation of an excessive deficit to an end, according to Article 104(7) of the Treaty.

COMMISSION OPINION

on the existence of an excessive deficit in Portugal – Application of Article 104(5) of the Treaty establishing the European Community

GENERAL CONSIDERATIONS

According to Article 104 of the Treaty, Member States shall avoid excessive government deficits. Decisions on the existence of an excessive deficit are governed by the excessive deficit procedure (EDP) specified by Article 104 of the Treaty and Council Regulation (EC) No 1467/97 “on speeding up and clarifying the implementation of the excessive deficit procedure”, which is part of the Stability and Growth Pact.

Article 104(2) of the Treaty requires the Commission to monitor the development of the budgetary situation and of the stock of government debt in the Member States with a view to identifying gross errors. In particular, the Commission has to examine compliance with budgetary discipline on the basis of two criteria, one for the ratio of the planned or actual government deficit to gross domestic product (GDP) and one for the ratio of government debt to GDP. The statistical data on these variables are provided by the Commission on the basis of reporting by the Member States.

Article 104(3) of the Treaty requires the Commission to prepare a report if the requirements under one or both of the criteria of Article 104(2) are not fulfilled or if, notwithstanding the fulfilment of the requirements under the criteria, the Commission is of the opinion that there is a risk of an excessive deficit in a Member State. Article 104(3) of the Treaty provides that the Commission report “shall also take into account whether the government deficit exceeds government investment expenditure and take into account other relevant factors”. The Ecofin report of 20 March 2005 clarifies the framework within which such relevant factors should be taken into account. Based on the data contained in the updated stability programme of Portugal for the 2005-2009 period submitted on 9 June 2005 and also taking into account the Commission services Spring 2005 forecast, the Commission adopted such a report for Portugal on 22 June 2005.

Subsequently, and in accordance with Article 104(4), the Economic and Financial Committee formulated an opinion on the report of the Commission on 4 July 2005.

Article 104(5) of the Treaty requires the Commission to address an opinion to the Council if the Commission considers that an excessive deficit in a Member State exists or may occur. In order to reach a conclusion on whether an excessive deficit exists or may occur, the Commission considers that account should be taken of: (i) the conclusions of its own report, namely whether the requirements under one or both of the criteria of Article 104(2) of the Treaty are not fulfilled, and (ii) the opinion of the Economic and Financial Committee on the report of the Commission. On the basis of these elements, the Commission has established a number of considerations for Portugal.

CONSIDERATIONS CONCERNING PORTUGAL

1. According to the June 2005 update of the Portuguese stability programme, the planned general government deficit for 2005 is 6.2% of GDP. This figure is in excess of the 3% of GDP reference value and not close to it. The excess of the deficit over the 3% reference value does not result from a severe economic downturn. While the rate of GDP growth has declined sharply since 2000, the economy has returned to positive economic growth in 2004 and is expected to remain on a gradual, even if moderate, upward trend for the years to come. Moreover, although the negative output gap is sizeable and not projected to narrow sharply in the coming years, the deterioration of the government balance is out of proportion with the recent widening of the output gap. Therefore, the excess over the reference value cannot be considered as resulting from a severe economic downturn in the sense of the Treaty and the Stability and Growth Pact. According to the Commission services Spring 2005 forecast, the deficit is projected to exceed the Treaty reference value by a large margin also in 2006, when the economic recovery is expected to gradually take hold. This is confirmed by the June 2005 update of the Portuguese stability programme, whereby the government deficit is expected to continuously improve over the coming years, but will exceed the reference value until 2007. Therefore, the excess over the reference value cannot be considered either exceptional or temporary. This indicates that the Treaty requirement concerning the deficit criterion is not fulfilled.

2. The debt-to-GDP ratio breached the 60% of GDP reference value of the Treaty in 2003, reaching 61.9% in 2004, an increase by some 8.5 percentage points of GDP since 2000. The increase in the debt ratio can be explained by a very low primary surplus, the existence of a sizeable debt-increasing stock-flow adjustment and also by the low nominal GDP growth. The debt targets for the years 2005 to 2007 contained in the June 2005 stability programme update, and largely in line with the debt projections of the Commission services Spring 2005 forecast, suggests a further sharp increase in the debt ratio up to a peak of just below 68% in 2007. This conflicts with the Treaty requirement that, in the event of an excess over the 60% of GDP reference value, the “debt ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace”. This indicates that the Treaty requirement concerning the debt criterion is not fulfilled.

3. In its report according to Article 104(3) if the Treaty, the Commission analysed relevant factors pertaining to the medium-term economic and budgetary positions, as well as others that appeared relevant to the assessment of public finances in Portugal.

4 In its report to the European Council on ‘Improving the implementation of the Stability and Growth Pact’, of 20 March 2005, endorsed by the latter on 22 March 2005, the Ecofin Council underlined that taking into account other relevant factors in the steps leading to the decision on the existence of an excessive deficit, thus including the Commission opinion in accordance with Article 104(5) and the Council decision in accordance with Article 104(6), “must be fully conditional on the overarching principle that – before other relevant factors are taken into account – the excess of the reference value is temporary and the deficit remains close to the reference value”. This condition is not met in the case of Portugal. Therefore, for the purpose of the Commission opinion in accordance with Article 104(5), other relevant factors are not taken into account.

5 The opinion of the Economic and Financial Committee in accordance with Article 104(4) of the Treaty is consistent with the assessment of the Commission report in accordance with article 104(3).

CONCLUSION

The monitoring of the budgetary situation in Portugal and, in particular, the examination of compliance with the criteria laid down in Article 104(2) has led the Commission to prepare a report in accordance with Article 104(3) of the Treaty. The Commission, having taken into account its report, and having regard to the opinion of the Economic and Financial Committee, is of the opinion that an excessive deficit exists in Portugal.

[1] These figures are subject to ongoing discussions between Eurostat and the Portuguese statistical authorities.

[2] OJ L 209, 2.8.1997.

[3] See Presidency conclusions of the Brussels European Council of 22 and 23 March 2005 (7619/05) and the (Ecofin) Council report to the European Council of 20 March 2005 (7423/05).