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Brussels, 20.7.2005

COM(2005) 992 final

Recommendation for a

COUNCIL DECISION

on the existence of an excessive deficit in Portugal prepared in accordance with Article 104(6) of the Treaty

(presented by the Commission)

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, has been addressed to the Council, according to Article 104(5) of the Treaty. The Commission recommends that the Council shall decide accordingly, in conformity with Article 104(6) and herewith addresses a recommendation for a decision to that effect. 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.

Recommendation for a

COUNCIL DECISION

on the existence of an excessive deficit in Portugal prepared in accordance with Article 104(6) of the Treaty

THE COUNCIL OF THE EUROPEAN UNION

Having regard to the Treaty establishing the European Community, and in particular Article 104(6) thereof,

Having regard to the recommendation from the Commission,

Having regard to the observations made by Portugal,

Whereas:

1. According to Article 104 of the Treaty Member States shall avoid excessive government deficits.

2. The Stability and Growth Pact is based on the objective of sound government finances as a means of strengthening the conditions for price stability and for strong sustainable growth conducive to employment creation.

3. The excessive deficit procedure under Article 104 provides for a decision on the existence of an excessive deficit; The Protocol on the excessive deficit procedure annexed to the Treaty sets out further provisions relating to the implementation of the excessive deficit procedure. Council Regulation (EC) No 3605/93[4] amended by Council Regulation (EC) No 475/2000[5] and by Commission Regulation (EC) No 351/2002[6] lays down detailed rules and definitions for the application of the provision of the said Protocol.

4. 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. The Commission addressed such an opinion on Portugal to the Council on 20 July 2005. Having taken into account its report in accordance with Article 104(3) and having regard to the opinion of the Economic and Financial Committee in accordance with Article 104(4), the Commission concluded that there exists an excessive deficit in Portugal. In delivering its assessment, the Commission took into account 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[7].

5. Article 104(6) of the Treaty lays down that the Council should consider any observations which the Member State concerned may wish to make before deciding, after an overall assessment, whether an excessive deficit exists. In the case of Portugal, this overall assessment leads to the following conclusions.

6. According to the June 2005 update of the Portuguese stability programme, the planned general government deficit is 6.2% of GDP for 2005. The deficit is in excess of the 3% of GDP reference value and not close to it. The excess of the deficit over the reference value does not result from an unusual event outside the control of the Portuguese authorities, nor is it the result of a severe economic downturn. 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. 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. Therefore, the excess over the reference value cannot be considered temporary in the sense of the Treaty and the Stability and Growth Pact. This indicates that the Treaty requirement concerning the deficit criterion is not fulfilled.

7. The debt-to-GDP ratio breached the 60% of GDP reference value of the Treaty in 2003, reaching to 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, the existence of a sizeable debt-increasing stock-flow adjustment and also by the low nominal GDP growth. Moreover, the projected debt figures for the years 2005 to 2007, contained in the June 2005 stability programme update, and broadly in line with the debt projections of the Commission services Spring 2005 forecast, suggest 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.

8. According to 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, taking into account other relevant factors in the Council decision on the existence of an excessive deficit 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. Therefore, for the purpose of the Council decision in accordance with Article 104(6), other relevant factors are not taken into account in the case of Portugal.

HAS ADOPTED THIS DECISION:

Article 1

From an overall assessment it follows that an excessive deficit exists in Portugal.

Article 2

This decision is addressed to the Portuguese Republic.

Done at Brussels,

For the Council

The President

[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).

[4] OJ L 332, 31.12.1993, p. 7.

[5] OJ L 058, 3.03.2000, p. 1.

[6] OJ L 055, 26.02.2002 p. 23.

[7] 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).