EUROPEAN COMMISSION Brussels, 26.2.2020 SWD(2020) 521 final COMMISSION STAFF WORKING DOCUMENT Country Report Portugal 2020 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2020 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2020) 150}



Contents Executive summary 1.Economic situation and outlook* 2.Progress with country-specific recommendations 3.Summary of the main findings from the MIP in-depth review 3.1.Introduction 3.2.Imbalances and their gravity 3.3.Evolution, prospects and policy responses 3.4.Overall assessment 4.Reform priorities 4.1.Public finances and taxation* 4.2.Financial sector* 4.3.Labour market, education and social policies* 4.4. Competitiveness, reforms and investment* 4.5.Environmental sustainability Annex A: Overview table Annex B: Commission debt sustainability analysis and fiscal risks Annex C: Standard tables Annex D: Investment guidance on Just Transition Fund 2021-2027 for Portugal

Annex E: Progress towards the Sustainable Development Goals (SDGs) References LIST OF Tables Table 1.1:Key economic and financial indicators11 Table 2.1:Assessment of 2019 CSR implementation (*) Table 3.1:Sensitivity analysis: current account balance and net international investment position Table 3.2:MIP assessment matrix Table 4.2.1:Financial stability indicators Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth Table E.1:Indicators measuring Portugal’s progress towards the SDGs LIST OF Graphs Graph 1.1: Contributions to real GDP growth Graph 1.2: GDP per capita in PPS

Graph 1.3: Nominal compensation growth: actual and predicted based on economic fundamentals Graph 1.4: Balance of trade with goods Graph 1.5: Current Account and Net International Investment Position Graph 1.6: Return on equity (%), domestic banks Graph 2.1: Level of implementation of 2011-2019 CSRs Graph 4.1.1: Public debt projections under the baseline and alternative scenarios for nominal GDP growth and interest rates Graph 4.1.2: Public debt projections under the baseline and alternative scenarios for fiscal consolidation Graph 4.1.3: Public expenditure by function in 2017 Graph 4.1.4: Public investment in 2001-2018 Graph 4.1.5: Tax revenue by function in 2018 Graph 4.1.6: Time to prepare and pay taxes in the euro area (2018) Graph 4.2.1: The funding gap closed Graph 4.2.2: Performing loans grow but the gross loan stock still falls Graph 4.2.3: New mortgages quadrupled, fresh consumer loans doubled, new corporate loans keep falling Graph 4.2.4: House prices (new dwellings) rise ever faster as the savings go quasi-unremunerated Graph 4.2.5: Valuation gap on price/income, price/rent and fundamental model valuation Graph 4.3.1: Unemployment rate and potential additional labour force Graph 4.3.2: Annual change in the employment rate of low and medium-skilled workers (age 20-64) since Q1-2009 Graph 4.3.3: At-risk-of-poverty or social exclusion rate and its components Graph 4.4.1: Total factor productivity

Graph 4.4.2: Historical evolution of net investment Graph 4.4.3: Labour productivity at the aggregate and sectoral levels Graph 4.4.4: Total population change in NUTS3 regions, 2011-2018 (% change) Graph 4.5.1: Greenhouse gas emissions in Portugal by sectors LIST OF Boxes Box 2.1: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Portugal Box 4.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 4.3.2: Demographic ageing 2 Box 4.4.1: Investment challenges and reforms in Portugal Executive summary A positive economic performance and policy effort is helping Portugal to address some of its challenges (). Economic expansion has brought unemployment down significantly. Though Portugal has also made progress on reducing macroeconomic imbalances associated with public and private indebtedness, they remain high. Little progress has been made with other imbalances, particularly productivity and the net international investment position. To address these issues, Portugal is taking steps to improve education, skills, innovation, the business environment, and the efficiency of the justice system. Portugal’s economic performance remains favourable. The economy continues to grow faster than the EU average, estimated at 2% in 2019, though the growth rate has slowed somewhat. The employment rate stands above the Europe 2020 target, while unemployment has reached its lowest level for 17 years. Both long-term and youth unemployment continue to fall, but remain above the EU average. Weaker external demand weighs negatively on exports, but domestic demand continues to grow steadily, helped by private consumption and investment. Although businesses are facing weaker economic sentiment, particularly in the industrial sector, increased use of EU funds is expected to support growth and investment. Portugal is continuing to correct its macroeconomic imbalances. While progress is steady with most imbalances, the reduction of external liabilities has slowed substantially since 2018. Debt ratios in both the private and public sectors are improving, and the outlook appears favourable. Significant progress has also been made with reducing the stock of non-performing loans, albeit from a high base. After two years of weak growth, labour productivity increased more substantially in 2019 but the gap towards more advanced Member States remains significant. Public finances have benefited from resilient domestic demand and favourable financing conditions. Higher cyclical revenue, combined with the lower interest burden and subdued public investment, has improved overall and structural budget balances. At the same time, the structural primary public balance is projected to deteriorate slightly over the period covered by the Commission’s forecast. It is projected that the ratio of public debt to GDP will continue falling steadily, although it is liable to remain very sensitive to any worsening of Portugal’s economic and financing conditions. Portugal faces significant shortfalls in investment. Making the economy carbon-neutral by 2050 require significant investment in energy and transport. Climate change is expected to make natural hazards more frequent and extreme. Investment in risk prevention and in adapting to and mitigating climate change is thus essential to achieve sustainable growth. Investment in transport infrastructure, particularly in railways and ports, would help make Portugal more competitive in comparison with other countries. Low investment in research and innovation hinder Portugal’s productive specialisation. The share of R&D expenditure as a proportion of GDP remains below the EU average. This is holding back Portugal’s prospects of increasing the share of value-added in the economy. Portugal has made limited progress on addressing the 2019 country-specific recommendations

There has been some progress in the following areas: ·Taking measures to tackle labour market segmentation. ·Improving the skills level of the population, in particular their digital literacy, including by making adult learning more relevant to the needs of the labour market. ·Increasing the number of higher education graduates, particularly in science and information technology. ·Focusing investment-related economic policy on the low-carbon and energy transition, and extending energy interconnections, taking account of regional disparities. ·Allowing for a swifter recovery of the collateral tied to non-performing loans by increasing the efficiency of insolvency and recovery proceedings. ·Increasing the efficiency of administrative and tax courts, in particular by decreasing the length of proceedings. There has been limited progress in the following areas: ·Improving the quality of public finances by prioritising spending to promote economic growth, while tightening up overall expenditure control, cost efficiency and appropriate budgeting, with a focus on durably reducing arrears in hospitals. ·Improving the financial sustainability of state-owned enterprises, while ensuring more timely, transparent and comprehensive monitoring. ·Improving the effectiveness and adequacy of the social safety net. ·Focusing investment-related economic policy on research and innovation, and on railway and port infrastructure.

·Reducing the administrative and regulatory burden on businesses, mainly by reducing sector-specific barriers to licensing. There has been no progress in the following area: ·Developing a roadmap to reduce restrictions in highly regulated professions. Portugal is performing well on most aspects of the European Pillar of Social Rights. The performance in gender employment gap, income inequalities, employment, unemployment and long-term unemployment is better than average. However, the proportion of students leaving education or training early is a major issue, as is the low level of digital skills. Changes to the social protection system have not improved the contribution of social transfers to poverty reduction. As regards progress towards the national target under the Europe 2020 strategy, Portugal is close to meeting its renewables target and is on track to achieve its energy efficiency targets. However, some challenges remain in these areas. The country is expected to meet its emission reduction objectives in what are known as ‘effort sharing’ sectors (transport, buildings, agriculture and waste) by a margin of 25 percentage points. The employment rate remains slightly above the target of 75%. Poverty reduction shows a positive trend, exceeding the initial target of 200,000 people by 175%. Further progress was made in 2018 in reducing the school drop-out rate (early school leaving), but it is still above the target of 10%. Meeting the targets for research and development investment and higher educational attainment remains challenging. Progress towards the Sustainable Development Goals (SDG) differs from one area to another ( ). Good progress has been made towards SDG 8, ‘Decent Work and Economic Growth’, thanks to improvements in real GDP per capita, employment increases and a reduction in the number of people in work who are nonetheless at risk of poverty. In contrast, SDG 13, ‘Climate Action’, is to be monitored. Although the Government has set an ambitious climate and energy agenda, including a commitment to net zero emissions by 2050, the associated indicators have deteriorated in recent years. This applies in particular to total greenhouse gas emissions and energy consumption. Full implementation of the Government’s policy plans would ensure progress on SDG 13. The main findings of the in-depth review contained in this report and the related policy challenges are as follows: ·External imbalances are now adjusting more slowly, and a further slowdown is predicted. This seems to be driven largely by higher imports of capital goods related to investment. If this trend continues, domestic savings will need to increase accordingly in order to enable further unwinding of external imbalances at a satisfactory pace. The importance of exports is growing steadily, with their share in GDP increasing from 27.3% in 2009 to 43.5% in 2018. Furthermore, non-debt liabilities are increasing its share within external imbalances. ·Portugal’s public debt continues to fall steadily from a high level. After having dropped to 122.2% of GDP in 2018, the ratio of public debt to GDP is forecast to have declined to 119.2% of GDP in 2019, while the overall budget balance gradually approached a balanced position. The ratio of public debt to GDP is projected to continue falling in 2020 and 2021, albeit at a slower pace. Portugal has deployed efforts to reduce interest expenditure, extend the average maturity of debt and smoothen annual peaks in its repayment profile. A more growth-friendly consolidation strategy and progress with reforms could have helped improving Portugal’s fiscal sustainability even further. There is scope to improve overall expenditure control, cost-efficiency and budgeting. Such measures could help slow the accumulation of hospital arrears and make state-owned enterprises and the pension system more sustainable. This could create room to improve the quality of public finances. ·Private debt is falling at a fast enough pace. The debt ratio, down from 210% to 155% of GDP, is now much closer to the indicative headline threshold of 133%. Yet the deviation is still large if judged by country-specific indicators. The corporate sector is reducing its debt slightly faster than households, although the difference has narrowed since the beginning of 2019. ·Portuguese banks have continued to improve their asset quality following further sales of non-performing loans. However, their non-performing loan ratio remains high compared to their European peers, making them vulnerable to adverse shocks. Efforts are being made to remove remaining impediments to the resolution of non-performing loans in the legal and judicial frameworks. Furthermore, while their capital ratios and profitability have improved slightly over the past few years, banks continue to face challenges in an environment of muted loan growth and low interest rates. ·Low productivity weighs negatively on Portugal’s income convergence. Although the economy is growing faster than the EU average, there has been little improvement in labour productivity. This is hampering the country’s growth potential and keeping incomes low by comparison with the EU average. Other key structural issues analysed in this report, which point to particular challenges for Portugal’s economy, are the following: ·Reforms are under way to address labour market segmentation and foster collective bargaining. To tackle the persistently high proportion of workers on temporary contracts, a tripartite agreement has led to a series of amendments to the labour code and the social security system’s code of contributory regimes. The reform is also designed to improve collective bargaining by reducing the individualisation of labour relations and introducing stricter criteria for terminating or modifying collective agreements. It also significantly improves the capacity of the labour authority to tackle false self-employment.

·Poverty and inequality continue to decrease, despite weak social protection and rising house prices. The proportion of people at risk of poverty and social exclusion fell in 2018 to 21.6%, and income inequality is now around the EU average. However, social transfers have limited impact on poverty, and rising housing prices are increasing financial pressures on the most vulnerable. In 2018, social transfers excluding pensions reduced the proportion of people at risk of poverty by 23.8%, significantly below the EU average of 34%. Portugal is taking action to address housing affordability, which is fast becoming a new social challenge. ·Demographic trends in Portugal are putting pressure on employment, education and training, social welfare, and health and care systems. The working-age population is expected to decline by nearly 40% and the total population by 24% by 2070. This will require considerable investment in education, training and healthcare. In view of Portugal’s low fertility rate, family support measures should be improved to achieve a better work-life balance and boost the coverage of early childhood education and care. An older population will also require more long-term care, so the recently approved legal status for informal carers is welcome. Addressing regional specificities and needs will also be important to guarantee access to an increased demand of healthcare services. ·The Portuguese education system is gradually improving, but challenges persist. The rates of early leaving from education and training and from tertiary education have fallen markedly in the past decade. Skills levels overall have also improved. However, a large proportion of adults have not completed upper secondary studies, grade repetition remains high, digital skills are generally too weak, and school infrastructure requires upgrading. Graduates in information and communication technologies account for too low a proportion of the total. The teaching labour force is ageing and teachers lack job stability. ·Portugal has adopted significant vocational education and training and adult learning measures, but more could be done in terms of monitoring and follow-up. Quality assurance mechanisms in vocational education and training have been improved. However, indicators from the European Quality Assurance Reference Framework are not systematically used to monitor the system. The Ministry of Education is currently assessing a national adult literacy plan. Data retrieval and monitoring would be helpful to ensure that vocational education and adult learning are both relevant to the labour market and effective. Participation in the flagship programme Qualifica, designed to tackle the low skills level of the adult population, continues to grow. However, detailed training and employability results are still lacking, which makes it hard to assess its effectiveness. ·Steps are being taken to lighten the administrative burden, and judicial efficiency is improving. However, challenges persist in product and services markets. The SIMPLEX+ programme has a strong focus on e-government initiatives. Sector-specific barriers associated with licensing persist, particularly in some professional business services and the transport sector, including railways and ports. Although the justice system is becoming more efficient, challenges persist, notably the backlog of cases and the length of time take to resolve individual cases, which remain considerable. The authorities continue to take measures to achieve further improvements. Competition in public procurement procedures has increased. However, shortcomings in the coordination, governance, planning and monitoring still hamper its efficiency and limit competition. Portugal has an ambitious agenda for adapting to and mitigating climate change, but faces implementation challenges. Despite significant progress with increasing the share of renewables in the energy mix, Portugal’s economy is still more greenhouse gas-intensive than the EU average. Moreover, the country faces difficulties with curbing the trend towards higher energy consumption. The Commission’s proposal for a Just Transition Mechanism under the next multi-annual financial framework for 2021-2027 includes a Just Transition Fund, a just transition scheme under InvestEU, and a new public sector loan facility with the EIB. It is designed to ensure that the transition to EU climate neutrality is fair by helping the most affected regions in Portugal to address the social and economic impact. Key priorities for support by the Just Transition Fund are identified in Annex D, building on the analysis of the transition challenges outlined in this report. 1. Economic situation and outlook* GDP growth Portugal’s economic performance remains favourable, although growth has been slowing somewhat. The short-term projections were positively affected by significant data revisions, lifting GDP growth to 3.5% in 2017 and 2.4% in 2018 from the previously reported rates of 2.8% and 2.1%, respectively. Weaker external demand brought further moderation in 2019 as net exports fell while domestic demand remained resilient. Growth is now estimated at 2.0% in 2019 and continues to outperform the EU average projection. Taking into account the recent retail and production reports and expectations as regards external demand, economic growth is projected to moderate further to 1.7% in both 2020 and 2021. Graph 1.1:Contributions to real GDP growth Source: Eurostat As a result of a substantial rebound in investment, domestic demand retained a strong contribution to growth in 2019. Both private consumption and investment are projected to remain major contributors to growth in 2020-21 albeit at a slower pace. The expected moderation in private consumption is linked to the recent slowdown in job creation. Meanwhile, investment is facing weaker economic sentiments, particularly in the industrial sector, but will be supported by the the EU funds over the forecast period. On the supply side, the strong performance in services and construction is projected to continue offsetting the weak industrial performance. Potential growth moves above the euro area average. The country’s strong economic performance in recent years has a positive impact on estimated potential growth. At 1.8% in 2019 and 1.9% in 2020, it is already above the EU average. This indicates a significant improvement from the trough of -1.2% in 2012. However, this has not translated into income convergence with more advanced Member States, as Portugal's per capita income in purchasing power standards (PPS) remains around 77% of the EU average. This development differs significantly from other catching-up economies. In fact, the average per capita income in PPS for the 10 countries that joined the EU in 2004 is already at the same level as Portugal, overcoming a gap of about 17 percentage points in 15 years (Graph 1.2). Graph 1.2:GDP per capita in PPS Source: European Commission

*CEE-10 refers to the ten Member States from Central and Eastern Europe that joined the EU in 2004. Regional disparities While Portugal’s internal cohesion increased, the main reason for this was slower GDP growth in the richer capital region. Regional disparities in Portugal started to decrease around 2010 and have been on a continuous downward path since then. However, a substantial part of this decrease owes more to the higher contraction of the capital region than to growth in the less developed regions. In 2017, GDP per capita in the Metropolitan Area of Lisbon corresponded exactly to the EU average (100%, 16 pps less than in 2010), while – apart from the Algarve (83%) – it was below 75% in all other regions. At sub-regional level, differences in GDP per capita ranged in 2016 from Alentejo Litoral (109%) to Alto Tamega (51%). Competitiveness varies across Portugal, closely matching economic output, GDP per capita, productivity and innovation levels. In a European perspective, Portuguese regions lack competitiveness. In the 2019 Regional Competitiveness Index (RCI), the Metropolitan Area of Lisbon is the most competitive Portuguese region –ranked at 141 out of 282 regions. All the other regions of Portugal are ranked between 212 and 267. When compared with other EU regions with similar characteristics, Lisbon, Centro, Norte and Alentejo show a similar performance on most dimensions of competitiveness, and some of their infrastructure is even rated as excellent. However, Madeira, Azores, and, in particularly the Algarve, underperform on many dimensions. Inflation Inflation fell from 1.2% in 2018 to 0.3% in 2019. The downturn reflects a significant decline in energy prices, including various regulatory components of electricity and gas tariffs, plus lower prices for other administrative services such as public transport and telecommunications. In addition, core inflation has been contained by a continuous decline in the prices of industrial goods and a drop in accommodation prices relative to a year earlier. Inflation is forecast to increase somewhat in the next few years with core inflation remaining slightly above the headline rate. However, the growth rate of house prices remained high at 10.1% (y-o-y) in Q2-2019 (see Section 4.2).

Labour market Unemployment continues to fall. It was estimated at 6.3% in 2019, down from 7.0% in 2018 and is forecast to fall further to 5.9% in 2020 and 5.6% in 2021, according to the Commission’s 2019 autumn forecast. The slack on the market is meanwhile set to decrease accordingly and wage growth to increase somewhat, also helped by the unfreezing of career progressions in the public sector. These expectations were further reinforced by wage reports in 2019, pointing to a growth rate of around 3% as compared to 2.5% in 2018. Portugal’s labour productivity is expected to have improved somewhat in 2019 after two years of decline while unit labour costs are likely to continue rising at a moderate rate of about 2%. Wage growth is moderate but has been inching up in recent years as labour market reserves have receded. Nominal compensation per employee growth turned positive in 2015, inching up to 2.3% in 2017 and 2.5% in 2018. Compensation growth is expected to be close to 3% in 2019 and the following two years (European Commission 2019 Autumn Forecast). Positive real wage growth was recorded one year after nominal wages started growing. Real compensation per employee grew at 1.2% in 2018 and it were expected to grow at 2.7% in 2019. Graph 1.3:Nominal compensation growth: actual and predicted based on economic fundamentals Source: Eurostat, European Commission Recent migration flows support labour supply. The working age population remained broadly stable in 2019. Against a background of demographic ageing and at slightly negative natural rate of change in population, labour supply was supported by a positive net migration flow accounting for about 0.2% of the total population. Migration flows have started to increase since 2017 but their positive impact has become more evident only recently. This is also confirmed by recent national data showing an increase in the number of registered foreign residents in Portugal. The figure reached 477,472 at the end of 2018, up by 14.6% from a year earlier, which is a significantly higher rate of growth than in previous years. A substantial proportion of art of the registrations are from Portuguese-speaking countries, so their integration into the labour market could be relatively smooth. However, the data currently available data do not provide a clear picture of the impact of migration on the structure of labour skills. Social developments Social conditions in Portugal have improved substantially in recent years, but some indicators still lag behind the EU average. Income inequality continues to fall and is now around the EU average. The proportion of people at-risk of poverty or social exclusion also continued to fall,( ) from 23.3% in 2017 to 21.6% in 2018. This brought it to slightly below the EU average of 21.9% for the first time. However, the risk of poverty faced by elderly people still give cause for concern. Inequality of opportunity in education also remains high. Social transfers have comparatively little impact on poverty in Portugal (see Section 4.3). Income inequality has been declining in recent years and is now close to EU average. In 2018, the ratio of incomes earned by the top 20 % to the bottom 20 % of the income distribution decreased from 5.7 to 5.2, down from a peak of 6.2 in 2014, getting to the EU average of 5.2. At the same time, the Gini coefficient ( ) decreased from 33.5 in 2017 to 32.1 in 2018, and is now below pre-crisis levels, yet remained above the EU average (30.9). The recent improvement was mostly driven by an increase in the share of income earned by the lowest part of the distribution, possibly related to improving labour market conditions, the impact of recent minimum wage increases on lower incomes and improved adequacy of some benefits. External position and competitiveness The current account continued to deteriorate in 2019. Following a decline in the surplus from 1.0% of GDP in 2017 to 0.1% in 2018 (national account terms), the current account is projected to post a deficit of 0.4% of GDP in 2019, which is close to the deficit explained by fundamentals. For the second year in a row, imports increased much faster than exports in 2019. The pattern is set to continue over the forecast period, triggering a significant deterioration in the country’s external balance. This reflects a significant and widening gap in trade in goods. Net flows in primary and secondary income are expected to benefit from lower interest payments to foreign creditors and higher receipts from EU structural funds. Trade in services is projected to retain a stable surplus of around 8% of GDP throughout the whole forecast period benefiting from a continuous growth in tourism. Despite the expected increase in the current account deficit, exports are still projected to grow faster than GDP. However, the gains in market shares achieved in recent years are likely to diminish significantly. Investment outpaces savings. The recent and projected declines in current account balances are related to the recovery of domestic investment, which slightly outpaced increases in domestic savings. Investment growth accelerated after 2016, driven mainly by higher construction. While the difference between savings and investment in 2018 narrowed down to only 0.2% of GDP, it is projected to worsen further in 2019-2021, reaching -1% of GDP at the end of the period. Thus, the current projections imply that the expected increase in savings would be insufficient to simultaneously enable a strong investment growth and a satisfactory dynamics of unwinding the high external stock of imbalances. The trade balance deterioration is closely linked with imports of investment goods. The breakdown of trade by investment, consumer and intermediary goods, shows that the deterioration in 2018 and especially in 2019 was largely driven by increased imports of investment goods. This could improve the country’s growth and export potential in the long term. At the same time, the trade in consumer goods improved from a deficit of 1.8% of GDP in 2017 to 1.5% in 2018 and 1.1% in 2019, according to balance of payments data and estimates for 2019. The deficit in trade in equipment increased from 1.7% of GDP to 4.7% for the same period, which exceeds the magnitude of the overall trade balance deterioration. Graph 1.4:Balance of trade with goods Source: Eurostat Tourism continues to support the external balance. Despite some slowdown in 2018 and 2019, net inflows from foreign tourism continue to make a significant contribution to Portugal’s exports. Measured by travel receipts in the balance of payments, foreign tourism accounted for about 8% of GDP in 2018 and nearly 19% of the country’s total exports of goods and services. Net travel revenues accounted for a surplus of 6% of GDP in 2018 and the share is estimated to have increased slightly in 2019. Both in 2018 and 2019, tourism grew faster than GDP, although the rate of growth was significantly lower than in previous years. By the end of 2017, growth in tourism was also helped by developments in some competing travel destinations. These factors however faded away in 2018 and 2019 highlighting the sector’s exposure to external risks. Nontheless, it is expected that the growth achieved in 2018-2019 could be maintained in the medium term, supported by global trends in tourism and the projected expansion of the aviation sector. The pace of reducing external liabilities is slowing. The stock of the net international investment position (NIIP) improved from revised -109.9% of GDP at the end of 2017 to -105.6% at the end of 2018 and further on to -101.5% until September 2019. However, it remains one of the most negative in the EU and significantly beyond the headline threshold of -35% in the macroeconomic imbalance procedure (MIP) scoreboard and the country’s specific threshold of -48%. Moreover, the pace of adjustment is set to diminish, as the current account is projected to worsen further, reflecting the robust domestic demand and weaker prospects in global trade. The aforementioned estimates on the current account balance show that it will still be better than the estimated deficit of -4.1% of GDP required to stabilise the NIIP but significantly below the estimated surplus of 2.2% needed to reach the NIIP country-specific threshold in 10 years. Graph 1.5:Current Account and Net International Investment Position Source: Eurostat The risk profile of NIIP is improving. The structure of the NIIP shows that the risks associated with the type and duration of liabilities are diminishing, although a large part of the NIIP (about 60%) is composed of marketable debt. On the one hand, it reflects the reduced risk-premium on government debt, accounting for nearly 60% of the NIIP. The structure of the government debt benefitted from active management resulting in increased average maturity and smoothing of the redemption profile, as well as the continuous improvement in the country’s credit rating and government bond spreads. On the other hand, the foreign direct investment (FDI) component of the NIIP increased from 36.8% of the NIIP at the end of 2017 to 38.1% at the end of 2018 and 39.2% at the end of June 2019. This implies that most of the external liabilities in the private sector are generated by non-defaultable instruments. Overall, the NIIP excluding non-defaultable instruments accounted for -57.1% of GDP at the end of 2018. While having improved from a trough of -82.1% at the end of 2012, it is still one of the lowest values across the EU countries. Unit labour costs continue to grow. However, pressure on cost competitiveness remains modest as unit labour costs continue to move broadly in line with trading partners, owing to sustained modest wage developments. As regards non-cost indicators of competitiveness and total factor productivity, Portugal has continued to gain market share in recent years, although the trend is declining. The export market share in volume terms increased by 0.4% in 2018. Although growth slowed from 2.8% in the previous year, there had been a sustained improvement since 2010. In nominal terms, the share of exports in world trade grew by 2.3% in 2018, slowing from 3.2% in 2017. Over a five-year period, the accumulated growth in the market share is estimated at 9.4%. However, the share of high-technology products in total exports dropped to 4.0% in 2018 from 4.5% in 2017. While this ratio improved in the longer-term basis, it was the lowest in the EU in 2018, indicating a structural weakness of the economy associated with specialisation in low-value-added sectors (see chapter 4.4). Financial sector Portuguese banks have made significant further progress in reducing non-performing loans (NPLs), on the basis of sales, write-offs and cures. All major banks now actively participate in the secondary market. Still, the NPL-ratio remained the third highest in the euro area. Despite previous reforms, the efficiency of the legal system remains a concern, as lenders’ inability to manage collateral in an efficient manner is weighing on the prices investors are willing to pay for distressed debt. Banks continue to be profitable and capital ratios are above regulatory requirements, but stronger buffers would make banks more resilient to a weakening in macroeconomic conditions or an increase in risk premia. Recently introduced macro-prudential limits to loan-to-value and debt service-to-income ratios appear to have contributed to an improvement in credit standards (see Sections 3 and 4.2).

Graph 1.6:Return on equity (%), domestic banks Source: European Central Bank Private indebtedness Private indebtedness continued to decline. Consolidated private debt dropped from 162.2% of GDP at the end of 2017 to 155.4% at the end of 2018. The latest data for 2019, available only in non-consolidated terms, show a similar pace of decline, reflecting a broadly stable debt stock in absolute terms while the debt ratio is pulled down by the growth in nominal GDP. In absolute terms, the debt level is expected to slightly increase over the medium term, driven mainly by lending to households where consumer loans retain a significant pace of growth. On the other hand, economic growth is projected ensure that private sector indebtedness increases at an overall adequate pace. The corporate sector is deleveraging slightly faster than households, although the difference has narrowed since the start of 2019. The debt ratios remain on a downward trend across most of the business sectors. The breakdown of data by the size of corporate debtors reveals similar dynamics for small, medium and large firms. The stable stock of corporate debt shows that the large increase in investment up to September 2019 was financed largely by corporate profits and other non-debt sources, most likely linked with foreign direct investments. Yet, debt ratios remain above the estimated country specific prudential and fundamental thresholds. For households, the debt ratio dropped from 69.2% of GDP at the end of 2017 to 66.6% at the end of 2018 relative to prudential and fundamental levels estimated at 38% each. For corporates, the debt ratio dropped from 93.0% of GDP to 88.9% relative to prudential and fundamental benchmarks of 57% and 65% respectively. Public finances Public finances continue benefitting from resilient domestic demand and favourable financing conditions. According to the Commission’s latest forecast, the public headline deficit is projected to have decreased from 0.4% of GDP in 2018 to a small deficit of 0.1% of GDP in 2019, helped by cyclical revenue, decreasing interest expenditure and lower-than-budgeted public investment( ). The headline balance net of one-offs ( ) is set to have improved from a surplus of 0.2% of GDP in 2018 to a surplus of 0.4% of GDP in 2019. The structural balance is projected to have improved by about 0.1% of GDP in 2019, mainly reflecting the decline in interest expenditure, to a deficit of 0.5% of GDP, while the structural primary balance is expected to have remained broadly stable at a surplus of around 2.6% of GDP last year. According to the Commission’s latest forecast, the structural balance is expected to gradually approach equilibrium in 2020 and 2021. The forecast projects the public headline balance to improve to a small surplus of 0.1% of GDP in 2020. At the same time, the headline balance net of one-offs is set to improve slightly to a surplus of 0.5% of GDP in 2020. On the back of further savings in interest expenditure, the structural balance is projected to improve by 0.2% of GDP in 2020. Looking ahead into 2021, according to the Commission’s latest forecast, the headline balance is set to turn into a surplus of 0.7% of GDP benefiting from a major positive one-off impact( ), while the structural balance is projected to remain broadly unchanged. Risks to the fiscal outlook are tilted to the downside and are linked to uncertainties surrounding the macroeconomic outlook and the potential deficit-increasing impact of further bank support measures. The public debt-to-GDP ratio is projected to continue on its gradual downward path, albeit at a slower pace. After falling by 3.8 pps to 122.2% in 2018, according to the Commission’s latest forecast, the public debt-to-GDP ratio is projected to decline further to 119.2% in 2019, 116.7% in 2020 and 113.7% in 2021, mainly thanks to continuous primary surpluses and favourable growth-interest rate differentials. While the projected lower pace of decrease in the debt ratio below 3 pps in 2019 and 2020 is mostly due to higher stock-flow adjustments, the slight acceleration in 2021 mainly reflects the expected higher primary surplus thanks to one-off revenue. Portugal is making progress towards achieving the Sustainable Development Goals (SDGs). Areas where progress is more evident refer to SDG 1 “No Poverty”, with all its associated indicators showing an improving performance during the last five years. Relatively similar performances are found for SDG 16 “Peace, Justice and Strong Institutions” and SDG 9 “Industry, Innovation and Infrastructure”. Notwithstanding this improving performance, current levels for some of these indicators are significantly lower than the EU average, particularly for basic needs related to dwellings (SDG 1), the perceived independence of the justice system (SDG 16) and R&D expenditure (SDG 9). Goals recording comparatively more modest progress include SDG 13 “Climate Action”, with Portugal showing a recent deteriorating trend on SDG 13 indicators for greenhouse gas (GHG) emissions, primary and final energy consumption. These two indicators also explain the more subdued progress towards SDG 7 “Affordable and Clean Energy”, which add to the recent increase in energy import dependency of the country. Table 1.1: Key economic and financial indicators (1) NIIP excluding direct investment and portfolio equity shares

(2) domestic banking groups and stand-alone banks, EU and non-EU foreign-controlled subsidiaries and EU and non-EU foreign-controlled branches.

(3) The tax-to-GDP indicator includes imputed social contributions and hence differs from the tax-to-GDP indicator used in the section on taxation

(4) Defined as the income tax on gross wage earnings plus the employee's social security contributions less universal cash benefits, expressed as a percentage of gross wage earnings Source: Eurostat and ECB as of 4-2-2020, where available; European Commission for forecast figures (Winter forecast 2020 for real GDP and HICP, ad-hoc forecast 2019 for budgetary indicators, Autumn forecast 2019 otherwise) 2. Progress with country-specific recommendations Since the start of the European Semester in 2011, 69% of all country-specific recommendations addressed to Portugal have recorded at least ‘some progress’.( ) 31% of these CSRs recorded ‘limited’ or ‘no progress’ (see Graph 2.1). Most progress was observed for CSRs associated with challenges in the labour market, education and social policies, the financial sector, and the justice system. Progress on challenges associated with fiscal-structural issues and certain aspects of the business environment have been more limited. Further effort is warranted to effectively tackle these challenges. Graph 2.1:Level of implementation of 2011-2019 CSRs Source: European Commission Portugal has made limited progress in addressing challenges associated with fiscal policy and fiscal governance. There are delays in the implementation of the 2015 Budgetary Framework Law, in particular in the areas of medium-term and programme-based budgeting (linked to CSR1 sub-part on improving the quality of public finances by prioritising growth‑enhancing spending) and accrual accounting (linked to the CSR1 sub-part on strengthening overall expenditure control, cost efficiency and adequate budgeting). The ongoing bottom-up review of public expenditure has generated overall modest efficiency savings. Despite efficiency-improving efforts in the health sector, hospital arrears remain a source of concern. Although efforts were made to improve the financial sustainability of state-owned enterprises, the objective of attaining an overall balanced financial position has been repeatedly moved forward and is unlikely to have been achieved in 2019. While past reforms had improved its long‑term sustainability, recent direct increases in pension spending and demographic ageing are exerting growing pressure on the pension system. Progress has been made towards improving tax compliance and making tax collection more efficient, while there is still scope to make the tax system more business-friendly. There is some progress in tackling a persistent share of temporary employment. Stemming from the 2018 tripartite agreement new measures are in force since October 2019 to tackle labour market segmentation. Furthermore, some progress has also been registered in improving the efficiency of active labour market policies targeting permanent employment, fostering collective bargaining and in stepping up the capacity of the labour authority, especially with regard to combating false self‑employment. Improving the skills level of the population registered some progress. Thanks to increased participation in Qualifica and a wide range of initiatives through INCoDe.2030, some progress is being made in tackling low skills levels. However, more detailed information and project upscaling are needed to amplify the impact of these measures. Also, the Portuguese government has announced that it will soon be presenting a national plan for adult literacy, designed to improve literacy levels in low-skilled sectors of the population. Some progress has been made in increasing the number of higher education graduates. The government has put in place several measures to ease the access to higher education and increase enrolment (see Section 4.3.3). In 2017/2018, student enrolment in the first university courses was almost 8% higher than in 2016/2017 (National Education Council, 2019). The number of university students is also growing in science and information technology, although they are still a small proportion of the total. In 2018, university graduates in information and communication technologies accounted for 2.2% of the total number of graduates, while those graduating in natural sciences, mathematics and computing accounted for 6.8% of the total. Portugal has made limited progress towards improving the effectiveness and adequacy of the social safety net. The poverty reduction capacity of social transfers (other than pensions) as well as its adequacy, remain comparatively low in Portugal (). The new government announced several measures to be adopted in the coming years to address this recommendation.

Limited progress has been made with focusing investment-related economic policy on research and innovation. The implementation of the Portugal 2020 strategy is well underway and a reprogramming aimed at assigning additional funding to investments in innovation was conducted in 2019. Yet, further investments and policy efforts are necessary in particular to foster linkages between R&D actors and businesses and support a thriving innovation driven economy. Limited progress has been made with focusing investment-related economic policy on transport. There has been limited progress regarding the Connecting Europe Facility projects under the 2020 Ferrovia programme. There is also limited progress regarding port infrastructure, with key investment projects in Sines (Terminal Vasco da Gama) and Barreiro still going through the early or preparatory stages of the public tendering process. Portugal has made some progress on investment policy associated with the low carbon and energy transition. Measures are being taken to increase the use of renewables. In addition, a new regulatory framework addressing self-consumption and renewables communities should help decentralise the energy supply. Progress has been limited as regards primary energy consumption, which has been rising over the past three years. The government has announced its intention to adopt a number of measures, such as raising awareness of and revising energy efficiency regulations in industry, buildings and transport. As regards interconnections, Portugal has been actively involved in regional fora to improve the energy connectivity of the Iberian Peninsula, however the new electrical interconnection between Portugal (Minho) and Spain (Galicia) remains incomplete. The share of non-performing loans declines continuously due to strategies implemented over the past years by the authorities and the concerned banks. Since July 2019, Portuguese lenders have the possibility to make use of a special regime allowing them to transfer loan portfolios in bulk to other financial institutions. This should enable a faster and less costly process of selling NPLs. Nevertheless, challenges related to lengthy proceedings remain. The legal and judicial frameworks are heavily affecting the recovery process and the prospects for efficient repossession of collateral by lenders. The longer the average duration of recovery proceedings and the uncertainty surrounding it, results in lower market valuations of non‑performing assets. Although the overall administrative burden on businesses is being reduced, limited progress has been made with reducing the sector-specific burden on licensing. In recent years, several measures introduced mainly under the SIMPLEX+ programme have led to improvements in the business environment. New initiatives addressing the business environment were launched in 2019 through the SIMPLEX+ and Capitalizar programmes. However, limited progress has been made with reducing the sector-specific burden on licensing. Reforms seldom replace ex ante checks by ex post checks. They may even rely on responsible declarations to replace the numerous authorisation schemes in place. Long procedural deadlines for decision and even the absence of tacit approval persist. Portugal is making efforts supported by the Structural Reform Support Programme to improve regulatory impact assessment, in particular with the ambition to introduce cost-benefit analysis and to put in place an effective consultation system. No progress has been made with reducing regulatory restrictions on highly regulated professions, which remain sheltered from competition. No reforms to reduce regulatory restrictions on highly regulated professions have been implemented or even announced. This is despite the Commission’s repeated recommendations and recommendations made by the OECD and the Portuguese competition authority. Portugal has made some progress towards improving the efficiency of the tax and administrative courts. Proceedings before tax and administrative courts remain among the lengthiest in the EU. Measures designed to introduce further improvements continue to be implemented, including rapid reactions teams to deal with case backlogs, and the establishment of specialised chambers, both in administrative and tax matters. Portugal has made limited progress in addressing the 2019 country-specific recommendations. Limited progress has been made with respect to the fiscal-structural part of CSR 1, with the government continuing to tackle expenditure control, cost efficiency and adequate budgeting. However, hospital arrears have again begun to rise at a steady rate. Progress with improving the financial sustainability of state-owned enterprises which struggle to achieve a balanced financial position has also been limited. There has been some progress in addressing CSR 2, with Portugal adopting measures to address labour segmentation. There has also been some progress on skills and education, thanks to new policy measures improving access to higher education, and the implementation of programmes such as Qualifica and INCoDe.2030. Yet, limited progress has been made towards improving the effectiveness and adequacy of the social safety net. As regards CSR 3, there has been some progress on investment-related policy in the area of energy transition, while limited progress for policies in the areas of research and innovation, and railway and port infrastructure. As regards the business environment (CSR 4), there has been some progress on increasing the efficiency of insolvency and recovery proceedings, as well as on reducing administrative burden. However, limited progress has been made on reducing sector-specific barriers to licensing. There has been no progress with removing regulatory restrictions in professional services, which remain largely sheltered from competition. Upon a request from a Member State, the Commission can provide tailor-made expertise via the Structural Reform Support Programme to help design and implement growth-enhancing reforms. Since 2017, 20 projects in Portugal have benefited from such support. Several projects were implemented in 2019. For instance, the Commission supported the Portuguese authorities in implementing the Budget Framework Law and improving the performance of the strategic water supply and sanitation sector plan — PENSAAR 2020. Support with designing the national adult literacy plan continued in 2019. Work also started on developing capacity to assess the impact of structural reforms and forecast investment in the circular economy in order to promote the efficient use of resources. Table 2.1:Assessment of 2019 CSR implementation (*) (Continued on the next page) Table (continued) Source: European Commission (*) The assessment of CSR 3 does not take into account the contribution of the EU 2021-2027 cohesion policy funds. The regulatory framework underpinning the programming of the 2021-2027 EU cohesion policy funds has not yet been adopted by the co-legislators, pending inter alia an agreement on the multiannual financial framework. Box 2.1: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Portugal Portugal is one of the countries benefiting most from EU support. Its financial allocation from the EU cohesion policy funds ( I ) under the current Multiannual Financial Framework amounts to €27.6 billion, equivalent to around 2.0% of the country’s annual GDP. By the end of 2019, Portugal had allocated some €28.6 billion (more than the total amount planned) to specific projects and spent € 13.0 billion ( II ), showing a level of implementation well above average. While bringing a more harmonious development through reducing economic, social and territorial disparities, EU Cohesion Policy funding significantly supports structural. In Portugal, the Cohesion Policy programmes allocated €6.7 billion for smart growth, €4.9 billion for sustainable growth and transport, and €9 billion for inclusive growth. In 2019, following a performance review ( III ),€1.4 billion was made available for Portugal within performing priorities. EU Cohesion Policy is contributing to transform the Portuguese economy by promoting growth and employment. By 2019, investment driven by the European Regional Development Fund had already provided support for around 14,500 companies. This in turn directly created over 16,900 jobs. The Fund also supported investment to reduce energy consumption in public buildings by 335 million KWh/year and expand additional waste management capacity to cope with a further 333,000 tonnes/year. Similarly, Cohesion Policy supported projects contributing to the reduction of greenhouse gas emissions by more than 97,000 tonnes/year of CO2-equivalent. Funds also financed modernisation of schools, benefiting over 34,000 pupils and provided improved health services for 3.6 million people. Additionally, the European Social Fund (ESF) supported 28,000 employees and 6,000 SMEs through in-work training programmes, helped 550,000 unemployed and 400,000 employed people into short-term training modules, supported the integration of 84,000 young people into the labour market and contributed to the reduction of early school leaving providing support to over 36,000 young students and 55,000 teachers and other education professionals and helped in hiring over 200 psychologists to improve the quality of education. 174,000 students attended ESF supported vocational education and training courses, thus strengthening their skills set and employability. Agricultural and fisheries funds and other EU programmes also contribute to addressing investment needs. Including the national co-financing, the European Agricultural Fund for Rural Development makes €5 billion available and the European Maritime and Fisheries Fund makes €502 million available. Portugal also benefits from other EU programmes, such as the Connecting Europe Facility, which allocated €715 million in EU funding to specific projects on strategic transport networks, and Horizon 2020, which allocated €771 million. EU funding helps mobilise significant amounts of private investment. By the end of 2018, the European Structural and Investment Funds ( IV ) alone mobilised additional capital by 3.4% committing about €992 million in the form of loans, guarantees and equity ( V ). EU funds already invest substantial amounts in actions in line with the Sustainable Development Goals. In Portugal, the European Structural and Investment Funds support 13 of the 17 SDGs and up to 94% of expenditure contributes to achieving these goals. 3. Summary of the main findings from the MIP in-depth review 3.1. Introduction The 2020 Alert Mechanism Report concluded that a new in-depth review should be undertaken for Portugal to assess the persistence or unwinding of the imbalances (European Commission, 2019a). In Spring 2019, Portugal was identified as having macroeconomic imbalances (European Commission, 2019a). The imbalances identified related in particular to the large stocks of net external liabilities, private and public debt, and a high share of non-performing loans in a context of low productivity growth. This chapter summarises the findings of the analyses in the context of the MIP in-depth review that is contained in various sections in this report( ) ( ). 3.2. Imbalances and their gravity

Portugal´s net international investment position remains one of the most negative in the EU. As of the end of 2018, the NIIP stands at -105.6% of GDP and is significantly beyond the estimated prudential and fundamentally-explained thresholds of ‑48% and ‑25%, respectively. That said, the NIIP structure shows an improving risk profile with non-defaultable instruments accounting for 54.1% of the NIIP. Nearly 60% of the NIIP stems from government debt, whose structure, outlook and market performance has improved over the past years. The remaining private liabilities are mostly composed of foreign direct investment. Private debt is still facing challenges despite large adjustments. Consolidated private debt is estimated at 155.4% of GDP as of the end of 2018. Compared to the peak in 2012, the ratio is now much closer to the indicative headline threshold of 133%. Yet, the deviation is still large judged by country specific indicators. The ratios of corporate and household debt stand at 88.9% and 66.6% respectively. Both are significantly beyond the estimated country-specific prudential and fundamentals-based benchmarks( ). For corporates, these benchmarks are estimated at 57% and 65%, respectively, and for households at 38% each. The legacy of non-performing loans remains a key weakness in the debt structure, particularly in the corporate sector. As regards households, the high level of indebtedness is also accompanied by a relatively low saving rate. Public debt is well above the relevant benchmark but risks have subsided. The public debt-to-GDP ratio is projected to have been roughly twice as high as the benchmark of 60% in 2019 and therefore risks still persist. However, various factors have moved the public debt to a more sustainable position. This includes a more favourable fiscal performance and outlook, as well as a series of rating upgrades resulting in more favourable financing conditions. In addition, active debt management has contributed to a longer average debt maturity and a smoother debt redemption profile, while the overall interest rate burden has declined. Recent market developments also show that the Portuguese sovereign yields have been less volatile to external shocks and spreads have continued to decline. Productivity weighs on Portugal’s income convergence. Although Portugal’s economy grew faster than the EU average in 2017 and 2018, the gap in the country’s labour productivity vis-à-vis the EU average remained broadly stable. This keeps the country’s income gap vis-à-vis the EU average also stable at about 23%, measured in purchasing power standards per capita. The gap stems from a low, albeit improving, stock of labour skills and capital accumulation. Productivity appears also restrained by the specialisation in low value added sectors and the large share of small firms. Portugal’s share of high technology products in exports was the lowest in the EU in 2018, indicting the aforementioned structural restraints to productivity. House prices exceed the long-term average but risks are contained. House prices retained a strong growth pace in 2018 and the first half of 2019. The calculations for 2018 show that prices were already above the long-term average and the valuation gap widened to 13.9%. However, the price to income gap was only slightly positive at 1.9%. Additional risks stem from housing affordability problems in some regions though they are partly mitigated by the country’s large share of property ownership. The risks from overvaluation are also offset by the non-debt nature of financing, as the stock of mortgage loans relative to GDP is still on a downward trend. In addition, authorities have introduced borrower-based macro-prudential measures aimed at improving credit standards. Overall, the increase in house prices is seen as a correction from previously low levels of valuation. It is currently not considered an imbalance but warrants close monitoring. 3.3. Evolution, prospects and policy responses Table 3.1:Sensitivity analysis: current account balance and net international investment position Source: European Commission calculations The external adjustment is expected to slow down substantially. Although the NIIP improved from its lowest value of -123.8% of GDP at the end of 2014 to -105.6% by the end of 2018 and -101.5% by September 2019, the current projections on the external flows point to a substantial slowdown in the pace of adjustment. The current account moved from a surplus of 1.0% of GDP in 2017 to 0.1% in 2018 (in national account terms). The flows worsened further in 2019 and the current account is projected at a deficit of 0.4% for the whole year which is to widen further to 1.0% of GDP by 2021. This is well below the current account value required to reach the prudential NIIP target over a 10-year period although it is still significantly better than the value required to stabilise the NIIP. Overall, the current projections on the combined impact of the current and capital accounts suggests that the NIIP would remain broadly stable in absolute terms until 2021 but the ratio to GDP would be still benefiting from the expected economic growth, declining by around three percentage points per year. Consequently, it is expected that the NIIP would only reach the estimated prudential threshold of -48% over a period of about 15 years (see Table 3.1). On the positive side, the structure breakdown of the current account shows that the ongoing deterioration is mostly driven by investment goods However, domestic savings are growing at a slower pace, which would not enable further unwinding of external imbalances at a satisfactory pace. Various policy efforts address the imbalances. These include a programme to strengthen the sustainability of the health system, measures to facilitate a reduction in non-performing loans and a swifter resolution of insolvency and restructuring proceedings, and improvements in the business environment. The latter include measures to reduce the administrative burden and to improve the efficiency of the justice system. Several weaknesses in the business environment persist, in particular related to regulatory restrictions in professional services, and sector-specific restrictions related to licensing activities.



Private debt is steadily decreasing. After reaching a peak of 210.6% of GDP at the end of 2012, the ratio of consolidated private debt to GDP dropped to 162.2% at the end of 2017 and 155.4% at the end of 2018. This indicates that close to three quarters of the deviation from the indicative threshold of 133% have been corrected. The outlook is also favourable, as data for 2019 confirm that the process of deleveraging continues, driven mainly by positive denominator impact of economic growth. Overall, the pace of adjustment appears adequate although the gap relative to the country-specific thresholds is still significant. The corporate sector is deleveraging slightly faster than households, although the difference has narrowed since the start of 2019. Banks’ asset quality has improved following further sales and restructurings of non-performing loan portfolios. The NPL ratio dropped from a peak of 17.9% in the first half of 2016 to 9.4% at the end of 2018, and further to 7.7% at the end of September 2019. All six banks with the highest NPL ratios are actively participating in the secondary market. The NPL reduction has been achieved on the basis of sales, write-offs and loan restructurings. Public debt is decreasing from a high level. After having dropped to 122.2% of GDP by the end of 2018, the public debt-to-GDP ratio is set to decline to 119.2% of GDP by the end of 2019 (). Looking ahead, the ratio is projected to continue decreasing by close to 3 pps per year to 113.7% of GDP by the end of 2021, on the back of steady primary surpluses and favourable growth-interest rate differentials. Portugal has deployed continuous efforts to reduce interest expenditure, extend the average debt maturity and reduce annual peaks in the debt redemption profile. Moreover, the financial assistance loans to the International Monetary Fund have been fully repaid by the end of 2018. Portugal also carried out in October 2019 an early first repayment of €2 billion in financial assistance loans to the European Financial Stability Facility, which were only due in 2025. At the same time, a more growth-friendly fiscal consolidation strategy could have helped strengthening Portugal’s fiscal sustainability even further. To that end, fiscal-structural reforms could have been implemented to improve the quality and composition of public finances, while containing the growing pressures on the expenditure side of the government budget. Labour productivity improved marginally in 2018. Portugal’s labour productivity improved only marginally in 2018, extending the period of sluggish increase since 2013. A more significant improvement is projected in 2019-2021 along with the rebound already recorded in the first half of 2019. Yet, recent productivity dynamics have been insufficient to push up the country’s income convergence towards the EU average and the projected productivity gains are insufficient to reverse the expected deterioration in the country’s external balance. Therefore, policy efforts for boosting productivity, particularly labour skills, are helpful to improve Portugal’s competitiveness and potential growth and to accelerate the pace of external rebalancing. 3.4. Overall assessment Portugal continues to correct imbalances but the external adjustment is slowing. The process of correcting macroeconomic imbalances is advancing at a steady pace apart from some slowdown in the external sector. The debt ratios in both the private and public sector have retained a downward trend and the outlook appears favourable. A significant progress is also achieved in reducing the stock of NPLs albeit from a high base. On the other hand, the pace of reducing external liabilities has weakened substantially since 2018 due mainly to the deterioration in trade with goods. On the positive side, this setback is fully driven by demand for investment goods, which could have a positive impact on the country’s productivity and potential growth in the future. Indeed, the current projections point to some rebound in labour productivity in 2019-2021, following a five-year period of weak performance. Policy progress differs across areas. While there are measures to address hospital arrears, debt sustainability requires further budgetary consolidation and growth-enhancing structural measures. Administrative simplification and efficiency of the justice system progress on the back of various initiatives, while reform action lags behind in addressing barriers to competition in professional services. Table 3.2:MIP assessment matrix (Continued on the next page) Table (continued) Source: European Commission 4. Reform priorities

4.1.Public finances and taxation* 4.1.1.Debt sustainability analysis and fiscal risks* The public debt-to-GDP ratio is projected to continue falling steadily from a high level. After hovering at above 130% between 2013 and 2016, Portugal’s public debt-to-GDP ratio posted a first substantial decline by 5.4 percentage points to 126.0% in 2017, followed by an additional decrease by 3.8 pps to 122.2% in 2018. According to the Commission’s latest forecast (), Portugal’s public debt-to-GDP ratio is projected to continue decreasing, albeit at a more gradual pace by close to 3 pps per year, from 119.2% in 2019 to 113.4% by 2021. The continuously downward path projected for Portugal’s public debt-to-GDP ratio reflects debt-reducing impacts stemming from solid primary surpluses and favourable nominal growth-interest rate differentials, whereby the combined effects of continued real GDP growth and inflation offset the sizeable, yet gradually diminishing, interest burden on the high debt overhang. Despite its high public debt-to-GDP ratio, Portugal is not projected to face significant fiscal sustainability risks in the short term. The S0 indicator (which evaluates fiscal sustainability risks in the short term, stemming from the fiscal, macro-financial or competitiveness sides of the economy) is below its critical threshold (European Commission, 2020a). In particular, both the fiscal and the financial competitiveness sub-indices have values below their critical thresholds. This is confirmed by the lower spreads of credit default swaps and gradually improving credit ratings during 2019, which allows Portuguese sovereign debt holdings to be included in wide institutional investor portfolios based on the investment grade credit assessment by all four relevant rating agencies. However, Portugal is projected to face high fiscal sustainability risks in the medium term. The assessment of medium-term fiscal sustainability risks reflects an overall conclusion based on the S1 indicator and Portugal’s debt sustainability analysis. First, the S1 indicator (which evaluates fiscal sustainability risks in the medium term) is only slightly below its upper critical threshold, thereby indicating medium, but close to high, fiscal sustainability risks in the medium term. In particular, it suggests that a cumulated additional improvement in the structural primary balance by 2.1% of GDP over 5 years, compared with the Commission’s no-policy-change baseline scenario (based on the ad-hoc forecast of December 2019), would be required to bring the public debt-to-GDP ratio down to the Treaty reference value of 60% by 2034. This relatively high score for the S1 indicator is mainly due to the distance of the public debt-to-GDP ratio from the Treaty reference value of 60%. Second, although the Commission’s no-policy-change baseline scenario entails medium fiscal sustainability risks in the medium term, the Commission’s debt sustainability analysis (still based on the 2019 autumn forecast) points to overall high risks based on plausible alternative scenarios that project public debt-to-GDP ratios above 90% by 2030. Graph 4.1.1:Public debt projections under the baseline and alternative scenarios for nominal GDP growth and interest rates Source: European Commission The Commission’s debt sustainability analysis confirms that public debt would be very sensitive to any worsening of Portugal’s economic and financing conditions. In a debt sustainability analysis still incorporating the Commission’s 2019 autumn forecast and other technical assumptions (see Annex B) ( ) for the medium term, the public debt-to-GDP ratio is expected to continue falling at a moderating pace by close to 3 pps per year and to reach approximately 90% by 2030, thereby still remaining significantly above the Treaty reference value of 60%. In particular, in the Commission’s no-policy-change baseline scenario, the public debt-to-GDP ratio would cross the threshold of 100% only in 2026. The projected gradual decrease in Portugal’s public debt-to-GDP ratio crucially hinges on continuous primary surpluses and favourable nominal growth-interest rate differentials in the projection’s outer years. While in plausible alternative scenarios incorporating potential shortfalls in nominal GDP growth or interest rate hikes, the public debt-to-GDP ratio would still be forecast to be on a steady downward path, the pace of debt reduction would be significantly impaired and it would thus take longer for the public debt-to-GDP ratio to pass under the threshold of 100% (see Graph 4.1.1). Overall, the current high public debt-to-GDP ratio constitutes a long-lasting legacy that reduces the scope of fiscal policy to cope with any worsening of Portugal’s economic and financing conditions and to smooth inherent business cycle fluctuations. A growth-friendly fiscal consolidation strategy remains instrumental to safeguard Portugal’s fiscal sustainability. If Portugal’s structural adjustment were consistently in full compliance with the Stability and Growth Pact, notably through fully adhering to its current medium-term budgetary objective of a balanced budgetary position in structural terms, the public debt-to-GDP ratio would be below both the threshold of 90% and the Commission’s no-policy-change baseline scenario by 2030 (see Graph 4.1.2). Conversely, were Portugal’s structural primary balance to revert back to its historical trend (that is, to gradually converge to its last 15-year historical average of a structural primary deficit of around 0.5% of GDP), the public debt-to-GDP ratio would stabilise at around 105%, as much as 15 pps above the Commission’s no-policy-change baseline scenario. In addition, debt-increasing costs stemming from demographic ageing are projected to deter the speed of debt reduction by close to 3 pps by 2030. Portugal’s currently favourable economic and financing conditions offer a window of opportunity to deploy a growth-friendly fiscal consolidation strategy and implement fiscal-structural reforms that could help accelerating the reduction of its public debt-to-GDP ratio and strengthening its resilience to any potentially worsening economic, financing and demographic trends. Graph 4.1.2:Public debt projections under the baseline and alternative scenarios for fiscal consolidation Source: European Commission 4.1.2.Fiscal-structural issues, including pensions and healthcare* Recent measures have entailed direct increases in pension spending. First, since 2017 lower pensions have been increased repeatedly above the reference for regular pension indexation linked to inflation and real GDP growth, leading to higher expenditure by close to 0.1% of GDP each year. Second, since 2017 pathways for early retirement have been consecutively broadened. In particular, a new flexible early retirement scheme has fully kicked in by October 2019 ( ), exempting from the applicable sustainability factor citizens who at age 60 had paid social contributions for at least 40 years, while preserving a penalty proportional to the missing months up to the legal retirement age. That is estimated to have increased expenditure even further, by close to 0.1% of GDP in 2019. There is a risk that the improvement of the balance in the pension system has been cyclical. On the one hand, spending on pensions has continued to increase in 2019 (by around 0.5% of GDP year-on-year on a cash basis), mostly reflecting the underlying upward trend driven by demographic ageing and the impact of the above-mentioned measures. On the other hand, the currently favourable labour market conditions have continued to translate into significantly higher revenue from social contributions and lower expenditure on unemployment benefits. The social security balance in 2019 has also benefited from other positive impacts from measures to prevent fraud and error, changes to the contributory scheme of self-employed workers and transfers from the state, partly related to earmarked revenue from the value-added tax (VAT), the corporate income tax (CIT) ( ) and the surcharge on the local property tax. In view of the balance-deteriorating effects of the recent measures and the growing pressure from demographic ageing, coupled with the lack of compensatory balance-improving measures, there is a risk that the improvement in the social security balance has been mostly cyclical and, thus, that the overall sustainability of the pension system has not been strengthened in the long term. The financial sustainability of the health system remains a source of concern. The health system posted continued deficits throughout 2019 (of around 0.3% of GDP on a cash basis by the end of the year), reflecting increases in the wage bill (including extra-hours compensation) and spending on medicines and other healthcare goods and services (including complementary means of diagnosis and therapeutic use, and material for clinical consumption). This was despite some improvements in cost-effectiveness and the gradual implementation of a new programme to improve the sustainability of the health system (see below). Looking forward, the balance of the health system is expected to be negatively impacted by the planned removal of user charges for primary care. At the same time, the authorities expect that this measure will provide incentives for the use of primary care and discourage the use of emergency care, where user charges will remain if there is no referral. If this materialises, the balance-deteriorating impact of the measure may be offset to some extent by an improvement in the overall cost-effectiveness of the health system (see Section 4.3.2 for the likely impact on the accessibility of healthcare). Moreover, the investment gap in the health system remains substantial in view of the planned construction of new hospitals, reinforcements in primary health care and medical equipment updates (European Observatory on Health Systems and Policies, 2018). Exploring the available scope to optimising efficiency savings could be instrumental to ensuring the long-term sustainability of the health system and financing sustained improvements in access to healthcare. Cost-effectiveness has continued to be promoted in the health system. Portugal’s health system appears to be relatively ‘good value for money’, producing good outcomes for the comparatively modest, albeit increasing, expenditure channelled into the system. The system performs particularly well in certain areas, with relatively fewer hospital beds (3.4 per 1,000 population in Portugal, compared with the average of 5.1 for the EU) and more day case surgeries (European Commission, 2019b). However, the average length of stay in hospital care is above the EU average ( ). There is nevertheless scope to continue improving cost-effectiveness further, notably through even greater reliance on centralised purchasing and uptake of biosimilars and generics. Initiatives have been undertaken to improve the use of biosimilars and generics where appropriate, producing significant savings that may still be increased. A joint task force of the Ministries of Finance and Health created in 2018 is working on a series of measures to improve overall cost-effectiveness, notably through reducing hospital arrears (see the paragraph below) evaluating and reforming central procurement, revising pharmacy margins and assessing the primary care model. The impact of these proposals will depend on the degree to which they are actually implemented. Prompt implementation of the new programme could improve the financial sustainability of the health system. As a rule, a high stock of hospital arrears has an adverse impact on supply chain relationships and may end up limiting the scope for cost-savings. Portugal has a well-established track record of in-year accumulation of hospital arrears only partly contained through sizeable ad-hoc clearance measures, with particular incidence in the last months of each year. Notwithstanding such ad hoc clearance measures, leading to a visible decrease in hospital arrears by December 2018, hospital arrears were back on a steadily increasing path between July and November 2019 (reaching a level close to 0.4% of GDP), before another one-shot sharp correction in December (falling to 0.1% of GDP). The implementation of a new fully-fledged programme to improve the overall sustainability of the health system and tackle the root causes of persistently high hospital arrears got under way in 2019, led by the above-mentioned joint task force. The programme is expected to introduce a new governance model for public hospitals, with substantial increases in hiring autonomy and annual budgets being combined with enhanced joint monitoring by the two Ministries. A formal structure to evaluate the management of public hospitals in line with the programme’s goals was created in June 2019. While a few hospitals will start operating on the basis of new business activity plans, thereby being granted some more autonomy, most of the hospitals’ business activity plans are yet to be agreed upon. While the new programme appears to be gradually progressing in the right direction, swift and effective implementation would be required to soften pressures causing the accumulation of arrears in hospital faster and more permanently. 4.1.3.Fiscal framework and state-owned enterprises* There is scope to optimise the quality of public finances through prioritising growth- and environment friendly spending. In Portugal, less than 20% of total public expenditure is channelled into categories with direct positive effects in long-term economic growth (European Commission, 2019a). Expenditure for long-term economic growth, including education, transport, environment protection and R&D expenditure) accounted in Portugal for only 7.7% of GDP in 2017 (broadly in line with the EU). Importantly, the country’s expenditure on environment protection that could help meet environmental and climate goals was somewhat below the EU benchmark (0.6% of GDP in 2017, compared with 0.8% for the EU). On the one hand, Portugal appears to have deployed significantly more resources on other spending items, including on general public services, compared with the EU benchmark (14.3% of GDP in 2017, compared with 11.9% in the EU as a whole). On the other hand, Portugal’s welfare spending, including expenditure on social protection and health, was below the EU benchmark (23.7% of GDP in 2017, compared with 26.1% for the EU as a whole). Graph 4.1.3:Public expenditure by function in 2017 Source: European Commission Public investment has been subdued for a prolonged period. After sustaining very high levels during the first decade of the 2000s, Portugal’s public investment was visibly reduced during the crisis and dropped below the euro area’s average (Graph 4.1.4). Throughout the post-programme period, public investment remained at an average of 1.9% of GDP over the period 2015-2018, below the government plans and the EU average of 2.8% (Graph 4.1.4). Looking ahead, while public investment is projected to continue on the gradually increasing path initiated in 2017, after its lowest level in 2016, sizeable investment gaps are expected to persist during the period covered by the Commission’s forecast compared with the EU benchmark and the pre-crisis levels. On the one hand, the correction of public investment from the very high pre-crisis levels could reflect a greater focus on high-quality projects, thereby excluding those with low or negative rates of return. On the other hand, a protracted period of continuously subdued public investment levels could jeopardise the public capital stock. Importantly, public investment in Portugal has been lower than the consumption of public fixed capital since 2012, translating into continuously negative net public investment and the potential erosion of the public capital stock. Clear focus on high-quality investment could support the effectiveness of public services and maximise the growth-friendliness of public finances (see Section 4.4.1.). Graph 4.1.4:Public investment in 2001-2018 Source: European Commission

The ongoing review of public expenditure could help making it more growth-friendly. Portugal has been undertaking a bottom-up review of public expenditure for a number of years, aiming at improving the efficiency of public spending in a broad range of areas (see European Commission, 2019a). In 2019, it is estimated to have yielded efficiency savings of €236 million (around 0.1% of GDP) across a series of public sectors. For 2020, according to Portugal’s updated Draft Budgetary Plan, the expenditure review is planned to lose some momentum, being expected to generate more modest efficiency savings of €190 million in 2020. The exercise is not yet undergoing a regular and independent evaluation, in particular regarding the quantification of the savings effectively achieved. Strengthening the growth-friendliness of public finances could have been best achieved through a two-pronged strategy, whereby the resulting bottom-up savings could have been complemented with a top-down focus on the overall composition of public expenditure. The ongoing spending review could thus have been used not only as a source of efficiency savings, but also as tool for more growth-friendly public expenditure. The wage bill is exerting growing pressure on public expenditure. The number of civil servants has been increasing at a steadily accelerating pace since mid-2015, having expanded by 2.8% year-on-year in September 2019. This occurred despite the initial plan not to replace every civil servant retiring until 2020 according to 2017 Stability Programme. Staff increases have been particularly pronounced in local administration and in the health and education systems. In addition, a wide-ranging programme in the public sector to convert temporary contracts into permanent ones has been gradually implemented since 2017, reducing labour market segmentation but also increasing the headcount in public services. Moreover, the 35-hour working week was extended in mid-2018 to health sector employees on private sector contracts, who had previously worked 40 hours a week. In addition, since 2018 public wages have benefited from the gradual unfreezing of career progression with full implementation by December 2019 ( ) and leading to higher expenditure by around 0.2% of GDP in both years. In combination with the increase in the minimum wage applicable to civil servants in 2019, higher variable allowances and extra-hours compensation, the wage bill increased above government plans (by 4.6% year-on-year in 2019, compared with the implicit annual target of 2.1%, both on a cash basis). The unfreezing of career progression also allowed for performance awards in 2019 (by 50% of their amount and up to the available funding). The expanding wage bill limits the room for manoeuvre for the government to adjust expenditure in line with potentially less favourable economic conditions and new policy objectives. State-owned enterprises (SOEs) continue to struggle to achieve a balanced financial position. While the net incomes of financial SOEs improved in the first three quarters of 2019, the net incomes of non-financial SOEs gradually worsened compared with 2018. As a result, it is expected that by the end of 2019 SOEs overall ended up being farther from balance compared with government plans. At the same time, the debt of public non-financial SOEs continued to decrease, though at a decelerating pace, from 18.4% of GDP in at the end of 2018, to 17.3% of GDP by the third quarter of 2019 (Banco de Portugal, 2020). Some measures to improve the sustainability of SOEs are only being implemented gradually; they include the analysis of quarterly data designed to identify and correct deviations from the approved budgets in good time. There are also plans to eventually introduce new incentives for employees and managers to improve reporting standards. Moreover, the capital structure of a series of SOEs has been strengthened through sizeable capital injections, while the liquidation of unprofitable or redundant SOEs has been continued. Transparency regarding the financial position of SOEs has been improved somewhat through the publication of aggregate quarterly financial data within a shorter timeframe. Having said that, planned rationalisation efforts and increased monitoring have yet to translate into a sustained improvement in net incomes. Recent changes to the legal and institutional framework for public-private partnerships (PPPs) will require close monitoring with a view to containing fiscal risks. During Portugal’s economic adjustment programme, the institutional and legal framework for PPPs was significantly strengthened. The aim was to end malpractice and uncertainties in the arrangements surrounding PPPs which had led to a substantial financial burden on public finances ( ). In particular, the revamped framework imposed stricter conditions on new PPPs. These included a cost-benefit test, affordability and compliance with stringent tendering requirements. The overall framework for PPPs was recently revised through Decree-Law No 170/2019 of 4 December, which included important changes. First, the Council of Ministers – instead of the sectorial Minister and the Minister of Finance – will decide on the launching of a new PPP. Second, while in the past the conditions for launching a new PPP were clearly laid down in law, they are now to be defined on a case-by-case basis for each new PPP, which allows more scope for discretion. Third, among others operations, partnership contracts designed to develop projects under the terms of the recent Housing Basic Law were excluded from the legal arrangements governing PPPs. It is currently unclear whether the narrower scope and the greater degree of discretion introduced by the recent changes will strengthen the legal and institutional framework for PPPs. It will be important to monitor the implementation of these changes closely to safeguard appropriate control mechanisms and ensure that any new PPPs have an unquestionable positive cost-benefit ratio. Strong framework conditions for fiscal policy contribute to achieving a growth-friendly path for fiscal consolidation. The full and effective implementation of the 2015 Budgetary Framework Law (BFL) is paramount. The 2015 BFL is designed to make budget units more accountable and strengthen the medium- to long-term focus of public finances. It allowed for a three-year transitional period for applying most new features. However, due to repeated delays, the entry into force of the main provisions of the 2015 BFL was postponed to 1 April 2020. A working group to evaluate the BFL has been appointed in February 2020 and tasked to present a report in May 2020. In terms of regulatory preparation, a series of decree-laws will require adjustment and consolidation, and a decree-law establishing the new budgetary programmes still needs to be drafted ( ). The lack of significant progress on enforcing the 2015 BFL and uncertainties as regards the way forward with operationalising the necessary changes mean that the new framework cannot be fully applied to the 2021 state budget as previously planned (Portuguese Court of Auditors, 2019). Moreover, the full and effective application of the new accrual-based public accounting framework is delayed, following implementation lags in particular for local authorities and social security. As with the 2015 BFL, its implementation may not be sufficiently advanced across all government sectors to ensure that the 2021 state budget is drawn up under the new framework. 4.1.4.Taxation issues, including tax administration* The tax burden increased in 2018, mostly on the back of the economic conditions that were generally favourable. The overall tax revenue-to-GDP ratio, meaning the sum of revenue from taxes and net social contributions as a percentage of nominal GDP, stood at 34.9% in 2018, slightly higher than in 2017 (34.1%). This increase in 2018 echoed year-on-year increments in the tax-revenue-to-GDP ratios of taxes on consumption (by 0.2 pps, reflecting solid consumption growth), taxes on capital (by 0.3 pps, reflecting the expansion of the real estate market) and of taxes on labour (by 0.3 pps). Overall, Portugal relies relatively heavily on consumption taxes (12.9% of GDP in 2018, compared with 10.9% for the euro area and 11.2% for the EU as a whole) (European Commission, 2020b). At the same time, the revenue from recurrent property taxes was relatively low in Portugal in 2018, accounting for 0.8% of GDP (or 2.3% of total tax revenue), compared with the EU average of 1.5% of GDP (or 43.9% of total tax revenue). Graph 4.1.5:Tax revenue by function in 2018 Source: European Commission The tax system has remained broadly stable in substance, despite the proliferation of marginal parametric changes. In 2019, various small changes were introduced in direct and indirect taxes (see European Commission, 2019a). For 2020, the final state budget reports some tax hikes to incentivise decarbonisation, combined with limited cuts in some other taxes (including selective reductions of personal income tax (PIT) for young workers and couples with children aged 3 or below, as well as of autonomous taxations and taxation on small and medium-sized companies under the CIT). Focusing on recent changes in CIT, the continued proliferation of size- and location-dependent preferential tax rules may put a drag on productivity and investment growth; in particular, by focusing on smaller firms and/or those operating in specific, possibly less productive areas, such policies may detract businesses from scaling up and/or benefiting from agglomeration spill-over effects that could help achieving greater economies of scale and efficiency gains. The efficiency of VAT collection continues to improve. The VAT gap (which provides an estimate of revenue loss due to tax fraud, evasion and avoidance, among other factors) has been steadily declining since 2011, falling by more than 5 pps between 2016 and 2017, from 13% to 10% of total VAT tax liability (Centre for Social and Economic Research, 2019). Portugal’s VAT gap thus remained somewhat below the EU average of 11%. Having said that, Portugal’s VAT policy gap (which provides an estimate of revenue loss due to the use of reduced VAT rates and exemptions) remained well above the EU average, at 51.2% in 2017, compared with 44.5% for the EU in general. In particular, the divergence of the actionable VAT policy gap (which excludes tax liability from imputed rents, public services and financial services) from the EU increased in 2017, with the gap amounting to 18.4%, above the 13.0% for the EU. The high actionable VAT policy gap is composed of the rate gap and the actionable exemption gap. The comparatively high actionable VAT policy gap in Portugal mostly reflects the use of reduced VAT rates. However, as far as inequality matters are concerned, reduced VAT rates are generally a rather poorly targeted tool to support low-income households. Direct mechanisms, such as income-tested cash transfers, are preferable. Environmental tax revenues remain stable and comparatively high. The revenue from environmental taxes was 2.6% of GDP in 2018, compared with 2.4% for the EU average (European Commission, 2020b). Revenue from these taxes relied mainly on transport-related taxes, which accounted for 0.7% of GDP in 2018, compared with 0.5% in the EU. At the same time, taxes on pollution and resources accounted for only 0.02% of GDP in 2018, compared with 0.08% for the EU and the euro area. Excise duties on diesel remain lower than those on petrol, even though the former has a higher carbon and energy content. Despite progress on this issue over the past four years, Portugal still has a significantly low ratio of duty on diesel to duty on petrol (0.76 in the country compared with 0.81 in the EU in January 2019). There is a scope to improve the transparency and economic rationale for tax expenditure in Portugal. Including the revenue foregone owing to extensive use of VAT preferential rates, tax expenditure in Portugal is estimated by the authorities to have reached 6.2% of GDP in 2019 (see Ministry of Finance, 2019). Excluding VAT, tax expenditure was still considerable at 1.9% of GDP in 2019. The Working Group on Tax Benefits concluded in June 2019 that the tax benefit system was complex and not sufficiently transparent (see Grupo de Trabalho para o Estudo dos Benefícios Fiscais, 2019). Importantly, more than 500 tax benefits have been identified, spread over more than 60 legal texts. On that basis, a methodology for assessing tax benefits has been proposed, defining guidelines for the creation of new tax benefits, their yearly monitoring and ex-post evaluation. At the same time, focusing on the current tax benefit system for R&D (Sistema de Incentivos Fiscais à Inovação e Desenvolvimento, SIFIDE), the findings were positive insofar as every euro of tax revenue foregone was estimated to have turned into more than one euro of R&D expenditure by the beneficiary firms. Overall, the conclusions of the Working Group are expected to further guide tax policy in the future. Graph 4.1.6:Time to prepare and pay taxes in the euro area (2018) Source: World Bank Greater simplification could make Portugal’s tax system more business-friendly. It remains burdensome to comply with taxes in Portugal. Although e-filing has become the norm in Portugal over the past few years and the pre-filing of PIT returns ensures that most of the information is already collected and computed by the tax administration, Portugal is one of the countries where it still takes too long to pay taxes. Indeed, according to the Paying Taxes 2020 Report (World Bank, 2019a), the time needed to prepare and pay taxes in Portugal was 243 hours in 2018, the longest in the euro area and the 4th longest in the EU (see Graph 4.1.6). This is significantly above the unweighted euro area average of 146.5 hours and the EU average of around 171.5. At the same time, the number of payments (8 per year, below average) and the post-filing index (one of the best observed) decreased. Furthermore, around two thirds of firms surveyed in 2017 perceived the Portuguese tax system as ‘complex and ineffective’, an increase of around 10 pps from two years earlier. The tax system could be made less complex by reducing the level of special provisions and simplifying the language used in legal drafting, thereby limiting the scope for divergent interpretations. Importantly, the efficiency of the justice system when dealing with taxation-related issues can be further improved, as the disposition time and the case backlogs remain high (see Section 4.4.4). 4.2. Financial sector* Portuguese banks have continued to improve their resilience despite a challenging environment. Most banks have markedly improved their performance, increased capital ratios somewhat and continued to eliminate legacy assets from their balance sheets. Nevertheless, similarly to their European peers, Portuguese lenders still face both pressures on profitability and efficiency challenges in an environment of muted loan growth. The protracted period of low interest rates and the relatively large, albeit declining stock of non-performing loans ( ) and foreclosed real estate assets further weigh on their general performance. Solvency ratios, measured by the Common Equity Tier 1 (CET1) ratio increased from 13.2% at the end of 2018 to 13.9% in Q2-2019 reflecting largely the incorporation of profits for 2018. The banks’ loan-to-deposit ratio remained stable at 76.7% whereas central bank funding w