Council opinion of 27 February 2007 on the updated stability programme of Portugal, 2006-2010
Date: 2007-02-27
Institutions: Council of the European Union
Subjects: Portugal, budget estimate, economic forecasting, public finance, stability programme

28.3.2007

EN

Official Journal of the European Union

C 71/5

COUNCIL OPINION

of 27 February 2007

on the updated stability programme of Portugal, 2006-2010

(2007/C 71/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

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

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

(3)

(4)

On 27 February 2007 the Council examined the updated stability programme of Portugal, which
covers the period 2006 to 2010.

The macroeconomic scenario underlying the programme envisages that real GDP growth will pick up
from 1,4 % in 2006 to 1,8 % in 2007 and 2,4 % in 2008 and eventually to 3 % per year over the
rest of the programme period. Assessed against currently available information, this scenario appears
to be based on favourable growth assumptions for 2008 and for the outer years, with the output gap
closing rapidly. The programme's projections for inflation appear realistic.

For 2006, the general government deficit is estimated at 4,6 % of GDP in the Commission services'
autumn 2006 forecast and in the new update, which would correspond to the target set in the
previous update of the stability programme. According to the new update, both total government
revenue and expenditure level targets have been largely met. As percent of GDP, both ratios are some-
what lower than in the Commission services' autumn 2006 forecast.

The main goal of the programme's medium-term budgetary strategy is a lasting correction of the
large fiscal imbalances, notably a reduction of the general government deficit to below the 3 % of
GDP reference value in the year 2008 and further budgetary consolidation thereafter. Substantial
steps towards fiscal consolidation are planned throughout the programme period: the government
deficit is targeted to gradually decline from 4,6 % of GDP in 2006 to 0,4 % in 2010; the adjustment
path for the primary balance is similar, with an improvement from a deficit of 1,7 % of GDP in 2006
to a surplus of 2,5 % in 2010. The planned deficit reduction is to be achieved mainly by curbing
primary expenditure, the overall level of which is to decline in real terms over the programme period
thanks to corrective measures of a structural nature concentrated on restructuring central govern-
ment, personnel and public services and also on controlling social security and health expenditure. In
the earlier years of the programme, higher tax revenues coming mainly from an increase in some
rates and lower tax benefits, and the continued efforts in fighting fraud and tax evasion, also contri-
bute to fiscal consolidation. The programme confirms the planned adjustment outlined in the
December 2005 update of the stability programme against a largely unchanged macroeconomic
scenario.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The

documents referred to in this text can be found at the following website:
http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

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Official Journal of the European Union

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(5)

(6)

(7)

(8)

(9)

the cyclically-adjusted balance net of one-off and other temporary
The structural balance (i.e.
measures) calculated according to the commonly agreed methodology is planned to improve from a
deficit of around 3½ % of GDP in 2006 to ½ % by 2010. Over the programme period, the structural
balance is planned to be reduced by an average of almost ¾ % of GDP per year. The medium-term
objective (MTO) for the budgetary position presented in the programme is a structural deficit of
0,5 % of GDP, which the programme aims to achieve by 2010, one year earlier than implicitly
targeted in the previous programme. As the MTO is more demanding than the minimum benchmark
(estimated at a deficit of around 1½ % of GDP), achieving it should fulfil the aim of providing a
safety margin against the occurrence of an excessive deficit. The MTO lies within the range indicated
for euro-area and ERM II Member States in the Stability and Growth Pact and the code of conduct
and adequately reflects the debt ratio and average potential output growth in the long term.

The budgetary outcomes are subject to downside risks deriving, in particular, from the impact of the
measures to contain government spending. Against the backdrop of a difficult macroeconomic envir-
onment, the government has recently implemented decisive measures to tackle expenditure growth,
notably in public administration, health care and social welfare, in addition to the new legal frame-
work to improve the fiscal discipline of regional and local governments. Others measures partly also
relating to the government sector, are still in preparation. The budgetary relief to be expected from
these measures is nevertheless subject to uncertainty, notably for 2008 and beyond. Since fiscal
consolidation relies crucially on expenditure retrenchment,
further progress with the ongoing
improvement of the budgetary framework and implementation of mechanisms of assessing and
controlling budgetary execution will also be instrumental to the achievement of the budgetary targets.
The macroeconomic scenario raises the risk of a less marked recovery of economic activity thus
providing more moderate relief to government finances. The assumptions about the elasticity of tax
revenue to economic activity in 2007 depend on the planned further improvement in tax collection..

In view of this risk assessment, the budgetary stance in the programme is broadly consistent with a
correction of the excessive deficit by 2008 as recommended by the Council, provided the measures
announced in the programme are fully and effectively implemented and reinforced in case of lower-
than-projected economic growth. Following the correction of the excessive deficit, the programme
targets an adjustment that is in line with the Pact. However, taking into account the risks to the
budgetary targets, the budgetary stance in the programme may not provide a sufficient safety margin
against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations until
the very end of the programme period. Consequently, the risks to the budgetary targets may compro-
mise reaching the MTO by 2010, as envisaged in the programme. Thus, in the years following the
correction of the excessive deficit, the adjustment towards the MTO outlined in the programme could
require reinforcing the measures to be in line with the Stability and Growth Pact, which specifies that,
for euro-area and ERM II Member States, the annual improvement in the structural balance should be
0,5 % of GDP as a benchmark and that the adjustment should be higher in good economic times and
could be lower in bad economic times.

Government gross debt is estimated to have reached 67½ % of GDP in 2006, above the 60 % of
GDP Treaty reference value. The programme projects the debt ratio to increase in 2007 and to
decline by close to 6 percentage points over the rest of the programme period. The evolution of the
debt ratio is subject to the risks to the budgetary targets mentioned above and continued uncertainty
about the stock-flow adjustment, which has tended to be large and predominantly debt-increasing in
the past. Finally, the performance of public enterprises provides a risk in the medium term. Subject to
these risks, the debt ratio would start to diminish towards the reference value at the end of the
programme period.

Portugal has recently enacted pension reforms aimed at strengthening the sustainability of the public
finances. Estimates in the programme suggest that the overall increase in age-related expenditure over
the coming decades would be significantly lower as a result of the reform, though remaining sizeable.
The initial budgetary position, albeit markedly improved compared with 2005, still constitutes a risk
to sustainable public finances even before the long-term budgetary impact of an ageing population is
considered. Moreover, the current level of gross debt is above the Treaty reference value. Overall,
Portugal appears to be at high risk with regard to the sustainability of public finances. The planned
the age-related expenditure,
budgetary consolidation coupled with the expected containment of
arising from ongoing reforms, would significantly contribute to reducing such risks.

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(10)

The stability programme contains a qualitative assessment of the overall impact of the October 2006
Implementation Report of the National Reform Programme within the medium-term fiscal strategy.
In addition, it provides systematic information on the direct budgetary costs or savings of the main
reforms envisaged in the National Reform Programme and its budgetary projections explicitly take
into account the public finance implications of the actions outlined therein. The measures in the area
of public finances envisaged in the stability programme seem consistent with those foreseen in the
National Reform Programme. In particular, both programmes address the linkages between public
administration reform and the fiscal consolidation strategy and provide complementary information
on various policy measures.

(11)

The budgetary strategy in the programme is broadly consistent with the broad economic policy
guidelines included in the integrated guidelines for the period 2005-2008.

(12) As regards the data requirements specified in the code of conduct for stability and convergence
programmes, the programme provides all required and most of the optional data (1). As regards the
model structure,
it deviates on some material points from the one specified in the code of
conduct (2).

The Council considers that the programme is broadly consistent with a correction of the excessive deficit by
2008, conditional on a full and effective implementation of the measures announced therein and on the
reinforcement of such measures in case of lower-than-projected economic growth. The fiscal consolidation
will also support the strategy of fostering competitiveness and economic growth. After the correction of the
excessive deficit, the programme envisages adequate progress towards the medium-term objective, but there
are risks to the achievement of the budgetary targets. In view of the above assessment, and also in the light
of the recommendation under Article 104(7) of the Treaty of 20 September 2005, the Council
invites
Portugal to:

(i) implement with rigour the structural measures envisaged in the programme so as to correct the exces-
sive deficit by 2008 and stand ready to reinforce these measures to deal with the budgetary impact of
possible lower-than-projected economic growth;

(ii) once the excessive deficit has been corrected, carry out the envisaged adjustment towards the MTO,
backing it up with reinforced measures if necessary; and ensure that the debt-to-GDP ratio is reduced
accordingly;

(iii) pursue the ongoing reform of public administration; continue strengthening the budgetary framework,
including the assessment and control of budgetary execution at all levels of the general government,
notably in order to attain the planned expenditure containment;

(iv) in view of the level of debt and the projected increase in age-related expenditure, improve the long-term
sustainability of public finances by achieving the MTO and by securing and possibly enhancing the
benefits of the adopted pension reforms.

Comparison of key macroeconomic and budgetary projections

Real GDP
(% change)

SP Dec 2006

0,4

1,4

1,8

2,4

3,0

3,0

2005

2006

2007

2008

2009

2010

COM Nov 2006

0,4

1,2

1,5

1,7

n.a.

n.a.

SP Dec 2005

0,5

1,1

1,8

2,4

3,0

n.a.

(1) In particular, the data on HICP inflation and compensation of government employees are not provided.
(2) The programme rather presents five sections: Executive Summary; Macroeconomic and Budgetary Situation; Macroeco-
nomic and Budgetary Forecasts; Long-term Sustainability of Public Finances; and Institutions, Processes and Budgetary
Rules.

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HICP inflation
(%)

Output gap
(% of potential GDP)

General government
balance
(% of GDP)

Primary balance
(% of GDP)

Cyclically-adjusted
balance
(% of GDP)

Structural balance (2)
(% of GDP)

Government gross debt
(% of GDP)

2005

2006

2007

2008

2009

2010

SP Dec 2006 (6)

COM Nov 2006

SP Dec 2005 (6)

2,5

2,1

2,3

3,2

2,9

2,3

2,2

2,2

2,2

2,2

2,1

2,2

2,1

n.a.

2,1

SP Dec 2006 (1)

– 2,5

– 2,6

– 2,4

– 1,8

– 0,7

COM Nov 2006 (5)

– 2,0

– 2,0

– 1,8

– 1,5

n.a.

SP Dec 2005 (1)

– 2,3

– 2,7

– 2,5

– 1,8

– 0,7

2,1

n.a.

n.a.

0.2

n.a.

n.a.

SP Dec 2006

– 6,0

– 4,6

– 3,7

– 2,6

– 1,5

– 0,4

COM Nov 2006

– 6,0

– 4,6

– 4,0

– 3,9

n.a.

SP Dec 2005

– 6,0

– 4,6

– 3,7

– 2,6

– 1,5

SP Dec 2006

– 3,3

– 1,7

– 0,7

0,4

COM Nov 2006

– 3,3

– 1,7

– 1,0

– 0,7

SP Dec 2005

– 3,2

– 1,7

– 0,6

0,6

1,5

n.a.

1,5

n.a.

n.a.

2,5

n.a.

n.a.

SP Dec 2006 (1)

– 4,9

– 3,4

– 2,6

– 1,8

– 1,2

– 0,5

COM Nov 2006

– 5,1

– 3,7

– 3,2

– 3,2

n.a.

SP Dec 2005 (1)

– 5,0

– 3,4

– 2,6

– 1,8

– 1,2

n.a.

n.a.

SP Dec 2006 (3)

– 4,9

– 3,4

– 2,6

– 1,8

– 1,2

– 0,5

COM Nov 2006 (4)

– 5,1

– 3,7

– 3,2

– 3,2

n.a.

SP Dec 2005

SP Dec 2006

COM Nov 2006

SP Dec 2005

– 5,0

– 3,4

– 2,6

– 1,8

– 1,2

64,0

64,0

65,5

67,4

67,4

68,7

68,0

69,4

69,3

67,3

70,7

68,4

65,2

n.a.

66,2

n.a.

n.a.

62,2

n.a.

n.a.

Notes:
(1) Commission services calculations on the basis of the information in the programme.
(2) Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures.
(3) There are no one-off and other temporary measures in the programme.
(4) There are no one-off and other temporary measures in the Commission services' autumn 2006 forecast.
(5) Based on estimated potential growth of 1,2 % in the period 2005-2007 and 1,4 % in 2008.
(6) Private consumption deflator.

Source:
Stability programme (SP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations