Council opinion of 4 March 2008 on the updated stability programme of Portugal, 2007-2011
Date: 2008-03-04
Institutions: Council of the European Union
Subjects: Portugal, budget estimate, economic forecasting, public finance, stability programme

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Official Journal of the European Union

19.3.2008

COUNCIL OPINION

of 4 March 2008

on the updated stability programme of Portugal, 2007-2011

(2008/C 73/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the 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)

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

From a phase of high economic growth in the second half of the nineties, the Portuguese economy
moved to a situation of sluggish GDP growth after 2000, accompanied by rising unemployment,
which all added to budgetary fragilities. This marked change in economic performance was rooted in
the accumulation of
fiscal policies
compounding the imbalances of the private sector and feeding uncertainty.

large external and budgetary deficits, with pro-cyclical

At the beginning of this decade, private domestic demand moderated considerably reflecting the
adjustment of spending to levels more in line with income patterns. At the same time, public primary
expenditure had to slow down from previous unsustainable trends, while the competitive position has
remained vulnerable reflecting a lasting misalignment between wages and productivity growth.
Whereas recent economic growth has been led by the external sector, accompanied by considerable
restructuring in some industries in the face of increased external competition, weaknesses of a more
structural nature stand in the way of a lasting improvement in economic performance. In particular,
overall productivity is low, mainly due to relatively low levels of human capital, and the efficiency
and effectiveness of the public sector needs particular attention. In recent years, significant progress
has been achieved to overcome this situation, in particular in containing public finances imbalances.
In all, continuing fiscal consolidation, improving the quality of public finances, and proceeding with
structural reforms with a view to improving potential GDP growth remain major challenges to put
back the Portuguese economy on a sustainable and dynamic catching-up path.

(3)

The macroeconomic scenario underlying the programme envisages a continuation of the upswing in
economic activity, with real GDP growth picking up from 1,8 % in 2007 to 2,2 % in 2008 and
further to 2,8 % in 2009 and 3 % in 2010 and 2011. Assessed against currently available informa-
tion (2), the economic outlook after 2008 appears to be based on favourable growth assumptions. In
particular, growth rates for private demand components seem to be on the high side, especially for
investment. The programme expects the labour market to improve gradually over the programme
period, but the employment outlook appears optimistic.

The projections for consumer inflation may be on the low side in the light of the recent surge in
food and oil prices in world markets. The economy's competitiveness position is expected to improve
in the coming years, with unit labour costs growing more slowly than in most of its trading partners.

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

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

(2) The assessment takes into account notably the Commission services' autumn forecasts and the Commission assessment of

the October 2007 implementation report of the national reform programme.

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The programme envisages a marked decline of the sizable external deficit, from 8,8 % of GDP in
2006 and an estimated 7 % of GDP in 2007 to 4,7 % of GDP in 2011. Assessed against current
information, however, the underlying improvement of the deficit in the balance of current transfers
and primary income projected in the update might be difficult to achieve.

(4)

(5)

(6)

(7)

For 2007, the general government deficit is estimated at 3 % of GDP in the updated programme and
in the Commission services' autumn 2007 forecasts, against a target of 3,7 % of GDP set in the
previous update of the stability programme. More recent and preliminary data on budgetary execu-
tion suggest that the 2007 deficit outturn is likely to be lower than 3 % of GDP. This development is
in line with and goes beyond the invitation in the Council opinion of 27 February 2007 on the
previous update to implement measures so as to correct the excessive deficit by 2008 (1). As the
better-than-expected outcome in 2006 was used to pursue a more ambitious target in 2007, the
Council notes that it is also consistent with the April 2007 Eurogroup orientations for budgetary
policies.

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

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

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

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

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(8)

(9)

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

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

Indeed,

(10)

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

(11) As regards the data requirements specified in the code of conduct for stability and convergence

programmes, the programme provides all required and most of the optional data (1).

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

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

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

(i) implement with determination the fiscal consolidation envisaged in the programme so as to secure the

correction of the excessive deficit;

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

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

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

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

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Comparison of key macroeconomic and budgetary projections

Real GDP
(% change)

HICP inflation (4)
(%)

Output gap (1)
(% of potential GDP)

Net lending/borrowing
vis-à-vis the rest of the
world
(% of GDP)

General government
balance
(% of GDP)

Primary balance
(% of GDP)

Cyclically-adjusted
balance (1)
(% of GDP)

Structural balance (3)
(% of GDP)

Government gross debt
(% of GDP)

2006

2007

2008

2009

2010

2011

SP Dec 2007

COM Nov 2007

SP Dec 2006

SP Dec 2007

COM Nov 2007

SP Dec 2006

1,3

1,3

1,4

3,0

3,0

3,2

1,8

1,8

1,8

2,3

2,4

2,2

2,2

2,0

2,4

2,1

2,4

2,2

2,8

2,1

3,0

2,1

2,3

2,1

3,0

n.a.

3,0

2,1

n.a.

2,1

SP Dec 2007

– 2,4

– 2,2

– 1,8

– 1,1

– 0,2

COM Nov 2007 (2)

– 2,1

– 1,7

– 1,2

– 0,8

SP Dec 2006

– 2,6

– 2,4

– 1,8

– 0,7

n.a.

0,2

3,0

n.a.

n.a.

2,1

n.a.

n.a.

0,5

n.a.

n.a.

SP Dec 2007

– 8,8

– 7,0

– 5,8

– 5,6

– 4,9

– 4,7

COM Nov 2007

– 8,8

– 7,9

– 7,7

– 7,7

n.a.

SP Dec 2006

– 7,5

– 7,3

– 6,9

– 6,3

– 6,0

n.a.

n.a.

SP Dec 2007

– 3,9

– 3,0

– 2,4

– 1,5

– 0,4

– 0,2

COM Nov 2007

– 3,9

– 3,0

– 2,6

– 2,4

n.a.

SP Dec 2006

– 4,6

– 3,7

– 2,6

– 1,5

– 0,4

SP Dec 2007

– 1,1

– 0,1

COM Nov 2007

– 1,1

– 0,1

SP Dec 2006

– 1,7

– 0,7

0,5

0,3

0,4

1,3

0,5

1,5

2,2

n.a.

2,5

n.a.

n.a.

2,5

n.a.

n.a.

SP Dec 2007

– 2,8

– 2,0

– 1,6

– 1,0

– 0,3

– 0,4

COM Nov 2007

– 2,9

– 2,2

– 2,1

– 2,1

n.a.

SP Dec 2006

– 3,4

– 2,6

– 1,8

– 1,2

– 0,5

n.a.

n.a.

SP Dec 2007

– 2,8

– 2,1

– 1,6

– 1,0

– 0,3

– 0,4

COM Nov 2007

– 2,9

– 2,3

– 2,1

– 2,1

n.a.

SP Dec 2006

SP Dec 2007

COM Nov 2007

SP Dec 2006

– 3,4

– 2,6

– 1,8

– 1,2

– 0,5

64,8

64,8

67,4

64,4

64,4

68,0

64,1

64,7

67,3

62,5

64,5

65,2

59,7

n.a.

62,2

n.a.

n.a.

56,7

n.a.

n.a.

Notes:
(1) Output gaps and cyclically-adjusted balances from the programmes as recalculated by Commission services on the basis of the informa-

tion in the programmes.

(2) Based on estimated potential growth of 1,5 %, 1,5 %, 1,6 % and 1,6 % respectively in the period 2006-2009.
(3) Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary measures are 0,1 % of GDP

in 2007 (deficit-reducing) according to the most recent programme and the Commission services' autumn forecasts.

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

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