Council opinion of 10 March 2009 on the updated stability programme of Portugal, 2008-2011
Date: 2009-03-10
Institutions: Council of the European Union
Subjects: Portugal, budget estimate, economic forecasting, public finance, stability programme

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OPINIONS

COUNCIL

COUNCIL OPINION

of 10 March 2009

on the updated stability programme of Portugal, 2008-2011

(2009/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)

On 10 March 2009, the Council examined the updated stability programme of Portugal, which
covers the period 2008 to 2011.

The Portuguese economy has been growing below the euro-area average and below potential during
the current decade. GDP stagnated in 2008, primarily influenced by sluggish external demand,
reflecting the financial crisis and the weak economic situation of main trading partners. External
imbalances have widened, which has led to growing indebtedness, and concomitantly, rising interest
payments abroad. Moreover, the competitiveness gap has not been reduced, reflecting mostly a feeble
productivity growth, which remains a major weakness of the Portuguese economy. Domestic demand
growth also fell, driven by the poorer performance of private consumption and especially gross fixed
capital formation. Slow growth, however, did not prevent the government deficit to be reduced in
recent years, standing at 2,2 % of GDP in 2008. The Portuguese authorities have adopted various
measures to stimulate economic activity in 2009 in line with the European Economic Recovery Plan
(EERP), amounting to 1,3 % of GDP, of which 0,8 % of GDP with a budgetary impact. The discre-
tionary measures on public finances limit the space for further fiscal impulses without risking the
long-term sustainability of public finances.

The macro-economic scenario underlying the programme envisages that GDP will contract by 0,8 %
in real terms in 2009 and recover in 2010 and 2011 with real GDP growth at 0,5 % and 1,3 %
respectively. These projections take into account the stimulus measures adopted in response to the
economic downturn. Assessed against currently available information (2), this scenario appears to be
based on favourable growth assumptions over the programme period, which is mainly reflecting rela-
tively optimistic projections for domestic demand, notably the modest contractions of gross fixed
capital formation in the programme scenario for 2009 and 2010. The programme's projections for

(1) OJ L 209, 2.8.1997, 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 notably takes into account the Commission services' January 2009 interim forecast, but also other infor-

mation that has become available since then.

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(4)

(5)

(6)

(7)

inflation appear to be realistic. The fiscal stimulus package for 2009 is expected to boost GDP,
mainly through measures targeted to leverage investment. On the back of a reduction in the balance
of goods and services deficit, the programme envisages a decline of net foreign borrowing from
10,5 % of GDP in 2008 to 7,5 % of GDP in 2011.

The 2008 general government deficit is estimated at 2,2 % of GDP in the Commission services'
January 2009 interim forecast and in the stability programme update, which is slightly better than
the deficit target of 2,4 % of GDP included in the previous update. The 2008 budgetary execution
benefited from the better-than-expected outcome of 2007, since the deficit outturn for that year was
almost 0,5 % of GDP lower than foreseen. In addition, the 2008 outturn was affected by the slow-
down in activity and the reduction of the standard VAT rate by one percentage point in July 2008,
which dampened tax revenue growth in the final part of 2008. This was partly offset by unforeseen
one-off sales of concessions by the government, mainly for the construction and exploitation of elec-
tric dams and motorways, worth some 0,75 % of GDP.

The updated programme plans a general government deficit of 3,9 % of GDP in 2009. The worsening
of the budget balance is explained mainly by the impact of discretionary measures. Some of these
measures had been announced earlier in 2008 to support households and firms and to reduce the
standard VAT rate by one percentage point as from July 2008 and will also impact the 2009
budgetary execution. However, the programme assumes that these two effects will be mitigated by the
impact of consolidation measures taken in earlier years to contain expenditure, particularly on
compensation of government employees and social
transfers. Measures with budgetary impact
amounting to 0,8 % of GDP through a combination of higher expenditure and tax exemptions have
been taken in the context of the EERP. In addition, the worsening of the balance will also reflect the
flooring of the one-off sales of concessions recorded in 2008, as well as the impact of automatic
stabilisers. Overall, with the structural balance loosening by about 1 percentage point, the stance of
fiscal policy is expected to be expansionary in 2009, which is in line with the EERP (1).

The headline deficit is projected to fall to 2,9 % of GDP in 2010 and further to 2,3 % of GDP
in 2011. Similarly, the primary balance is aimed to improve gradually from a deficit of 0,6 % of GDP
in 2009 to surpluses of 0,4 % and 1,1 % of GDP in 2010 and 2011 respectively. After 2009, the
budgetary strategy outlined in the programme aims at resuming the convergence to the medium-term
objective (MTO) of a structural balance (i.e., the cyclically-adjusted balance net of one-off and other
temporary measures) of – 0,5 % of GDP. Nonetheless, the structural deficit would still be in excess of
the MTO in the final year of the programme. The improvement in the fiscal balance projected for
2010 is mainly explained by the reversal of the temporary stimulus package adopted for 2009. In
addition, the improvements targeted for 2010 and 2011 are assumed to reflect past consolidation
efforts to contain expenditure, namely the lagged effects of measures taken at the level of public
administration, mainly to rein in compensation of government employees, and of old-age pension
systems reforms. The update does not present new sizeable fiscal consolidation measures. Finally,
according to the programme, the headline deficit is expected to fall also thanks to the expected
upswing in economic activity. Government gross debt, estimated at 65,9 % of GDP in 2008,
is
projected to increase further to a peak of 70,5 % of GDP in 2010 as the result of the rise in the
deficit, low GDP growth and a significant stock-flow adjustment in 2009 mainly reflecting commer-
cial debt repayments and acquisition of financial assets in the context of the financial recapitalisation
package put in place by the Portuguese authorities. Some reversion of these factors is expected to
allow a small decline in the debt ratio to 70 % of GDP in 2011.

The budgetary outcomes are subject to downside risks throughout the programme period. In the
context of the current international economic and financial conditions, a major source of uncertainty
is related to the macro-economic scenario, which appears to be based on favourable growth assump-
tions. Hence, a scenario where lower-than-expected GDP growth would dampen revenue growth and
jeopardise the fall in the expenditure-to-GDP ratio envisaged in the programme is a distinctive possi-
bility. To a lesser extent, the additional expenditure savings that can be rendered by recently taken
measures, namely at the level of public administration, are subject to uncertainty. The evolution of
the debt ratio may be less favourable than projected in the programme, given the risks to the macro-
economic and budgetary scenarios and the uncertainty about the impact of guarantees granted and of

(1) Using the recalculated cyclically-adjusted balance, based on the information in the programme, and the definition of one-
offs and other temporary measures applied by the Commission services — which indicates higher values for these
measures than the programme, especially in 2008 — the structural balance would be – 2,8 % of GDP in 2007, – 2,7 %
in 2008, – 3,1 % in 2009 and – 1,8 % of GDP in 2010.

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financial assets acquired in the context of the financial rescue package. However, the increase in debt
linked to the measures taken in support of the financial sector would be reversed at a later stage if
the support scheme and the financial operations linked to it are successful.

(8) While the long-term budgetary impact of ageing is somewhat higher than on average in the EU,
recently enacted pension reforms have helped contain the projected increase in pension expenditure
over the coming decades. The budgetary position in 2008, as estimated in the programme, is almost
sufficient to stabilise the debt ratio over the long term before the budgetary impact of population
ageing is taken into account. If the 2009 budgetary position as projected in the Commission services'
January 2009 interim forecast was taken as the starting point, the sustainability gap would worsen.
Moreover, the current level of gross debt is above the Treaty reference value. Achieving higher
primary surpluses over the medium term, as already foreseen in the programme, would contribute to
reducing the medium risks to the long-term sustainability of public finances.

(9)

(10)

(11)

The programme presents a number of measures aimed at strengthening the budgetary framework.
The main elements are the gradual implementation of programme budgeting and of multi-annual
cycles with the preparation of budgetary plans for the entire legislative period associated with annual
expenditure ceilings. Besides these changes to ex ante budget planning, further changes towards a
swifter and more integrated reporting of ex post budgetary execution are also envisaged. Overall, these
efforts recognise the importance of strengthening the budgeting process and address two aspects
where the Portuguese budgetary framework has shown needs of continued improvement, in particular
planning fiscal policy in the broader medium-term setting and controlling expenditure developments
in a more thorough way. In addition, the programme outlines measures to improve the efficiency and
effectiveness of government services and changes to the governance of State-owned enterprises.

The Portuguese authorities have adopted various measures to help stabilise the financial sector. These
include strengthening information disclosure obligations by financial
increased bank
deposit guarantees (from EUR 25 000 to EUR 100 000 per account holder and bank); and, up to a
maximum amount of EUR 20 billion (11,75 % of GDP), both for granting of guarantees to
borrowing by Portuguese banks until end 2009 and for reinforcing the core capital of domestic
banks through government investment (the latter not exceeding EUR 4 billion).

institutions;

The Portuguese government adopted significant discretionary fiscal measures in response to the
economic downturn. The stimulus package for 2009 adopted in December 2008 is in line with the
European Economic Recovery Plan (EERP) agreed in December 2008 by the European Council and
represents an adequate response to the economic downturn. This package yields a temporary support
to economic activity in 2009 and will be discontinued in 2010. It mainly focuses on investment,
support to firms and exports and support to employment and social protection. This budgetary effort
is intertwined with a frontloading of EU funds of almost 0,5 % of GDP, which is neutral for the
budget balance. These measures add to other measures amounting to a total of 0,4 % of GDP that
had already been announced over the course of 2008 to support households and firms. The stimulus
package is timely, targeted and temporary and the measures broadly respond to the main policy
objectives in terms of the short-term challenges posed by the downturn. In addition, the package
includes various structural measures that support the longer-term policy reform agenda, to the extent
that they can help enhancing potential GDP growth, strengthening competitiveness and employment
as well as supporting incomes of disadvantaged groups, for instance by financing upgrades of physical
infrastructure or reducing personnel hiring costs. These measures are related to the medium-term
reform agenda and the country-specific recommendations proposed by the Commission on
28 January 2009 under the Lisbon Strategy for Growth and Jobs. Financial operations are also
outlined in the programme, notably subsidising credit lines for corporations and the speeding up of
commercial debt payments by the general government to the private sector (financed mainly by the
recourse to financial debt).

(12)

The overall fiscal stance in the programme is expansionary in 2009 and restrictive in 2010. More
specifically, the programme targets for 2010 a reversal of the 2009 fiscal expansion, such that the
headline deficit would be brought below the 3 % of GDP reference value in 2010 after exceeding it
in 2009. A structural improvement is envisaged for 2010 and 2011. However, taking into account
the negative balance of risks to the budgetary plans, the reversal in 2010 could require further action
to be effective to the extent planned in the programme. Finally, taking into account the risks to the
debt projections mentioned above,
the whole
programme period.

the debt-to-GDP ratio may be increasing over

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(13) 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 aims at a significant temporary fiscal impulse in 2009 in line
with the EERP, which represents an adequate response to the economic downturn. The programme rightly
plans the resumption of fiscal consolidation as soon as the economy recovers. Yet, in the light of the favour-
able macro-economic assumptions, economic growth may underpin fiscal consolidation by less than envi-
saged in the programme. Progress with fiscal consolidation is also necessary to strengthen the long-term
sustainability of public finances. In addition, further strengthening the budgetary framework can be instru-
mental to achieve the planned fiscal path. Finally, continue to fostering the quality of public finances is
important also to underpin a smooth adjustment of the economy in the light of the imbalances it is faced
with, notably by supporting potential GDP growth, helping improving competitiveness and supporting the
correction of the external deficit.

In view of the above assessment, Portugal is invited to:

(i) implement the 2009 fiscal policy as planned in line with the EERP and within the framework of the
SGP, while avoiding a further deterioration of public finances in 2009 and carry out with determination
the planned adjustment in 2010 and beyond, strengthening the pace of budgetary consolidation if
cyclical conditions are better than projected;

(ii) further strengthen the budgetary framework, as envisaged, and ensure that fiscal consolidation measures
continue to be geared towards enhancing the quality of the public finances in the light of the needed
adjustment of the existing imbalances.

Comparison of key macro-economic and budgetary projections

2007

2008

2009

2010

2011

Real GDP
(% change)

HICP inflation
(%)

SP Jan 2009

COM Jan 2009

SP Dec 2007

SP Jan 2009

COM Jan 2009

SP Dec 2007

Output gap (1)
(% of potential GDP)

SP Jan 2009

COM Jan 2009 (2)

1,9

1,9

1,8

2,4

2,4

2,3

0,2

0,8

0,3

0,2

2,2

2,6

2,7

2,1

– 0,8

0,5

– 1,6

– 0,2

2,8

1,2

1,0

2,1

3,0

2,0

2,0

2,1

1,3

n.a.

3,0

2,0

n.a.

2,1

– 0,4

– 2,1

– 2,5

– 2,5

0,2

– 1,7

– 2,5

n.a.

0,5

SP Dec 2007

– 2,2

– 1,8

– 1,1

– 0,2

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

SP Jan 2009

– 8,7

– 10,5

– 9,2

– 8,4

– 7,6

COM Jan 2009

– 8,7

– 10,2

– 8,2

– 8,7

n.a.

SP Dec 2007

– 7,0

– 5,8

– 5,6

– 4,9

– 4,7

(1) In particular optional data on deflators of public consumption and of investment (Table 1b) and on government consump-

tion (Table 2) are not provided.

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General government
revenue
(% of GDP)

General government
expenditure
(% of GDP)

General government
balance
(% of GDP)

Primary balance
(% of GDP)

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

Structural balance (3) (4)
(% of GDP)

Government gross debt
(% of GDP)

SP Jan 2009

COM Jan 2009

SP Dec 2007

SP Jan 2009

COM Jan 2009

SP Dec 2007

SP Jan 2009

COM Jan 2009

SP Dec 2007

SP Jan 2009

COM Jan 2009

SP Dec 2007

SP Jan 2009

COM Jan 2009

SP Dec 2007

SP Jan 2009

COM Jan 2009

SP Dec 2007

SP Jan 2009

COM Jan 2009

SP Dec 2007

2007

2008

2009

2010

2011

43,2

43,1

42,4

45,7

45,7

45,4

– 2,6

– 2,6

– 3,0

0,2

0,2

– 0,1

– 2,7

– 3,0

– 2,0

– 2,7

– 3,1

– 2,1

63,6

63,6

64,4

43,5

44,2

42,7

45,8

46,3

45,1

– 2,2

– 2,2

– 2,4

0,8

0,8

0,5

– 2,0

– 2,3

– 1,6

– 2,0

– 3,0

– 1,6

65,9

64,6

64,1

44,1

42,6

42,8

48,0

47,2

44,4

– 3,9

– 4,6

– 1,5

– 0,6

– 1,7

1,3

– 3,0

– 3,8

– 1,0

– 3,0

– 3,9

– 1,0

69,7

68,2

62,5

43,6

42,4

43,1

46,5

46,8

43,5

– 2,9

– 4,4

– 0,4

0,4

– 1,3

2,2

– 1,8

– 3,3

– 0,3

– 1,8

– 3,3

– 0,3

70,5

71,7

59,7

43,6

n.a.

43,1

45,9

n.a.

43,3

– 2,3

n.a.

– 0,2

1,1

n.a.

2,5

– 1,2

n.a.

– 0,4

– 1,2

n.a.

– 0,4

70,0

n.a.

56,7

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

information in the programmes.

(2) Based on estimated potential growth of 0,7 %, 0,7 %, 0,4 % and 0,5 % respectively in the period 2007-2010.
(3) Cyclically-adjusted balance excluding one-off and other temporary measures. There are no one-off and other temporary measures in
the programme; according to the Commission services' January 2009 interim forecast they are 0,1 % of GDP in year 2007, 0,7 % in
year 2008 and 0,1 % in year 2009, all deficit-reducing.

(4) Using the recalculated cyclically-adjusted balance, based on the information in the programme, and the definition of one-offs and other
temporary measures applied by the Commission services, the structural balance would be – 2,8 % of GDP in 2007, – 2,7 % of GDP
in 2008, – 3,1 % in 2009 and – 1,8 % of GDP in 2010.

Source:
Stability programme (SP); Commission services' January 2009 interim forecasts (COM); Commission services' calculations.