Recommendation for a COUNCIL RECOMMENDATION with a view to bringing an end to the situation of an excessive government deficit in Portugal
Date: 2012-09-27
Institutions: European Commission
Subjects: Portugal, administrative reform, budget deficit, economic reform, financial intervention, financial planning, public debt, stability programme, tax reform

EUROPEAN 
COMMISSION 

Brussels, 27.9.2012  
COM(2012) 566 final 

Recommendation for a 

COUNCIL RECOMMENDATION 

with a view to bringing an end to the situation of an excessive government deficit in 
Portugal 

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Recommendation for a 

COUNCIL RECOMMENDATION 

with a view to bringing an end to the situation of an excessive government deficit in 
Portugal 

THE COUNCIL OF THE EUROPEAN UNION, 

Having  regard  to  the  Treaty  on  the  Functioning  of  the  European  Union  (TFEU),  and  in 
particular Article 126(7) thereof, 

Having regard to the recommendation from the European Commission, 

Whereas: 

(1) 

(2) 

(3) 

(4) 

(5) 

According  to  Article  126  of  the  TFEU  Member  States  are  to  avoid  excessive 
government deficits. 

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

On 2 December 2009, the Council decided, in accordance with Article 126(6) of the 
TFEU,  that  an  excessive  deficit  exists  in  Portugal  and  issued  a  recommendation  to 
correct  the  excessive  deficit  by  2013  at  the  latest,  in  accordance  with  Article  126(7) 
TFEU  and  Article  3  of  Council  Regulation  (EC)  No  1467/97  of  7  July  1997  on 
speeding  up  and  clarifying  the  implementation  of  the  excessive  deficit  procedure.  In 
order to bring the headline government deficit below the 3% of GDP reference value 
by 2013, an average annual fiscal effort of 1¼ % of GDP over the period 2010-2013 
was recommended. In calculating the average annual fiscal effort, the 2011 deficit in 
the Commission services’ 2009 Autumn Forecast was taken as the starting point. The 
total fiscal effort needed to reach the nominal below 3% deficit target by the deadline 
was then calculated by assuming a gradual closure of the output gap by 2015. 

On 15 June 2010, the Commission concluded that Portugal had taken effective action 
in  compliance  with  the  Council  recommendation  of  2  December  2009  to  bring  its 
government  deficit  below  the  3%  of  GDP  reference  value  and  considered  that  no 
additional step in the excessive deficit procedure was therefore necessary.  

According to Article 3(5) of Regulation (EC) No 1467/97, the Council may decide, on 
a  recommendation  from  the  Commission,  to  adopt  a  revised  recommendation  under 
Article  126(7)  TFEU,  if  effective  action  has  been  taken  and  unexpected  adverse 

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(6) 

(7) 

(8) 

economic  events  with  major  unfavourable  consequences  for  government  finances 
occur  after  the  adoption  of  that  recommendation.  The  occurrence  of  unexpected 
adverse economic events with major unfavourable budgetary effects is to be assessed 
against the economic forecast underlying the Council recommendation. 

In  accordance  with  Article  126(7)  of  the  TFEU  and  Article  3  of  Council  Regulation 
(EC)  No  1467/97,  the  Council  is  required  to  make  recommendations  to  the  Member 
State  concerned  with  a  view  to  bringing  the  situation  of  excessive  deficit  to  an  end 
within a given period. The recommendation has to establish a deadline of at most six 
months for effective action to be taken by the Member State concerned to correct the 
excessive deficit. Furthermore, in a recommendation to correct an excessive deficit the 
Council  should  request  the  achievement  of  annual  budgetary  targets  which,  on  the 
basis of the forecast underpinning the recommendation, are consistent with a minimum 
annual improvement in the structural  balance, i.e.  the  cyclically-adjusted balance net 
of one-off and temporary measures, of at least 0.5% of GDP as a benchmark.  

After  recording  a  significant  contraction  in  2009,  when  real  GDP  fell  by  2.9%,  the 
Portuguese  economy  rebounded  in  2010  to  positive  growth  of  1.4%,  largely  due  to 
exceptional  factors  that  boosted  exports  and  private  consumption.  The  economy  fell 
back into recession in 2011 when real GDP fell by 1.7%, but this decline was smaller 
than  initially  expected  as  strong  net  exports  partly  compensated  for  the  substantial 
decline  in  private  consumption  and  investment.  At  the  same  time,  the  labour  market 
situation  continued  to  worsen.  In  2012,  according  to  the  most  recent  update  by 
Commission services of the economic outlook for Portugal, which takes into account 
the  fiscal  measures  presented  by  the  authorities  during  the  fifth  review  of  the 
Economic  Adjustment  Programme  in  early  September,  real  GDP  is  expected  to 
contract  by  3.0%  in  2012  reflecting  a  further  deterioration  of  domestic  demand, 
particularly  investment  activity.  At  the  same  time  exports  are  holding  up  well  and, 
despite  their  deceleration  from  last  year  on  the  back  of  a  worsening  of  external 
demand,  are  set  to  record  further  market  share  gains.  Growth  will  continue  to  be 
sluggish  in  2013,  reflecting  weaker  import  growth  in  euro  area  trading  partners  and 
additional  budget  consolidation  measures,  but  is  expected  to  move  into  moderate 
positive territory around mid-year due to a recovery in exports and investment activity. 
For  the  year  as  a  whole,  GDP  growth  is  projected  to  decline  by  about  1%. 
Unemployment is expected to peak at somewhat above 16% in 2013. 

The general government deficit reached -9.8% of GDP in 2010, slightly down from -
10.2%  of  GDP  in  2009.  The  poor  performance  was  mostly  due  to  the  statistical 
reclassification of some state-owned enterprises and Public-Private Partnerships within 
the general government as well as the costs related to the rescue of two troubled banks. 
These effects were only partly compensated by the one-off effect of the transfer of a 
pension  fund  to  the  government  and  somewhat  better  revenues  than  in  the  previous 
year.  In  2011,  the  deficit  outturn  was  4.2%  of  GDP  compared  with  a  5.9%  of  GDP 
target.  The  better  nominal  performance  is  explained  by  a  transfer  of  banks'  pension 
funds to the social security system which was used to close a fiscal gap amounting to 
to  correct  budgetary 
1½%  of  GDP.  The  government 
underperformance  during  the  first  half  of  the  year  by  adopting  additional  revenue 
measures  such  as  a  one-time  tax  surcharge  on  personal  income  and  raising  the  VAT 
rate  on  electricity  and  natural  gas  from  the  reduced  to  the  standard  rate  while 
tightening  expenditures.  Hence,  the  fiscal  gap  is  explained  mainly  by  non-recurrent 
deficit-increasing  factors,  namely  non-tax  revenue  underperformance  at  the  level  of 

reacted  promptly 

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(9) 

(10) 

concessions and real state, the recording of the debts of an SOE and a PPP both in the 
remit of the Madeira regional government and the reclassification of a PPP within the 
general government after the introduction of tolls.  

According  to  the  most  recent  update  by  the  Commission  services  of  the  economic 
outlook in Portugal, the general government deficit in 2012 is projected at 5.3% based 
on unchanged policies, which compares with an expected deficit of 4.5% of  GDP in 
the  2012  Budget  Law  and  the  2012  Stability  Programme.  The  2012  budget,  as 
amended by its March supplement, includes consolidation measures estimated at 5½% 
of GDP. Expenditure reducing measures include wage and pension cuts together with 
lower public sector employment and a reduction in health, education and SOEs capital 
and  current  expenditures.  Revenue-raising  measures  are  based  on  higher  indirect 
taxation  by  shifting  certain  goods  and  services  from  the  reduced  and intermediate to 
higher VAT rates. Changes in direct taxation mostly aimed at broadening the tax base 
by  reducing  deductions  and  exemptions  applicable  to  personal  and  corporate  income 
taxation.  

In 2012, the projected deviation from the budget plan is about 2¼% of GDP, mainly 
linked to a faster-than-expected rebalancing of the economy towards less tax-intensive 
exports and higher-than-projected unemployment weighing on social security budgets. 
Revenue  shortfalls  are  broad-based  and  relate  to  lower-than-expected  direct  and 
indirect taxes but also social security contributions. The change in tax bases has led to 
an  overall  shortfall  of  about  2%  of  GDP  compared  to  the  revenues  projected  in  the 
2012  budget,  while  ¼%  of  GDP  is  due  to  one-off  operations.  Overall  expenditure  is 
developing  according  to  plans,  with  higher  expenditure  on  unemployment  benefits 
balanced by savings in other areas, particularly compensations for employees. Savings 
amounting to 1.5% of GDP – lower net interest payments and the reprogramming of 
EU structural funds - and, possibly, one-off revenues from an airport concession will 
help to partly offset the revenue shortfalls. As some of the deficit-reducing factors in 
2012 are one-off, the 2012 gap translates into a carry-over of about 1½% of GDP in 
2013 caused by the shrinkage in tax revenue bases and labour market developments.  

(11)  According  to  the  most  recent  update  by  the  Commission  services  of  the  economic 
outlook in Portugal, on the basis of unchanged policies, the government deficit in 2013 
is projected at 4¾ % of GDP which compares with an original target of 3%. Within the 
framework  of  the  Economic  Adjustment  Programme  for  Portugal,  the  unchanged 
policies scenario takes into account the measures agreed in the Council Implementing 
Decision 2011/344/EU on granting Union financial assistance to Portugal of 17 May 
2011  and  the  Fourth  update  to  the  Memorandum  of  Understanding  on  Specific 
Economic Conditionality between the European Commission, acting on behalf of the 
European  Union,  and  the  Republic  of  Portugal.  The  Fourth  Review  Update  of  the 
Memorandum  of  Understanding  on  Specific  Economic  Conditionality  considered 
fiscal  consolidation  measures  worth  about  2%  of  GDP  in  2013  including  a  sizeable 
decrease  in  expenditures  through  lower  compensation  per  employees  and  cuts  in  the 
areas  of  education  and  health  coupled  with  gains  from  restructuring  the  central 
administration and SOEs. On the revenue side, measures aimed at broadening the tax 
base  by  reducing  tax  benefits  and  tax  deductions  in  corporate  and  personal  income 
taxes  and  by  increasing  excises  duties.  Along  the  same  lines  of  action,  the  2012 
Stability  Programme  considers  fiscal  consolidation  measures  worth  about  1.4%  of 
GDP. 

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(12)  The  latest  update  by  the  Commission  services  of  the  economic  outlook  in  Portugal 
shows  that  the  structural  deficit  was  -8.7%,  -8.5%  and  -6.3%  of  GDP  in  2009,  2010 
and 2011 respectively. It is expected to reach -4.2% of GDP in 2012. This implies an 
average  apparent  fiscal  effort,  measured  as  the  difference  between  the  structural 
deficits,  of  1.5%  of  GDP  between  2010  and  2012,  which  is  above  the  minimum 
required average annual fiscal effort of 1¼% of GDP specified by the Council in 2010-
2013.  Correcting  for  the  change  in  the  macroeconomic  scenario  between  the 
projections  underlying  the  Council  recommendations  of  2  December  2009  and  the 
current  forecast,  the  estimated  average  annual  fiscal  effort  between  2010  and  2012 
would  be  about  0.8  pp.  of  GDP  higher.  Portugal  has  thus  taken  effective  action  as 
regards the path for the structural deficit up to 2012.  

(13)  According to the Commission services’ 2009 Autumn Forecast, which was underlying 
the  Council  recommendation  under  Article  126(7)  TFEU  of  2  December  2009,  the 
Portuguese economy was expected to grow by 0.3% in 2010 and by 1.0% in 2011. The 
years 2012 and 2013 were beyond that forecast's horizon period, but implicitly higher 
growth  than  in  2011  was  expected  for  2012  and  2013  given  the  assumption  of  a 
gradual closure of the large negative output gap by 2015. The outcome of real GDP for 
2010  and  2011  was  very  much  at  odds  with  the  projected  path  in  the  2009  Autumn 
Forecast,  with  largely  due  to  exceptional  factors  higher  non  sustainable  growth  in 
2010  and  much  lower  growth  in  2011.  In  addition,  the  composition  of  economic 
growth  was  much  less  based  on  domestic  demand.  The  accumulated  contribution  of 
domestic demand for 2010 and 2011 was -5 percentage points of GDP, compared with 
a forecast of 0.6 percentage points. At the same time, the labour market deteriorated to 
a  larger  extent  and  more  rapidly  than  foreseen  in  the  Commission  Services'  Autumn 
2009  forecast.  The  latest  update  of  the  Commission  services'  forecast  of  the 
Portuguese  economy  expects  significant  negative  growth  rates  for  2012  and  2013. 
Furthermore,  the  growth  composition  is  likely  to  continue  to  be  tilted  towards  net 
exports. These growth projections show that the Portuguese economy has been hit by 
unexpected events. 

(14)  Gross public debt rose from 93.3% in 2010 to 107.8% of GDP in 2011 and, according 
to the latest update by the Commission services of the economic outlook in Portugal, 
is expected to rise to 119.1% of GDP in 2012 and to reach 123.7% of GDP in 2013, 
thus exceeding the Treaty reference value in all years. This increase in the debt ratio is 
mainly  driven  by  higher  interest  payments  including  payments  linked  to  the 
programme loans and, to a lesser extent, by the dynamics of the primary deficit. The 
stock-flow adjustment is sizeable in 2012, contributing 3.3 percentage points of GDP 
to the increase, and is linked to the plan to settle invoices of providers of public bodies 
and other outstanding operations.  

(15)  The budgetary position has deteriorated substantially compared with the assumptions 
in  the  initial  Council  recommendation,  due  to  a  worse-than-expected  economic 
outlook, which is also less tax-rich. Moreover, the sizeable contraction of the economy 
is  affecting  employment  and  unemployment  in  a  very  negative  way.  This  is  having 
negative  effects  on  both  the  revenue  and  expenditure  side,  with  a  shortfall  of  social 
contributions  and  higher  social  transfers.  Considering  all  these  factors,  and  given  in 
particular  the  marked  deterioration  in  the  fiscal  outlook  since  the  original  Council 
recommendation  under  Article  126(7)  TFEU  and  the  fact  that  Portugal  has  taken 
effective  action,  an  additional  year  for  the  correction  of  the  excessive  deficit  would 
therefore be warranted.  

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(16)  Granting  an  additional  year  for  the  correction  of  the  excessive  deficit  requires  the 
attainment of intermediate headline deficit targets of 5.0% of GDP for 2012, 4.5% of 
GDP  for  2013  and  2.5%  of  GDP  for  2014  as  defined  in  the  fifth  update  to  Council 
Implementing  Decision  2011/344/EU.  .  On  the  basis  of  the  Commission  services' 
update of the economic outlook in Portugal, the underlying required improvement in 
the  structural  fiscal  balance  resulting  from  these  headline  targets  is  2.3%  of  GDP  in 
2012,  1.6%  of  GDP  in  2013  and  1.3%  of  GDP  in  2014.  The  Portuguese  authorities 
will adopt additional measures to achieve the deficit targets in 2012, 2013 and 2014 in 
view  of  the  needs  identified  in  the  Fifth  Review  of  the  Economic  Adjustment 
Programme.  In  addition,  the  authorities  will  develop  contingency  measures  for  the 
following years in case of slippages, given possible implementation risks.  

(17)  Despite  some  relief  over  the  past  few  months,  market  pressure  on  Portuguese 
sovereign  debt  remains  high  and  there  is  a  need  to  underpin  the  credibility  of  the 
consolidation effort. This would require specifying in detail all the structural measures 
that are necessary to achieve the budgetary targets in 2013 and 2014, and accelerating 
the  reduction  of  the  deficit  if  economic  or  budgetary  conditions  turn  out  better  than 
currently expected. The importance of taking timely action to avoid the risk of future 
slippages warrants the deadline of three months to take effective action. 

(18)  On  6  July  the  Council  adopted  country-specific  recommendations  for  Portugal  to 
implement the measures as laid down in Council Implementing Decision 2011/344/EU 
and  further  specified  in  the  Memorandum  of  Understanding  of  17  May  2011  and  its 
subsequent  supplements.  Overall,  these  measures  aim  at  adopting  a  credible  and 
balanced  fiscal  consolidation  strategy  supported  by  structural  fiscal  measures  and 
better fiscal control over SOEs and PPPs, deep and frontloaded structural reforms in 
the products and services markets and efforts to safeguard the financial sector through 
recapitalisation supported by back-up facilities.  

(19) 

In parallel to the regular reviews of the Economic Adjustment Programme for Portugal 
as defined in Council Implementing Decision 2011/344/EU, monitoring of progress on 
implementation  of  its  EDP  commitments  will  be  carried  out  at  an  interval  of  three 
months. 

(20)  Portugal  fulfils  the  conditions  for  the  extension  of  the  deadline  for  correcting  the 
excessive general government deficit as laid out in Article 3(5) of Regulation (EC) No 
1467/97  on  speeding  up  and  clarifying  the  implementation  of  the  excessive  deficit 
procedure, 

HEREBY RECOMMENDS: 

(1) 

(2) 

That the Portuguese authorities put an end to the present situation of excessive deficit 
by 2014. 

That  the  Portuguese  authorities  deliver  an  improvement  of  the  structural  balance 
of 2.3% of GDP in 2012, 1.6% of GDP in 2013 and 1.3% of GDP in 2014, in order 
to  bring  the  headline  government  deficit  below  the  3%  of  GDP  reference  value  by 
2014,  based  on  the  Commission  services'  update  of  the  economic  outlook  in 
Portugal. The headline deficit targets should be 5.0% of GDP for 2012, 4½% of GDP 
for 2013 and 2.5% of GDP in 2014. 

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(3) 

(4) 

(5) 

(6) 

That the Portuguese authorities implement the measures adopted in the 2012 budget 
and its March supplement and that they take additional measures worth 0.3% of GDP 
to  confine  the  deficit  to  5.0%  of  GDP.  These  include  freezing  some  of  the  2012 
budget appropriations for investment projects not yet initiated, rising stamp duties on 
high value properties and tax rates on investment income, frontloading some of the 
2013  budget  measures  to  reduce  social  benefits  and  applying  other  measures 
generating savings in intermediate consumption and revenues from sales.  

That the Portuguese authorities adopt permanent consolidation measures of 3.0% of 
GDP  to  reach  the  4.5%  of  GDP  target  in  2013.  Unless  otherwise  specified  the 
measures  to  be  adopted  with  the  2013  budget  law  include:  i)  a  reduction  in 
compensation per employees generated through a substantial reduction in the number 
of  public  employees,  in  overtime  payments  and  in  non-wage  compensation;  ii) 
improved  means  testing  and  scale  down  some  social  programmes  and  benefits;  iii) 
deepen  health  care  and  SOEs  reform.  On  the  revenue  side,  the  projected  measures 
include:  i)  a  reform  of  the  personal  income  tax  simplifying  the  tax  structure, 
eliminating some tax expenditures, increasing the average tax rate while improving 
progressivity,  ii)  broadening  the  corporate  income  tax  base  by  eliminating  interest 
deductibility  and  iii)  rising  property  taxes.  The  Portuguese  authorities  will  use 
contingency measures in 2013 if slippages occur.  

That the Portuguese authorities adopt permanent consolidation measures of 1¾% of 
GDP to achieve the 2014 deficit target. A comprehensive expenditure review to fully 
specify measures amounting to about EUR 4 billion over 2014-2015 will be carried 
out for the Sixth review of the Economic Adjustment Programme and measures will 
be  fully  specified  by  mid-February  2013.  The  fiscal  consolidation  plans  for  2014-
2015 will be fully detailed in the 2013 Stability Programme.  

The  Portuguese  government  is  to  take  effective  action  to  implement  this 
recommendation within three months from adoption of this recommendation and, in 
accordance with Article 3(4a) of Council Regulation (EC) No 1467/97, to report in 
detail the consolidation strategy that is envisaged to achieve the targets.  

Furthermore, the Council invites the Portuguese authorities: 

- In addition to the report foreseen in recommendation (6) and in parallel to the requirements 
defined  in  the  Council  Implementing  Decision  2011/344/EU  on  granting  Union  financial 
assistance to Portugal of 17 May 2011, to report on progress made in the implementation of 
this  recommendation  every  three  months  as  well  as  in  a  separate  chapter  in  the  stability 
programmes which will be prepared until 2015. 

-  To  maintain  reform  momentum  in  public  financial  management  by  reforming  the  Budget 
Framework  Law  to  comply  with  the  new  European  Union  fiscal  governance  rules  and  to 
continue  improving  transparency  and  control  at  all  budgetary  stages  as  well  as  ensuring 
adherence  to  its  medium-term  budgetary  framework  and  targets  for  all  levels  of  general 
government. This recommendation is addressed to the Republic of Portugal. 

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Done at Brussels, 

For the Council 
The President 

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