COMMISSION STAFF WORKING DOCUMENT Analysis by the Commission services of the budgetary situation in Portugal following the adoption of the COUNCIL RECOMMENDATION to Portugal on 21 June 2013 with a view to bringing an end to the situation of an excessive government deficit and the COUNCIL DECISION of 12 July 2016 establishing that no effective action has been taken by Portugal in response to the Council Recommendation of 21 June 2013 Accompanying the document Recommendation for a COUNCIL DECISION giving notice to Portugal to take measures for the deficit reduction judged necessary in order to remedy the situation of excessive deficit
Date: 2016-07-27
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: Portugal, budget deficit, budgetary control, budgetary equilibrium, gross domestic product, macroeconomics, multiannual financial framework, public expenditure, public finance, stability pact

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   EUROPEAN COMMISSION  Brussels, 27.7.2016  SWD(2016) 264 final   COMMISSION STAFF WORKING DOCUMENT Analysis by the Commission services of the budgetary situation in Portugal following the adoption of the COUNCIL RECOMMENDATION to Portugal on 21 June 2013 with a view to bringing an end to the situation of an excessive government deficit and the COUNCIL DECISION of 12 July 2016 establishing that no effective action has been taken by Portugal in response to the Council Recommendation of 21 June 2013 Accompanying the document Recommendation for a  COUNCIL DECISION giving notice to Portugal to take measures for the deficit reduction judged necessary in order to remedy the situation of excessive deficit {COM(2016) 520 final}  
 
 
 
1.  INTRODUCTION  

Portugal  has  been  under  the  excessive  deficit  procedure  since  2  December  2009.  Due  to 
unforeseen  adverse  economic  circumstances,  the  Council  adopted  revised  recommendations 
to correct the excessive deficit in two occassions after 2009; first in 2012 and then in 2013.  

Specifically,  on  21  June  2013,  following  a  recommendation  from  the  Commission,  the 
Council  adopted  a  revised  recommendation  under  Article  126(7)  TFEU  and  set  a  2015 
deadline  to  correct  the  excessive  deficit.  In  order  to  bring  the  general  government  deficit 
below the Treaty reference value of 3% of GDP by 2015 in a credible and sustainable manner, 
Portugal was recommended to undertake the following adjustment path: a headline deficit of 
5.5% of GDP in 2013, 4.0% of GDP in 2014 and 2.5% of GDP in 2015, which was deemed 
consistent with  an  improvement in  the structural balance of 0.6%  of GDP in  2013,  1.4%  in 
2014 and 0.5% in 2015.1 

According to the budgetary data notified by Portugal and validated by Eurostat on 21 April 
2016, the general government deficit reached 4.4% of GDP in 2015. As a result, Portugal did 
not  correct  its  excessive  deficit  by  the  recommended  2015  deadline.  The  headline  deficit 
included the deficit-increasing one-off impact of 1.4% of GDP stemming from the financial 
sector support measure in the context of the Banif resolution at the end of 2015; taking into 
account also the deficit-reducing one-off measures, the headline deficit net of one-offs would 
still have been above the Treaty reference value. In addition, the cumulative fiscal effort over 
2013-2015 is estimated at 1.1% of GDP, significantly below the 2.5% of GDP recommended 
by the Council. 

On  12  July  2016,  following  a  Commission's  recommendation  in  compliance  with  Article 
126(8) TFEU, the Council adopted a decision establishing that no effective action had been 
taken  by  Portugal  in  response  to  the  2013  Council  Recommendation.2 In  compliance  with 
Article 126(9), within two months form the Council decision establishing non effective action 
the  Council  shall  give  notice  to  the  country  on  a  new  deadline  for  the  correction  of  the 
excessive deficit with a specified adjustment path.3 

This  document  proposes  a  new  deadline  for  the  correction  of  the  excessive  deficit  and  an  
adjustment path that could ensure a durable correction  of the excessive deficit.  To this  end, 
Sections 2 and 3 present the recent macro-economic and budgetary developments and outlook 
for 2016, respectively. Section 4 presents a proposal for a new fiscal adjustment path and the 
last section concludes.   

2.  RECENT MACRO-ECONOMIC DEVELOPMENTS AND OUTLOOK FOR 2016 

According  to  the  Commission  2016  spring  forecast,  the  economic  recovery  is  set  to 
continue  moderately  in  2016  and  real  GDP  is  projected  to  grow  by  1.5%  y-o-y  at  the 

1 See SWD(2016) 240 final for additional information on Portugal's EDP.  
2 See ECOFIN 678 UEM 264  
3   In addition to the requirements of EDP recommendations under Article 126(7), the Council decision to give 
notice under Article 126(9) shall not only set the new budgetary targets but also "indicate measures conducive to 
the achievement of those targets" according to Article (5)1 of Council Regulation No 1467/1997. 

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same  pace  as  in  2015.  Private  consumption  is  expected  to  lose  momentum  due  to  higher 
indirect  taxes  and  the  slight  recovery  in  energy  price  inflation.  The  strong  rebound  in  the 
consumption of durable goods in the first half of 2015 is not forecast to be maintained as still 
high unemployment and high debt levels are projected to keep upward pressures on household 
savings. Most of the soft investment indicators point to a weaker investment performance in 
2016  as  well.  Business  investment  already  decelerated  significantly  over  the  second  half  of 
2015 and is not expected to resume its previous growth rate soon despite the relatively high 
capacity utilisation rate. Exports are forecast to grow in line with foreign demand, but imports 
are still expected to outbalance exports over the forecast horizon. As a result, the contribution 
of  net  trade  to  GDP  growth  would  remain  slightly  negative.  Employment  creation  is  set  to 
slow  down  in  2016,  thereby  becoming  more  aligned  with  GDP  growth.  Therefore,  the 
unemployment rate is estimated to decrease to 11.6%. HICP inflation is projected to increase 
only marginally to 0.7% in 2016, mainly driven by higher taxes. HICP inflation is expected to 
increase to 0.7% in 2016, mainly driven by higher indirect taxes. While downward risks to the 
outlook have increased since the publication of the spring forecast, data on the first quarter of 
2016  and  preliminary  information  on  the  second  quarter  overall  confirm  the  outlook  of  the 
forecast for the rest of the year.  

The  macroeconomic  scenario  underlying  the  2016  Budget  is  more  optimistic  than  the 
Commission  2016  spring  forecast.  The  Commission  expects  a  slower  economic  recovery 
than  the  Portuguese  authorities  (1.5%  vs.  1.8%  real  GDP  growth),  mostly  on  account  of  a 
lower  expected    contribution  of  domestic  demand  to  GDP  growth  (1.5  pps.  in  the  spring 
forecast against 2.4 pps. in the 2016 Budget). The Commission is less optimistic with respect 
to investment and private consumption which are set to grow by 1.6% and 1.8% respectively 
in 2016, as opposed to 3.9% and 2.4% in the 2016 Budget. The projections also differ on the 
nominal side of the economy, as the Commission estimates a significantly lower increase of 
the  GDP  deflator  in  2016  (1.4%  compared  to  2.1%  in  the  2016  Budget).  Nonetheless,  the 
expectations with  regard to  labour market developments  in  2016 are broadly  in  line in  both 
projections.  

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Table 1 – Recent macroeconomic developments and outlook 

Real GDP in Q1-2016 is in line with the Commission forecast but its composition points 
to  a  higher  than  expected  contribution  from  private  consumption.  Real  GDP  grew  by 
0.9%  y-o-y  and  0.2%  q-o-q  in  Q1-2016,  in  line  with  the  Commission  2016  spring  forecast 
quarterly profile. Nonetheless, private consumption grew above expectations and investment 
came in more negative than projected in the Commission 2016 spring forecast. Net external 
demand  also  posted  a  bigger  negative  contribution  reflecting  feebler  exports  outlook  (-1.1 
pops.  vs  -0.4  pops).  As  the  higher  growth  in  private  consumption  is  not  expected  to  be 
maintained and as long as there is no sign of pick-up in investment and exports, there is a risk 
of  downward  revision  of  the  headline  GDP  in  2016  and  some  negative  carry  over  effect  in 
2017. As regards the nominal side, GDP deflator grew by 2.4% in Q1-2016, reflecting some 
upside risks to the Commission 2016 spring forecast as well.  

Risks to the macro outlook are tilted to the downside, also on account of new uncertainty 
emerging  from  the  outcome  of  the  referendum  in  the  United  Kingdom  on  the 
membership  of  the  European  Union.    Were  the  risks  associated  with  the  outcome  of  the 
referendum in the United Kingdom on the membership of the European Unionto materialize, 
the  envisaged  slight  recovery  for  exports  and  investments  would  be  very  unlikely.  Trade 
flows with the U.K. and other EU countries would decline, while  uncertainty in the business 
environment  would  have  an  adverse  impact  on  investment  and  weigh  negatively  on  a  still 
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2015COMCOMSPReal GDP (% change)1,51,51,8Private consumption (% change)2,61,82,4Gross fixed capital formation (% change)3,91,64,9Exports of goods and services (% change)5,24,14,3Imports of goods and services (% change)7,44,35,5Contributions to real GDP growth:- Final domestic demand2,51,52,4- Change in inventories-0,10,00,0- Net exports-0,9-0,1-0,6Output gap1-2,3-1,1-1,3Employment (% change)1,40,90,8Unemployment rate (%)12,611,611,4Labour productivity (% change)0,10,61,0HICP inflation (%)0,50,71,2GDP deflator (% change)1,91,42,1Comp. of employees (per head, % change)-0,61,62,4Net lending/borrowing vis-à-vis the rest of the world (% of GDP)1,11,51,6Note:1In % of potential GDP, with potential GDP growth recalculated by Source:Commission 2016 spring forecast (COM);Stability Programme (SP).2016 
 
 
 
 
recovering financial sector. This could result in a downward revision of the headline GDP in 
2016 and negative carry over effect in 2017. 

3.  RECENT BUDGETARY DEVELOPMENTS AND OUTLOOK FOR 2016 

The  Commission  2016  spring  forecast  is  less  optimistic  than  the  authorities'  budget. 
Taking into account an assessment of the fiscal policy measures specified in the 2016 Budget 
that entered into force on 31 March, the Commission 2016 spring forecast projects the general 
government  deficit  to  fall  to  2.7%  of  GDP  in  2016.  The  structural  balance  is  expected  to 
slightly  deteriorate  further  by  about  0.25%  of  GDP  in  2016.  The  2016  Budget  targets  a 
general government deficit of 2.2% of GDP and an improvement of the structural balance by 
0.3% of GDP. The 2016 Budget intends to more than offset revenue-decreasing measures of 
around 0.3% of GDP (notably the partial reversal of the PIT surcharge and the reduction of 
the VAT rate for restaurants) through revenue-increasing measures of around 0.5% of GDP, 
of which about two thirds relate to increases in indirect taxes (on petroleum products, tobacco, 
vehicles and the stamp duty), complemented by a series of smaller measures concerning direct 
taxes  and  enhanced  compliance  in  both  tax  collection  and  Social  Security.  Expenditure-
increasing  measures  amounting  to  0.4%  of  GDP  (mostly  the  gradual  reversal  of  the  public 
sector  wage  cuts,  increases  in  a  series  of  social  benefits  and  the  unfreezing  of  pension 
indexation) are planned to be more than compensated by expenditure-decreasing measures of 
close  to  0.5%  of  GDP  (most  of  which  relate  to  the  nominal  freeze  of  intermediate 
consumption  -  except  for  PPPs-,  efficiency  gains  in  other  current  expenditure,  expenditure 
control in social transfers and a new civil servants rotation policy (2:1 replacement rule)). The 
tax  revenue  included  in  the  2016  Budget  is  however  also  affected  by  negative  carry-over 
effects  of  tax  measures  of  previous  years  amounting  to  around  0.25%  of  GDP.  The 
Commission 2016 spring forecast incorporates more conservative yield estimates for some of 
the  2016  Budget  measures,  in  particular  as  regards  the  nominal  freeze  of  intermediate 
consumption  and  other  current  expenditure.  The  Commission  forecast's  less  optimistic 
macroeconomic  scenario  also  leads  to  lower  projected  revenue  from  taxes  and  social 
contributions, as well as higher social transfers. The Portuguese Public Finance Council in its 
analysis of the State Budget also sees important risks to the macroeocnomic scenario which 
would have implications on tax revenue, and deems the savings from the measures indicated 
not sufficiently specified. 

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Table 2 – Composition of budgetary adjustment  

Budgetary execution until May 2016 has been broadly on track, but risks for the rest of 
the full-year execution remain high. The general government balance in National Accounts 
for the first quarter improved to 3.2% of GDP as compared to 5.5% of GDP in the first quarter 
of 2015, the best first-quarter balance since 2008. Although the first quarter deficit typically 
tends to be higher than in the full year, the 3.2% of GDP is still one percentage point above 
the  full  year  budget  target  of  2.2%.  Looking  at  budgetary  execution  until  May,  using  cash 
data, there is indeed an improvement of the overall general government balance compared to 
May  last  year,  due  to  an  overall  increase  of  revenue  and  a  containment  of  expenditure. 
However,  the  increase  in  revenue  is  not  as  strong  as  the  one  implied  by  the  budget  for  the 
whole year, and the containment in spending is largely due to a reduction in investment and 
purchases  of  goods  and  services  that  appear  to  have  been  restrained  by  the  late  entry  into 
force of the 2016 budget on 31 March.  The corresponding underspending was broadly offset 
by  increases  of  interest  payments  and  compensation  of  employees  above  the  budget  targets 
pointing  to  several  challenges  for  the  full-year  achievement  of  the  budget  target.  These  are 
aggravated by the series of budgetary measures that are backloaded towards the second half of 
the year (quarterly reversal of public sector wage cuts, 35hour week from 1 July,  VAT rate 
reduction on meals in restaurants).  

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20152016OutturnForecastRevenue43,944,0of which:- Taxes on production and imports14,515,0- Current taxes on income, wealth, etc.10,810,3- Social contributions11,511,5- Other (residual)6,97,2Expenditure48,346,6of which:- Primary expenditure43,742,2of which:Compensation of employees11,311,2Intermediate consumption5,96,3Social payments19,218,9Subsidies0,70,8Gross fixed capital formation2,21,9Other (residual)4,43,1- Interest expenditure4,64,5General government balance (GGB)-4,4-2,7Primary balance0,21,8Output gap (*)-2,3-1,2Structural balance (SB)-2,0-2,2(% of GDP)(*) % of potential GDPSource: Commission 2016 spring forecast  
 
 
 
 
Progresses in  fiscal  structural reforms  have been  mixed. The short-term sustainability of 
the pension system is not yet ensured and is further challenged by the government's reversal 
of expenditure-saving measures. Arrears in the health sector are still very high which calls for 
a more effective enforcement of the Commitment Control Law, while the implementation of 
the  new  Budgetary  Framework  Law  (BFL)  to  be  completed  by  2018  is  experiencing 
important  delays.  Revenue  administration  is  proceeding  with  its  reforms  and  a  series  of  tax 
policy  shifts'  foreseen  in  the  plans  of  the  new  government  are  under  study.  Recent 
backtracking  in  reforming  state-owned  enterprises  (SOEs)  and  partial  reversal  of  a 
privatisation may entail fiscal risks. As structural consolidation in Portugal requires a durable 
reduction  of  the  high  level  of  public  expenditure,  a  comprehensive  spending  review  with  a 
clear political mandate and a set target for savings would be crucial.   

4.  PROPOSED NEW FISCAL ADJUSTMENT PATH 

Table  3  summarises  the  main  elements  from  the  Commission  2016  spring  forecast  that 
underpin the new adjustment path.  

Table 3 –  Forecast of key macroeconomic and budgetary variables under the baseline scenario 

Taking  into  account  the  available  time  span  and  heightened  risks  to  the  macro  and 
budgetary  outlooks, additional measures of 0.25% of GDP could be considered in order 
to ensure that the public deficit remains under the 3% reference value. Under heigthened 
risks  to  the  outlook  and  a  still    fragile  financial  system,  an  adjustment  higher  than  the  one 
envisaged in the authorities' budget would be warranted to ensure a durable correction of the 
excessive deficit for 2016. Taking into account the time span available for the correction and 
considering the possible secound round effects of a fiscal adjustment in the current economic 
context, the Commission is of the view that an adjustment that entails an unchanged structural 
balance  with  respect  to  2015  would  realistically  bring  the  deficit  durably  below  3%. 
Compared to the baseline of the spring forecast, the proposed adjustment path would imply a 
reduction of the headline deficit to 2.5% of GDP. This adjustment path would be consistent 
with 0.25% of GDP additional measures to those implied in the baseline scenario.  Taking into 
account  the  second-round  effects  on  economic  growth  of  the  additional  consolidation 
measures needed, GDP growth would reach about 1.3%. Besides the measures included in the 
2016 Budget, Portugal shall consider the expenditure control mechanism in the procurement 
of  goods  and  services,  which  is  currently  highlighted  in  the  2016  Stability  Programme.  In 
addition, Portugal should focus on revenue side measures aiming at increasing the yields of 

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20152016Real GDP growth %1,5%1,5%Output gap %-2,3%-1,1%General government balance%GDP-4,4%-2,7%Structural balance %GDP-2,0%-2,2%Change in structural balancepps-0,6%-0,2%Source: Commission 2016 spring forecast  
 
 
 
 
 
indirect  taxation  by  broadening  the  tax  base  and  reducing  tax  expenditures.  One  way  to 
achieve this could be by adjusting the still broad use of reduced VAT rates. 

Table 4 – Forecast of key macroeconomic and budgetary variables under the EDP scenario 

5.  CONCLUSIONS 

On  12  July  2016,  in  compliance  with  Article  126(8)  TFEU  and  following  a  Commission 
reccomendation, the Council issued a decision establishing that no effective action had been 
taken by Portugal in response to the 2013 Council recommendation. Hence, as prescribed by 
Article  126(9),  the  Council  upon  Commission  reccomendation,  shall  give  notice  to  the 
country to correct its excessive deficit, indicating the adjustment path. 

Within this context, and taking into account the country's current macroeconomic conditions, 
achieving  an  unchanged  structural  adjustment  which  entails  0.25%  of  GDP  of  additional 
measures appears justified. This would lead to a headline deficit of 2.5% in 2016.  

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20152016Amount of measures% GDP0,2%Real GDP growth %1,5%1,3%Output gap %-2,3%-1,3%General government balance%GDP-4,4%-2,5%Structural balance %GDP-2,0%-2,0%Change in structural balancepps-0,6%0,0%Source: Commission 2016 spring forecast  
 
 
 
 
 
 
 
ANNEX – STANDARD TABLES 

Table 5 – Forecast of key variables for the computation of the fiscal effort under the baseline 
scenario 

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2016Structural expenditure (% of potential GDP)45.7Potential GDP growth (%)0.3Current revenue (national currency)79,355.8Discretionary measures wih impact on current  revenue (national currency)-257.0Nominal GDP growth (%)2.8p.m Elasticity on current revenue 1.0p.m Output gap (% of Pot. Output)-1.1Discretionary measures wih impact on total  revenue net of one-offs and other temporary measures (national currency)-252.0Total expenditure net of one-offs and other temporary measures  (national currency)86,033.0Interest expenditure (national currency)8,221.4Total unemployment594,900.0Unemployment benefits (national currency)2,684.5Source: Commission calculations based on spring 2016 forecastEnters top-downαβEnters bottom-up