Portugal’s Post-Pandemic Recovery Significantly Stronger Than European Average

Written by Helen Richards

GRI Club members gathered for the Economic Series Club Meeting in Lisbon last month to gain invaluable insights from the International Monetary Fund’s Mission Chief for Portugal & Sweden, Assistant Director, European Department, Rupa Duttagupta.

The International Monetary Fund (IMF) has a surveillance relationship with Portugal, meaning both parties are obliged to hold regular dialogue about the economic situation of the country, including discussions regarding risks around growth and inflation, the regular economic indicators, and policies to improve prospects and balance growth.

This annual discussion is known as an Article IV consultation, and most recently took place in Portugal in May. A synopsis of the resultant report, released in June, was presented by Rupa during the GRI Club Meeting in Lisbon.

Portuguese Economy

Similar to other European economies, Portugal has been hit by multiple “shocks” Rupa explained. Firstly, the COVID-pandemic; secondly, the energy price crisis, amplified by Russia's invasion of Ukraine; and now, elevated interest rates due to the European Central Bank’s (ECB) monetary tightening.

Despite this, Portugal’s recovery from the pandemic has been strong, with growth averaging significantly higher than its average, and one of the highest in the euro area.

However, when put in historical context, the economy lags behind on converging to the higher income levels seen in Europe, still being around two-thirds away from the euro area level. Many other emerging markets in Europe, including Poland, Czech Republic, and even Romania, are catching up. This means that growth will continue to be the number one priority going forward. 

The industry is all too familiar with elevated inflation, which seemingly peaked in October of last year, and in Portugal is now down to approximately 5.4%. Despite this fall in inflation rates however, the IMF does not predict them to reach the ECB’s target of 2% until 2025.

Rupa divulged that although a large part of this inflation is imported due to external energy and food prices, inflation has recently moved into services within Portugal, posing a problem - especially for lower income families.

Global Picture

Globally, expectations are for a slow-down of growth across most countries, with the slight exception of the US. The US economy is doing marginally better than the IMF's projections as they started their tightening cycle sooner and are now reaping the benefits, including a sharper fall in inflation.

In the euro area - a big trading partner for Portugal, both in terms of goods and tourism - more recent data for Q2 and Q3 of 2023 shows a growth downturn, subdued domestic demand growth, as well as weak private investment. There is hope the latter will pick up considering the resilience recovery plan containing elements aiming to boost investment.

Portugal stood out at the beginning of 2023, showing strength in Q1 largely driven by robust consumption and continued recovery in the tourism sector, but the GDP flattened in Q2 and is predicted to continue to do so for a while. Overall, the IMF has projected GDP growth to soften to 2.6% for 2023, followed by 1.8% for 2024, before stabilising to around 2%.

Weighing Up Risks

The IMF has the challenge of weighing the potential risks facing the Portuguese economy, Rupa elaborated.

The key risk is regarding the domestic economy and the tightening of financing conditions. So far households have coped well, but this is not normally the case historically, so caution is necessary.

Profit margins have remained relatively strong, as well as wage growth - relative to Portugal’s historical experience and also to other countries. The potential risks that this wage growth will feed into inflation are currently limited, as inflation expectations are still very anchored, largely because both the ECB and the government are keeping a tight policy stance.

Unlike many other European countries, Portugal has upside risks including the labour market and tourism momentum. The labour market has been exceptionally strong, with labour force participation going up despite difficulties, and unemployment remaining low. If this sustains itself, there is a huge upside risk.

Tourism outcomes for this year have already surpassed 2019, which was considered to be a once-in-a-decade year for tourism. This is likely to be a post-pandemic rebound, but there are also structural factors suggesting tourism could remain strong.

Government Fiscal Policy

After the energy crisis there were a number of government fiscal measures used to support households and farms. This year's fiscal support is proving lower following the fall in energy prices which materialised sooner than expected thus meaning many companies no longer need the support.

As is typically expected when inflation is high, there has been an over-performance in tax revenue this year, gratefully contributing to a sharp fall in fiscal deficit. Other factors have also contributed, such as the removal of COVID support measures, and - unfortunately - under-execution of public investment leading to a fiscal surplus.

This fiscal surplus has assisted the lowering of public debt, in turn placing Portugal among the few countries whose debt has been falling sharply - good news for Portugal's sovereign debt rating.

Not so positively, the level of public investment as a share of GDP has been falling in recent years, and is less than the European average. This clearly reflects the country’s need for more infrastructure push and increased investment in housing, roads, airports, and more.

The Housing Market

Policy rates in the euro area have risen to 400 basis points in just over a year, marking a huge change in the financing environment and naturally contributing to housing price increases.

Considering the price to income ratio in the housing market, Portugal does not particularly stand out in the European context, but house prices have increased by about 40% in the last five years, which is tremendously sharp growth.

The major challenge facing Portugal's housing market, however, is lack of supply. Many other factors can assist in bringing demand and prices down, but it is crucial that an increase in supply is a part of that.

The recently approved government programme, Mais Habitação, can certainly help with supply problems through zoning restrictions and improving licensing. Furthermore, the end of the Golden Visa is a positive sign for the housing market, as well as Anti-money laundering (AML) safety.

However, Rupa was clear in her message that supply needs to improve in itself, with the simple construction of more housing.

The construction sector was booming before the crisis of 2011-12, but since this crash construction levels have not regained the same strength, despite the clear need for more housing and construction over the past 5 years.

Rupa also made a cautionary comment around too many regulatory interventions, explaining that they can deteriorate the business environment. The IMF’s recommendation is for the government to be transparent and work to improve the supply - “tinkering on the side will not help”.

Similarly, infrastructure must be addressed. The current lack of adequate infrastructure will not withstand the high demand coming from abroad to live and work in the country’s capital.

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