Portugal: Bright Spot

Portugal is posting economic growth ahead of the EU average, but a high debt load and unmet needs for public investment signal lingering risks.

Portugal is an unexpected bright spot on the mostly sluggish landscape of postcrisis Europe, surprising many with its relatively rapid recovery and return to modest growth following a dramatic 2011 bailout by the EU and the International Monetary Fund (IMF).

“The Portuguese economy has made great strides in recent years, and its real GDP is now back above its level before the crisis,” says Paula Carvalho, chief economist at Banco BPI in Lisbon. “We expect GDP to grow by 1.8% and 1.7% in 2019 and 2020, respectively.”

Last year, Portugal performed better than the eurozone as a whole—which notched growth of 1.2%, according to Trading Economics—and Carvalho’s projections suggest it will continue to do so. The economy is expanding for the sixth consecutive year, albeit at a slower clip.

With booming tourism and exports, a stable government and strict control of its fiscal policy, Lisbon has also regained the trust of the financial markets and interest from international investors. How to keep the positive momentum alive is now the agenda-topping issue, economists say. Growth could be higher, and returning to its precrisis levels of GDP and unemployment (6.8%, from more than 12%) took longer for Portugal than other countries.

“If you look at formerly peripheral Euro countries that had serious troubles—Ireland, Spain, Portugal, Greece and Italy—there was a very clear outperformer: Ireland, which is no longer viewed as a peripheral economy,” says Andrew Kenningham, chief European economist at Capital Economics in London. “Whereas Portugal and Spain have hugely improved their positions—and they have done a lot through fiscal adjustment—they still have a high debt-to-GDP ratio of around 120%, and that is still a concern.”

The biggest question is whether Portugal can attract enough investment from abroad to boost its potential long-term growth. Much will depend on the majority that emerges from the October elections and from the fiscal policy the next government will implement. The coalition in power, led by Prime Minister António Costa and bolstered by support from the left, reduced the public deficit without cutting wages and pensions, a result it achieved mainly by slashing public investment.

“If the center-left gets elected, and again it does not have a full majority, we know—based on the experience of the last four years—that they can buy the support of the far left,” says Ricardo Reis, professor of economics at the London School of Economics. “The question is whether you can keep, in order to gain that support, detracting from public investment. That will be very hard. You can stop all investment for a year; but after four years, it starts showing. The trains are breaking down; public services are getting slower; the machines need to be repaired. That is going to be a big challenge for the government to come.”

The ruling Socialist Party won the May elections for the European Parliament and is expected to do even better in the October vote, in which some forecasts give it as much as a 39% share. But it will still need to re-form the so-called Geringonça alliance—“contraption” in English—a term initially used by the opposition to ridicule the wide spectrum of views in the coalition, including the Left Bloc and Communists.

Debt Reduction and Public Investment

Political concerns aside, developments have been moving in the right direction, economists say. “During the last decade—and in particular from 2011 to 2018—households, the public sector and nonfinancial corporations [NFCs] have been reshaping and equilibrating their balance sheets,” says BPI’s Carvalho. “That now looks much healthier.” The ratio of NFC debt to GDP fell from 141% in 2013 to 100.6% in 2018, placing it below the eurozone average of 135.7 (Q4 2018); public debt declined from 130.6% in 2014 to 121.5% last year; and household debt fell from 92% of GDP in 2009 to 66.9% in 2018.

Focusing on debt reduction has constrained Portugal’s investment capacity, but there may now be room for this to ease up. “We believe this process, although continuing, is now assuming a more gradual trend, and investment prospects are brighter,” says Carvalho. BPI foresees gross fixed capital formation rising by 4% in 2019, compared with 9.2% and 4.4% in 2017 and 2018, respectively.

The public role remains key. “Investment has evolved in a positive way, but it remains below precrisis levels,” says Pedro Castro e Almeida, CEO of Santander Portugal. “The quality of investment is better, as the recovery has been in capital expenditure on machinery and equipment and on transportation. Public investment has remained at around 2% of GDP, and could be used as an instrument to lever private investment.”

In January, French builder Vinci signed a €1.15 billion ($1.32 billion) deal to expand Lisbon Airport and build a new passenger hub in nearby Montijo, helping to accommodate Portugal’s rising number of tourists (some 13 million visited in 2018). But a grand 10-year, €20 billion plan to improve infrastructure still needs to be approved by the Parliament.

Another part of the country’s bedrock—financial institutions—is stabilizing and so may be able to contribute more to the recovery going forward. “Banks have continued to reduce their exposure to impaired assets,” says Castro e Almeida. “At the end of 2018, the NPL [nonperforming loan] ratio for the system was reduced to 9.4%, which compares with the peak of 17% seen in 2016; and it will continue to be reduced in 2019.” That’s still high, however, compared to the average NPL ratio for the EU: less than 3.7% in 2017, according to the World Bank.

Portugal’s GDP rose by 2.1% last year after a 2.8% increase in 2017, and the Bank of Portugal still expects it to expand in 2019, albeit by a tamer by 1.8%, while private economists’ estimates range between 1.5% and 1.8%. Austerity-oriented reforms carried out during the “troika period”—when the economy was monitored by the European Central Bank, the European Commission and the IMF following the bailout—were intended to position the country for a durable recovery.

“The centers of Lisbon and Porto have nothing to do with what they were 10 years ago,” says Reis. “It is the result of a reform of the housing market that put to an end some rent control and allowed the revitalization of the cities.”

Reis believes Portugal offers an excellent climate for international investors. “You have a very educated labor force; a relatively stable political climate; and compared to 10 years ago, a lot of orientation toward foreign markets,” Reis argues. “If I were an investor interested in the export market, I would go.”

That doesn’t mean there aren’t any risks. A high level of debt makes the country vulnerable to shocks from the rest of the eurozone, Kenningham says. “Portugal would not be the center of concern—it would be Italy—but there could be contagion from Italy to Spain and Portugal.” He acknowledges that this isn’t likely now, or even in the next two years, but “if you look at a five- to 10-year horizon, it is still a risk.”