Portugal: On The Brink Of Recovery

While Portugal is still recovering from the global financial crisis that began a dozen years ago, its recent performance has been promising within the European context. In 2019, its GDP grew well above the eurozone average, and it started this year at a similar pace. For the first time in 45 years, the government posted a budget surplus in 2019, a year ahead of expectations. As an open economy heavily reliant on exports and tourism, Portugal was been working to diversify its output by increasing activities in information technology and services.

Then Covid-19 hit. While cases were fewer than in Spain and Northern Italy, the pandemic and the lockdown to contain it brought the economy to a halt. The recovery so far has been mixed, and the full impact of the recession and the shape of the post-pandemic economy are still unknown. The only certainty is that the continent’s westernmost nation will be heavily affected because of its reliance on exports and tourism.

“Within Europe, Portugal will probably be among the most affected, with a double-digit recession rate in 2020,” says Paula Carvalho, chief economist at Banco BPI. “We expect minus  12% 2020 GDP. This is especially due to the importance of cultural, entertainment and tourist-related activities for the economy, as well as to still-high public debt levels. We estimate that direct measures to support the economy will amount to about 7% of GDP, contrasting with its European peers.” Germany has extended unlimited credit lines to small and medium-size enterprises, for instance, she notes.

Forecasts range widely, however. The Bank of Portugal expects a GDP decline of 9% in 2020 and a sharp rebound next year. “The big caveat is that all GDP projections are fairly uncertain at the moment,” says Michele Napolitano, head of Western European Sovereigns at Fitch Ratings. Capital Economics says it is unlikely that Portugal will recover all its economic lost ground by the end of 2021.

Sun, Low Taxes, Cheap Labor, Good Hospitals

A big question mark is tourism, a key industry in the small country.

“Tourism has been the most affected sector, not only because of worldwide travel bans that with some countries are still active, but also due to the domestic lockdown,” says Pedro Castro e Almeida, CEO at Santander Portugal. “Tourism in Portugal represents 15% of the economy and 17% of employment, and we have seen cancellations on the order of 80% to 90% in some cases. Recovering will take time, and it’s important that we, as country, can make a strong case for getting back lost international demand as soon as possible—and, at the same time, seize this opportunity to further diversify our economy and find new avenues for the country to grow in the future.”

In July, Portuguese officials strongly protested the UK’s decision to keep their country off the list of those exempted from quarantine.

A short-term lack of tourists might be made up for by a longer-term increase in permanent residents. Portugal is a small economy with a relatively low cost of labor, and as such it could benefit from some relocation during the post-pandemic period, says Ricardo Reis, professor of economics at the London School of Economics.

“As the world moves more and more toward online distance working and centrality becomes perhaps less relevant,” he says, some industries may decide to move to Portugal, where rents are cheaper and workers can have a better quality of life. “Whenever there’s a crisis, there are lots of opportunities.”

A 2009 law that shielded foreign pensioners from taxes for 10 years if they moved their residency to Portugal was reviewed in 2020. After some other EU countries raised concerns, Portugal’s 2020 budget imposed a 10% flat tax on foreign pension income. While the tax exemption contributed to some pensioners’ decision to move to Portugal from neighboring countries, the impact of the new flat tax won’t be known until it comes into effect next March.

But the nation has other attractions for older people. Along with good weather, it offers a “very good private health sector,” says Reis. “Portugal’s health sector actually dealt pretty well with the pandemic and showed it’s a very safe place where you can rely on very good hospitals and very good treatment.”

Stimulus and Prudence

The public policy response to the crisis so far has been positive, some economists say, and the financial markets have welcomed the extra spending—underway or planned—to support the economy. In July, the government published a 142-page study detailing measures aimed at facing “one of the worst crises” in the country’s history. The plan includes new infrastructure, including expansion of metro lines in Lisbon and Porto plus a new bridge over the Douro river.

“The decline in GDP should lead to an increase of the public debt ratio, which we estimate at 138%, already including the widening of the fiscal deficit to 8.5% in 2020,” says Santander’s Almeida. “Private debt should also increase, largely reflecting the decline in nominal GDP. However, we see this as temporary increase, resuming a downward trend from 2021 onward as we return to a situation of fiscal primary surplus and GDP growth.”

For the present, the emphasis needs to be on sustaining the economy “and assuring that viable productive capacity does not disappear, with long-term losses,” says BPI’s Carvalho. “However, it is also certain that it will be necessary to frame these actions in a medium-term plan that guarantees the sustainability of public accounts. In this respect, Portugal has sound credentials in promoting fiscal consolidation.”

Fitch Ratings affirmed its BBB long-term rating in April, reducing Portugal’s outlook to stable from positive.

“Despite this shock on the public finances, we still believe that the Portuguese government is committed to fiscal sustainability going forward, in terms of putting out a plan and stabilizing government debt,” says Kit Ling Yeung, associate director and secondary rating analyst with Fitch. “Before this crisis hit, Portugal had made very strong improvements in its public finances, and we expect them to return to a relatively prudent fiscal policy framework once the shock subsides and the need for kind of fiscal measures in response to the shock is lessened.”

In a time of crisis, the government is reaping the reward of its fiscal prudence, the agency argues. “Portugal was successful in controlling its deficit and debt,” says Napolitano. “The level of public debt is high, for sure, but it is one of the countries that used the good times between 2015 and 2019 to reduce its stock of public debt. Portugal and Italy, to give you an example, had the same level of public debt in 2015, more than 130% of GDP; in 2019, Portugal’s debt-to-GDP was 114%, whereas Italy had the same level as 2015. We look at the track record, and the track record in that respect is quite positive in terms of public finance management.”

The EU’s Covid response may hasten Portugal’s recovery, as well. Helped by an expansive monetary policy, the central bank’s bond yields have hit record lows. Immediate savings will be limited, but the low cost of money will have a positive impact in the years to come, says Andrew Kenningham, chief Europe economist at Capital Economics.

“The policy response in Europe has been much better than during the global financial crisis,” he says, adding that the new €750 billion ($882 billion) package aimed at funding post-pandemic relief efforts across the EU has sparked greater optimism. The aid must still be approved and will be likely not be available until 2021.

“For Portugal, the immediate savings this year will be very low,” says Kenningham. “But what matters really is that the debt becomes far more sustainable in the long term.”