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Economic and financial conditions in Portugal have remained broadly stable since the conclusion of the second post-programme surveillance mission in June 2015. However, the economic recovery continues to be held back by macroeconomic imbalances and rigidities in labour and product markets. While the authorities have committed to comply with European budgetary rules, the effort to reduce the underlying structural budget deficit needs to be significantly increased. As the mission concluded, discussions on this subject with the European Commission were ongoing. Progress in structural reforms lost momentum during 2015. Reforms need to be stepped up to further enhance medium-term growth prospects, job creation and competitiveness.
After a positive first half of 2015, real GDP growth slowed in the second half across all components. Looking ahead, economic activity is expected to expand at a moderate pace, held back by persistent deleveraging pressures in the private sector. Domestic demand is set to be the key driver of growth, while net exports are projected to make a negative contribution due to strong import growth.
The government estimates a headline deficit in 2015 of 4.2%. Excluding the resolution operation of Banco Internacional do Funchal (Banif) in December 2015, the deficit is estimated to have reached 3% of GDP. A nominal budget deficit of 2.6% of GDP in 2016 is included in the Portuguese Draft Budgetary Plan as submitted on 22 January, while the mission projects a figure markedly above 3%. The adjustment in the underlying structural deficit in 2016 reflects an insufficient consolidation effort. The debt-to-GDP ratio, which stood at around 129% at the end of 2015 is expected to continue its downward path, though more slowly than earlier expected.
Banks continue to consolidate their balance sheets, albeit at a slower pace than previously observed, and have seen minor improvements in profitability. While the flow of new non-performing loans is decreasing, high levels of non-performing exposures continue to weigh negatively on profitability and capital.
Moreover, the mission urged the authorities to pursue an ambitious reform agenda. While the labour market reforms adopted during the programme are increasingly starting to deliver results, the reform effort needs to continue as labour market segmentation, long term and youth unemployment remain high.
Overall, the mission recalled the importance of increasing the flexibility and competitiveness of the Portuguese economy to underpin the gradual economic recovery, strengthen its resilience to shocks and improve potential growth prospects.
Borrowing conditions for Portugal remain favourable, driven largely by European and global factors. However, compared to the 2015 Stability Programme, the budgetary strategy by the new government has increased the gross financing needs. More generally, financial markets have become more volatile, making financing the high levels of sovereign debt more of a challenge for the government.