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Real GDP is forecast to fall by 1.9 per cent this year, as opposed to the 1 per cent fall projected in the autumn 2012 forecast. The close to 1 pp downward revision is primarily driven by the ¾ pp additional negative mechanical carry-over effect from the unexpectedly strong Q4-2012 slump in real GDP and the remainder is motivated by the less benign outlook for Portugal's export markets as well as the poor labour market developments. Domestic demand is likely to continue contracting during the first half of 2013. The recovery is expected to gather pace in 2014 with real GDP predicted to grow by 0.8 per cent, with broadly equal contributions from domestic and external demand.
Risks to the macro-economic outlook are clearly tilted to the downside as the deeper-than-expected worsening in the labour market situation may point to a persisting deterioration of the growth outlook. If this is confirmed by forthcoming data releases on the composition of the contraction in the last quarter of 2012, further downward revisions could be warranted. The projected recovery is also contingent on positive trade and financial market developments which remain fragile. In addition, in view of the largely revenue-based fiscal adjustment, macro-fiscal feedback loops might be more adverse to economic activity than projected. On the positive side, spillovers from a gradual and successful sovereign-bond market access could help boost business investment.
The general government deficit is expected to reach 5 per cent of GDP in 2012. Available cash data showed a marked expenditure decline. This compensated for lower-than-expected revenues and social security contributions resulting from the Member States, Portugal continued rebalancing of the economy towards exports and the more intense labour shedding. There are, however, downside risks to the 2012 fiscal outcome related, in particular, to the statistical treatment of the sale of the airport concession and possible cash/accrual adjustments that could widen the deficit in national-accounts terms.
Following the downward revision of the macro-economic outlook, the general government deficit is forecast at 4.9 per cent of GDP in 2013. Weaker revenues resulting from more subdued consumption and labour market performance are behind this revision. The projection considers measures worth more than 3 per cent of GDP, with a strong reliance on revenue measures, inter alia a profound reform of the personal income tax and increases in excise duties and property taxation. On the expenditure side, measures include substantial decreases in the wage bill, intermediate consumption and social transfers. Additional downward risks arise from a further deterioration of the macro-economic outlook and the pending decision of the Constitutional Court regarding some high yielding budget measures. The budgetary forecast is based on the usual assumption of unchanged policies and hence does not take into account any contingency measures the government plans to adopt in view of the expected deviation from the budget target in 2013.
The deficit is expected to reach 2.9 per cent of GDP in 2014. This projection crucially hinges on the projected economic recovery starting from mid- 2013. It also includes expenditure-reducing measures worth at least 1¾ per cent of GDP. With a view to identifying these measures, the authorities are conducting a comprehensive expenditure review to improve public services efficiency and to generate large permanent savings. The results will be presented during the 7th review of the Economic Adjustment Programme for Portugal and further specified in the 2013 Stability Programme. In structural terms, the cumulative adjustment over the 2012-14 period is expected to be around 5 per cent of GDP for the overall balance and 5¾ per cent for the primary balance. The projected fiscal consolidation and the gradual pick-up in growth are expected to lead to a declining debt-to-GDP ratio over the medium term after peaking in 2014.