Portugal Programme Assessment

European Commission, DG ECFIN

15 May, 2014

1

Root causes of Portugal's initial imbalances and need for assistance

Low GDP and productivity for more than a decade

High household, corporate and public debts

Subdued implementation of structural reforms

Deterioration of confidence and rating downgrades provoked rates incompatible with long-term fiscal sustainability

Banking sector lost international market funding and started reliance on the Eurosystem for funding

Macro-economic

imbalances

Trigger for financial

assistance request

2

EU-IMF Economic Adjustment Programme Restoring investor confidence via consolidating public

finances, enabling sustainable growth and safeguarding financial stability

Executing a credible, balanced fiscal consolidation strategy

Rebalancing the economy from non-tradable to tradable sector to improve Portugal's net external position

Further supporting the financial sector through more robust supervision and strengthening bank capitalisation

Implementing an ambitious structural reform agenda to boost potential growth, improve labour market outlook and regain competitiveness

Mitigating negative social impact of the adjustment process

3

Key Programme Achievements

4

Output Recovery Gaining Momentum Real GDP growth projection for 2014 in line with EA

Source: Eurostat, DG ECFIN

-5

-4

-3

-2

-1

0

1

2

3

4

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014f

Portugal EA-18

% change y-o-y

5

Government Bonds at Pre-Crisis Yields

Note: Daily data as of 14 May 2014 Source: Bloomberg

Financing costs have been reduced in recent issuances

0

50

100

150

200

250

France Ireland Spain Italy Slovenia Portugal

Spread 10-year Germany Government Bond

bps

0

2

4

6

8

10

12

14

16

18

20

2007 2008 2009 2010 2011 2012 2013 2014

Portugal 10-year Bond Germany 10-year Bond

in %

6

Transition to Export-Oriented Growth Model

Exports as % of GDP have improved but remain below comparable EU MS

Source: Eurostat; DG ECFIN

20

25

30

35

40

45

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014f

Exports as % of GDP Imports as % of GDP

% of GDP

0

20

40

60

80

100

120

Ireland The

Netherlands

Belgium Austria Portugal

Nominal exports as of 2013

% of GDP

7

Competitiveness Is Recovering

Keeping reforms on track will be crucial to maintain the upward trend

Note: NULC and REER series are inverted Source: DG ECFIN

96

98

100

102

104

106

108

110

112

114

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

NULC EA18 REER 37 Countries

index 2005=100

8

External Adjustment Is Ongoing

Further improvements in the external balance are necessary to reduce NIIP

Source: Eurostat

-140

-120

-100

-80

-60

-40

-20

0

-14

-12

-10

-8

-6

-4

-2

0

2

4

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Net lending/ Net Borrowing as % of GDP

Net International Investment Position as % of GDP (rhs)

% of GDP

9

Labour Market Has Bottomed Out

High youth and general unemployment remains concerning

Source: Eurostat

15

20

25

30

35

40

45

5

10

15

20

2009 2010 2011 2012 2013 2014

General Unemployment Rate Youth Unemployment Rate (rhs)

% %

10

Fiscal Adjustment Has Been Substantial

Note: For the purposes of the Programme, the budget deficit in 2012 excludes the impact of CGD recapitalisation (about 0.5% of GDP), and in 2013 BANIF recapitalisation (about 0.4% of GDP). Source: Eurostat; DG ECFIN

-12

-10

-8

-6

-4

-2

0

2

4

2009 2010 2011 2012 2013 2014f 2015f

Deficit - Programme purposesStructural balanceStructural primary balance

% of GDP

11

Public Debt High but Sustainable

Source: Eurostat; DG ECFIN

60

70

80

90

100

110

120

130

140

2010 2015 2020 2025 2030Baseline

Shock : -1p.p. GDP growth from 2016

Shock : +1pp GDP growth from 2016

Interest rate shock : +1p.p. from 2016

Combined shock (growth -1 pp, interest +1pp) from 2016

Combined shock (growth +1 pp, interest -1pp) from 2016

% of GDP

12

12

Banks Have Adjusted Significantly

Note: Core Tier 1 ratio according to Programme definition and excluding the banks in resolution Source: Banco de Portugal

60

80

100

120

140

160

180

2009Q4 2010Q4 2011Q4 2012Q4 2013Q4

0

2

4

6

8

10

12

14

Core Tier 1 Ratio (rhs) Loan-to-deposit ratio

% %

13

13

Corporate Sector: Slow Deleveraging and High NPLs

Note: Indebtedness refers to lending and securities other than shares in the domestic banking sector Source: Banco de Portugal; DG ECFIN

0

2

4

6

8

10

12

14

60

70

80

90

100

110

120

130

140

2007 2008 2009 2010 2011 2012 2013

NFCs Indebtedness Total NFCs NPLs (rhs)

% GDP %

14

14

Key Structural Reforms Were Undertaken

Key labour code changes to improve flexibility, reduce segmentation and increase incentives to work

Implementation of strategic plan to fight youth unemployment

Labour market

Comprehensive reform of pre-university education system to increase school autonomy and accountability

Vocational training reforms to enhance labour market matching

Education

New urban lease law to increase access to rental housing and improve labour mobility

New incentives for renovations

Housing market

15

Liberalisation of electricity and gas markets

Several wide-ranging reform packages aimed at reducing excessive rents and cutting the electricity tariff debt

Energy markets

Modernization of regulatory framework, including creation of AMT

Reform package in ports sector to reduce end user costs, including new port labour law and elimination of port use fees

Various cost-saving and liberalisation measures in railways sector

Transport sector

Liberalisation and opening up to competition of telecoms and postal sectors, including privatization of postal services company

Strengthening of regulatory framework for telecoms sector

Telecoms & postal sector

Key Structural Reforms Were Undertaken

16

Simplification of licensing procedures for businesses, moving to a zero authorisation approach

Establishment of Single Point of Contact for entrepreneurs

Introduction of "one-in/one-out" rule for burdensome new regulations

Compilation of inventory and cost analysis of regulations

Business environ-

ment

Services & regulated

professions

Sector-specific amendments to liberalise a wide range of legal regimes governing the services sector

Framework law and new by-laws (in progress) to remove unjustified barriers to entry in key regulated professions

Key Structural Reforms Were Undertaken

17

New Code of Civil Procedure to expedite court process

Court system reform to improve efficiency and accountability

Various measures aimed at speeding up debt enforcement cases

Judicial system

Adoption of new legal framework to strengthen role of key sectorial regulators and Competition Authority and to ensure their independence

Regulatory framework

Key Structural Reforms Were Undertaken

18

Ease of Doing Business Improving

*Note: "Distance to Frontier" measures performance relative to the best performance ever observed for any country. Index values ranges from 0-100, with 100 being the best. Source: World Bank "Doing Business" reports, 2010-2014

"Distance to Frontier*" evolution for selected "Doing Business" indicators (Portugal versus average for other EU countries)

71

72

73

74

75

76

77

2010 2011 2012 2013 2014

Dis

tan

ce

to

Fro

ntie

r (*

)

Overall ease of doing business

PT

EU26 exc. PT

84

86

88

90

92

94

96

98

2010 2011 2012 2013 2014

Dis

tan

ce

to

Fro

ntie

r (*

)

Starting a business

PT

EU26 exc. PT

60

65

70

75

80

85

2010 2011 2012 2013 2014

Dis

tan

ce

to

Fro

ntie

r (*

)

Dealing with construction permits

PT

EU26 exc. PT

19

Much Achieved But Challenges Remain

GDP growth still not robust and unemployment is unacceptably high

High debt levels suggest Portugal could be affected by a turn in bond market sentiment

Corporate sector indebtedness and high NPLs continue to weigh on bank profitability and growth

Concern that reform momentum has slowed in key areas

A continued strong commitment to structural reforms and fiscal consolidation is essential

20