The war in Ukraine will slow down the catching up

The pandemic mainly affected the economy due to its dependence on the tourism sector (17% of GDP, 50% of services exports in 2019), whose recovery remained limited in 2021 with still 62% fewer foreign tourists than two years earlier. Thus, at the end of 2021, while the Eurozone had recovered to its pre-crisis GDP, Portugal was still 1.4% lower. In 2022, the economic consequences of the war in Ukraine will slow the rebound in activity. The sharp rise in commodity prices will lead to a marked acceleration in inflation, which will spread to all products and remain high throughout the year. As purchasing power declines, household consumption should slow sharply. Uncertainty will not encourage households to draw on savings built up during the pandemic (10.9% of gross disposable income at the end of 2021, compared with 7% before the crisis). The conflict will also have a significant impact on businesses through, on the one hand, the worsening of supply difficulties, which had already hampered industrial activity in 2021, particularly in the critical automotive sector (15% of goods exports in 2019) and, on the other, the surge in production costs, which will lead to a contraction in margins and profits. Therefore, the investment will likely remain limited in this adverse environment for business confidence. Despite little trade with Russia - which accounted for 0.3% of exports and 1.3% of imports in 2021 - the economy will also be impacted through the foreign trade channel since 71% of its exports go to the rest of the European Union (76% when including the UK) markets, where demand will slow sharply. Despite these numerous headwinds, activity should nevertheless be driven by the rebound in tourism, provided that the health situation does not deteriorate - a scenario that cannot be ruled out given the increase in COVID-19 cases in some European countries in early spring. Investments in energy transition, infrastructure, and digital transformation will also support growth, as the country is one of the primary beneficiaries of EU funds, with EUR 13.9 billion in grants (6.5% of 2019 GDP) - plus EUR 2.7 billion in loans - for the period 2021-2026. 

Forced halt in the improvement of public and external accounts 

The consolidation of public finances that began in 2021 is expected to come to a halt in 2022 due to the additional measures taken by the government to limit the effects of the crisis on household and business finances (fuel price discounts, energy tax cuts, allowances for low-income households, new guaranteed loans for energy-consuming companies). The country’s high level of debt will limit its fiscal leeway. This is all the more true as its financing costs will continue to rise in 2022, insofar as the ECB has announced that it will stop its net asset purchases in the third quarter before, if the environment allows, raising its deposit rate at the end of the year.

After turning into a surplus in 2021, the current account balance is expected to return to a deficit in 2022 due to the substantial increase in the energy bill. While the proportion of goods is structurally in debt (7.6% of GDP in 2019), the balance of services (8.4% of GDP), fuelled by tourism revenues, is mainly surplus. However, the expected rebound of the sector should not compensate for the surge in energy imports. On the other hand, the income balance is relatively balanced, with remittances from the Portuguese diaspora-making up for dividends repatriated by foreign investors. In 2021, the country had the third largest net external debt in the European Union (81% of GDP), behind Cyprus and Greece.

Absolute majority for Prime Minister António Costa 

After two years in power, the left-wing coalition led by António Costa (PS) did not survive the rejection of the 2022 budget - a first since the advent of democracy in 1974 - by its partners in the Left Bloc (BE) and the Unitary Democratic Coalition (CDU, union of communists and ecologists). At the beginning of November 2021, the President of the Republic, Marcelo Rebelo de Sousa, dissolved the Parliament and called early legislative elections for January 2022. These allowed the PS to obtain an absolute majority in Parliament with 117 seats out of 230 (9 more than in 2019) and enabled it to govern without the support of its former allies. The BE (5 seats, -14 compared to 2019) and the CDU (6 seats, -6) were the big losers in the early elections. On the other side of the political spectrum, while the main opposition party remains the PSD (center-right, 76 seats), the main breakthrough was achieved by the far-right Chega party (12 seats, up from 1 in 2019), which has become the country’s third political force. In this recomposed political spectrum, António Costa will benefit, for his third term, from the stability that was absent for more than a decade.