Portugal: Risk Assessment
Country Risk Rating
Business Climate Rating
- Potential in renewable energy (hydroelectric, wind and photovoltaic)
- Above-average absorption of European funds
- Low labor costs and nascent manufacturing industry (food products, electronics)
- Comparatively stable governance
- Increasingly attractive to foreign talent
- Underdeveloped manufacturing sector with low-to-medium range added value
- Highly exposed to pandemic-sensitive sectors (tourism, textiles, auto parts)
- Slow-functioning legal system
- Poor quality of bank portfolios, high bad debt rates
- Deepening infrastructure gap
Tourism dependence leads to a sizeable contraction and an uncertain recovery
Despite a relatively less severe early outbreak, the Portuguese economy is highly singularly vulnerable to the pandemic. This is in large part due to the overwhelming importance of the tourism sector (17% of GDP, 50% of services exports in 2019), which is expected to lose 65-70% of its annual revenues in 2020 and whose prospects for recovery remain highly uncertain in 2021. Indeed, Portugal’s off-centre position in Europe makes it highly dependent on air transport for tourism income. Overall, exports of goods and services (43% of GDP) contracted by 21% in 2020 and should rebound by 10% in 2021. Internal demand and imports are being less elastic, making for a strong negative contribution of net exports (-3%) in 2020, which will become slightly positive in 2021 thanks to the revival of exports. Furthermore, SMEs tend to have lower chances of survival, and they are disproportionately prevalent in the Portuguese industrial landscape: 77% of employment and 68% of value added (EU average: 66% and 56%, respectively). Renewables (30% of the energy mix, mostly solar and offshore wind), on the other hand, will continue expanding, increasing capacity by 7% and generation by 6% in 2021. The contraction in private consumption (62% of GDP) will be contained to 9% in 2020 thanks to a battery of measures including transfers to furloughed workers (0.3% of GDP) and other transfers to households (0.5%). The 2021 budget plans for further employment subsidies (0.5% of GDP), extended transfers for households (0.2% of GDP) and a 20% increase in public spending. Tax deferrals have been instrumental in supporting the private sector (11% of GDP), notably the fractioned payment of VAT that was extended to H1 2021. Under the effect of pent-up demand, consumption will rebound by 5%.
The pandemic response brings unprecedented fiscal pressure, but Europe ensures the funding
Emergency economic measures accounted for 2.5% of GDP. These include the aforementioned subsidies, social transfers and tax deferrals. While discretionary measures were smaller relative to Eurozone peers, the effect of automatic stabilizers will be particularly strong given the importance of social benefits (18% of GDP) and taxes on production and income (15%). The 2020 deficit is further amplified by one-off transfers, such as the activation of Novo Banco’s contingent capital mechanism (0.5% of GDP) and the bailout of flagship airline TAP (0.6%). Overall, expenditure is expected to increase by 11% in 2020, while revenues plunged by 13%. The deficit is expected to normalize only gradually and mostly thanks to the rebound in activity, as the fiscal stance will remain accommodative in 2021. The new budget includes an expanded subsidy for employment and resumption of activity (0.5% of GDP), resumed hiring in health and education, and a 20% increase in public investment. Indeed, the degradation of public finances will no longer weigh on public investment, as EU rules are set to remain suspended and the Next Generation EU fund is set to provide funds equivalent to 27% of 2019 GDP over 2021-2027. Furthermore, thanks to ECB stimuli, borrowing costs have sunk to record lows. Private debt, which prior to the pandemic had fallen to 149% of GDP from its 210% peak in 2012, is set to gain 20 pp. The oversized dependence on tourism exports will shift the current account back into deficit in 2020, which will linger into 2021. While this is not reassuring given the large external debt (203% of GDP) and negative investment position (-100% of GDP), it is mostly financed through FDI (3% of GDP, much less from 2020 onwards) and Eurosystem funds.
Cracks start to emerge in the left-leaning coalition government
Led by PM Antonio Costa, the center-left Socialist Party (SP) holds 106 seats out of 230 in the unicameral legislature, 10 short of an absolute majority. After the 2019 election, it looked like Costa would be able to govern comfortably through a left-wing coalition with the support of either the Left Bloc (LB, 19 seats) and/or the Portuguese Communist Party (PCP, 12 seats). It has since become apparent that consolidating the left is easier said than done, as shown by the razor-thin 2-vote majority in the November 2020 budget vote. Indeed, the LB voted against the SP for the first time in the legislature, raising doubts over the coalition’s stability. Nevertheless, a complete term ending in 2023 remains the more probable outcome. The most controversial aspect of the bill is an amendment seeking to cancel the state’s contingent commitments to Novo Banco. The measure is expected to be overturned by the courts due to its apparent incompatibility with international law (Novo is owned by a U.S. fund). Nonetheless, it is telling that many in parliament are willing to compromise enforcement of property laws, especially considering that the motion was authored by the nominally liberal leader of the opposition, the Social Democrats.