kom (2016) 0520 - Ingen titel

Europaudvalget 2016
KOM (2016) 0520
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EUROPEAN

COMMISSION

Brussels, 27.7.2016

SWD(2016) 264 final

COMMISSION STAFF WORKING DOCUMENT

Analysis by the Commission services of the budgetary situation in Portugal following the

adoption of the COUNCIL RECOMMENDATION to Portugal on 21 June 2013 with a

view to bringing an end to the situation of an excessive government deficit and the

COUNCIL DECISION of 12 July 2016 establishing that no effective action has been

taken by Portugal in response to the Council Recommendation of 21 June 2013

Accompanying the document

Recommendation for a

COUNCIL DECISION

giving notice to Portugal to take measures for the deficit reduction judged necessary in

order to remedy the situation of excessive deficit

{COM(2016) 520 final}

kom (2016) 0520 - Ingen titel

1. I

NTRODUCTION

Portugal has been under the excessive deficit procedure since 2 December 2009. Due to

unforeseen adverse economic circumstances, the Council adopted revised recommendations

to correct the excessive deficit in two occassions after 2009; first in 2012 and then in 2013.

Specifically, on 21 June 2013, following a recommendation from the Commission, the

Council adopted a revised recommendation under Article 126(7) TFEU and set a 2015

deadline to correct the excessive deficit. In order to bring the general government deficit

below the Treaty reference value of 3% of GDP by 2015 in a credible and sustainable manner,

Portugal was recommended to undertake the following adjustment path: a headline deficit of

5.5% of GDP in 2013, 4.0% of GDP in 2014 and 2.5% of GDP in 2015, which was deemed

consistent with an improvement in the structural balance of 0.6% of GDP in 2013, 1.4% in

2014 and 0.5% in 2015.

According to the budgetary data notified by Portugal and validated by Eurostat on 21 April

2016, the general government deficit reached 4.4% of GDP in 2015. As a result, Portugal did

not correct its excessive deficit by the recommended 2015 deadline. The headline deficit

included the deficit-increasing one-off impact of 1.4% of GDP stemming from the financial

sector support measure in the context of the Banif resolution at the end of 2015; taking into

account also the deficit-reducing one-off measures, the headline deficit net of one-offs would

still have been above the Treaty reference value. In addition, the cumulative fiscal effort over

2013-2015 is estimated at 1.1% of GDP, significantly below the 2.5% of GDP recommended

by the Council.

On 12 July 2016, following a Commission's recommendation in compliance with Article

126(8) TFEU, the Council adopted a decision establishing that no effective action had been

taken by Portugal in response to the 2013 Council Recommendation.

In compliance with

Article 126(9), within two months form the Council decision establishing non effective action

the Council shall give notice to the country on a new deadline for the correction of the

excessive deficit with a specified adjustment path.

This document proposes a new deadline for the correction of the excessive deficit and an

adjustment path that could ensure a durable correction of the excessive deficit. To this end,

Sections 2 and 3 present the recent macro-economic and budgetary developments and outlook

for 2016, respectively. Section 4 presents a proposal for a new fiscal adjustment path and the

last section concludes.

2. R

ECENT MACRO

ECONOMIC DEVELOPMENTS AND OUTLOOK FOR

2016

According to the Commission 2016 spring forecast, the economic recovery is set to

continue moderately in 2016 and real GDP is projected to grow by 1.5% y-o-y at the

See

SWD(2016) 240 final

for additional information on Portugal's EDP.

See

ECOFIN 678 UEM 264

In addition to the requirements of EDP recommendations under Article 126(7), the Council decision to give

notice under Article 126(9) shall not only set the new budgetary targets but also "indicate measures conducive to

the achievement of those targets" according to Article (5)1 of Council Regulation No 1467/1997.

kom (2016) 0520 - Ingen titel

same pace as in 2015.

Private consumption is expected to lose momentum due to higher

indirect taxes and the slight recovery in energy price inflation. The strong rebound in the

consumption of durable goods in the first half of 2015 is not forecast to be maintained as still

high unemployment and high debt levels are projected to keep upward pressures on household

savings. Most of the soft investment indicators point to a weaker investment performance in

2016 as well. Business investment already decelerated significantly over the second half of

2015 and is not expected to resume its previous growth rate soon despite the relatively high

capacity utilisation rate. Exports are forecast to grow in line with foreign demand, but imports

are still expected to outbalance exports over the forecast horizon. As a result, the contribution

of net trade to GDP growth would remain slightly negative. Employment creation is set to

slow down in 2016, thereby becoming more aligned with GDP growth. Therefore, the

unemployment rate is estimated to decrease to 11.6%. HICP inflation is projected to increase

only marginally to 0.7% in 2016, mainly driven by higher taxes. HICP inflation is expected to

increase to 0.7% in 2016, mainly driven by higher indirect taxes. While downward risks to the

outlook have increased since the publication of the spring forecast, data on the first quarter of

2016 and preliminary information on the second quarter overall confirm the outlook of the

forecast for the rest of the year.

The macroeconomic scenario underlying the 2016 Budget is more optimistic than the

Commission 2016 spring forecast.

The Commission expects a slower economic recovery

than the Portuguese authorities (1.5% vs. 1.8% real GDP growth), mostly on account of a

lower expected contribution of domestic demand to GDP growth (1.5 pps. in the spring

forecast against 2.4 pps. in the 2016 Budget). The Commission is less optimistic with respect

to investment and private consumption which are set to grow by 1.6% and 1.8% respectively

in 2016, as opposed to 3.9% and 2.4% in the 2016 Budget. The projections also differ on the

nominal side of the economy, as the Commission estimates a significantly lower increase of

the GDP deflator in 2016 (1.4% compared to 2.1% in the 2016 Budget). Nonetheless, the

expectations with regard to labour market developments in 2016 are broadly in line in both

projections.

kom (2016) 0520 - Ingen titel

Table 1 – Recent macroeconomic developments and outlook

Real GDP (% change)

Private consumption (% change)

Gross fixed capital formation (% change)

Exports of goods and services (% change)

Imports of goods and services (% change)

Contributions to real GDP growth:

- Final domestic demand

- Change in inventories

- Net exports

Output gap

Employment (% change)

Unemployment rate (%)

Labour productivity (% change)

HICP inflation (%)

GDP deflator (% change)

Comp. of employees (per head, % change)

Net lending/borrowing vis-à-vis the rest of the world (% of GDP)

Note:

2015

COM

1,5

2,6

3,9

5,2

7,4

2,5

-0,1

-0,9

-2,3

1,4

12,6

0,1

0,5

1,9

-0,6

1,1

2016

COM

1,5

1,8

1,6

4,1

4,3

1,5

0,0

-0,1

-1,1

0,9

11,6

0,6

0,7

1,4

1,6

1,5

1,8

2,4

4,9

4,3

5,5

2,4

0,0

-0,6

-1,3

0,8

11,4

1,0

1,2

2,1

2,4

1,6

In % of potential GDP, with potential GDP growth recalculated by

Source :

Commission 2016 spring forecast (COM);Stability Programme (SP).

Real GDP in Q1-2016 is in line with the Commission forecast but its composition points

to a higher than expected contribution from private consumption.

Real GDP grew by

0.9% y-o-y and 0.2% q-o-q in Q1-2016, in line with the Commission 2016 spring forecast

quarterly profile. Nonetheless, private consumption grew above expectations and investment

came in more negative than projected in the Commission 2016 spring forecast. Net external

demand also posted a bigger negative contribution reflecting feebler exports outlook (-1.1

pops. vs -0.4 pops). As the higher growth in private consumption is not expected to be

maintained and as long as there is no sign of pick-up in investment and exports, there is a risk

of downward revision of the headline GDP in 2016 and some negative carry over effect in

2017. As regards the nominal side, GDP deflator grew by 2.4% in Q1-2016, reflecting some

upside risks to the Commission 2016 spring forecast as well.

Risks to the macro outlook are tilted to the downside, also on account of new uncertainty

emerging from the outcome of the referendum in the United Kingdom on the

membership of the European Union.

Were the risks associated with the outcome of the

referendum in the United Kingdom on the membership of the European Unionto materialize,

the envisaged slight recovery for exports and investments would be very unlikely. Trade

flows with the U.K. and other EU countries would decline, while uncertainty in the business

environment would have an adverse impact on investment and weigh negatively on a still

kom (2016) 0520 - Ingen titel

recovering financial sector. This could result in a downward revision of the headline GDP in

2016 and negative carry over effect in 2017.

3. R

ECENT BUDGETARY DEVELOPMENTS AND OUTLOOK FOR

2016

The Commission 2016 spring forecast is less optimistic than the authorities' budget.

Taking into account an assessment of the fiscal policy measures specified in the 2016 Budget

that entered into force on 31 March, the Commission 2016 spring forecast projects the general

government deficit to fall to 2.7% of GDP in 2016. The structural balance is expected to

slightly deteriorate further by about 0.25% of GDP in 2016. The 2016 Budget targets a

general government deficit of 2.2% of GDP and an improvement of the structural balance by

0.3% of GDP. The 2016 Budget intends to more than offset revenue-decreasing measures of

around 0.3% of GDP (notably the partial reversal of the PIT surcharge and the reduction of

the VAT rate for restaurants) through revenue-increasing measures of around 0.5% of GDP,

of which about two thirds relate to increases in indirect taxes (on petroleum products, tobacco,

vehicles and the stamp duty), complemented by a series of smaller measures concerning direct

taxes and enhanced compliance in both tax collection and Social Security. Expenditure-

increasing measures amounting to 0.4% of GDP (mostly the gradual reversal of the public

sector wage cuts, increases in a series of social benefits and the unfreezing of pension

indexation) are planned to be more than compensated by expenditure-decreasing measures of

close to 0.5% of GDP (most of which relate to the nominal freeze of intermediate

consumption - except for PPPs-, efficiency gains in other current expenditure, expenditure

control in social transfers and a new civil servants rotation policy (2:1 replacement rule)). The

tax revenue included in the 2016 Budget is however also affected by negative carry-over

effects of tax measures of previous years amounting to around 0.25% of GDP. The

Commission 2016 spring forecast incorporates more conservative yield estimates for some of

the 2016 Budget measures, in particular as regards the nominal freeze of intermediate

consumption and other current expenditure. The Commission forecast's less optimistic

macroeconomic scenario also leads to lower projected revenue from taxes and social

contributions, as well as higher social transfers. The Portuguese Public Finance Council in its

analysis of the State Budget also sees important risks to the macroeocnomic scenario which

would have implications on tax revenue, and deems the savings from the measures indicated

not sufficiently specified.

kom (2016) 0520 - Ingen titel

Table 2 – Composition of budgetary adjustment

(% of GDP)

Revenue

of which:

- Taxes on production and imports

- Current taxes on income, wealth, etc.

- Social contributions

- Other (residual)

Expenditure

of which:

- Primary expenditure

of which:

Compensation of employees

Intermediate consumption

Social payments

Subsidies

Gross fixed capital formation

Other (residual)

- Interest expenditure

General government balance (GGB)

Primary balance

Output gap (*)

Structural balance (SB)

(*) % of potential GDP

Source: Commission 2016 spring forecast

2015

Outturn

43,9

14,5

10,8

11,5

6,9

48,3

43,7

11,3

5,9

19,2

0,7

2,2

4,4

4,6

-4,4

0,2

-2,3

-2,0

2016

Forecast

44,0

15,0

10,3

11,5

7,2

46,6

42,2

11,2

6,3

18,9

0,8

1,9

3,1

4,5

-2,7

1,8

-1,2

-2,2

Budgetary execution until May 2016 has been broadly on track, but risks for the rest of

the full-year execution remain high.

The general government balance in National Accounts

for the first quarter improved to 3.2% of GDP as compared to 5.5% of GDP in the first quarter

of 2015, the best first-quarter balance since 2008. Although the first quarter deficit typically

tends to be higher than in the full year, the 3.2% of GDP is still one percentage point above

the full year budget target of 2.2%. Looking at budgetary execution until May, using cash

data, there is indeed an improvement of the overall general government balance compared to

May last year, due to an overall increase of revenue and a containment of expenditure.

However, the increase in revenue is not as strong as the one implied by the budget for the

whole year, and the containment in spending is largely due to a reduction in investment and

purchases of goods and services that appear to have been restrained by the late entry into

force of the 2016 budget on 31 March. The corresponding underspending was broadly offset

by increases of interest payments and compensation of employees above the budget targets

pointing to several challenges for the full-year achievement of the budget target. These are

aggravated by the series of budgetary measures that are backloaded towards the second half of

the year (quarterly reversal of public sector wage cuts, 35hour week from 1 July, VAT rate

reduction on meals in restaurants).

kom (2016) 0520 - Ingen titel

Progresses in fiscal structural reforms have been mixed.

The short-term sustainability of

the pension system is not yet ensured and is further challenged by the government's reversal

of expenditure-saving measures. Arrears in the health sector are still very high which calls for

a more effective enforcement of the Commitment Control Law, while the implementation of

the new Budgetary Framework Law (BFL) to be completed by 2018 is experiencing

important delays. Revenue administration is proceeding with its reforms and a series of tax

policy shifts' foreseen in the plans of the new government are under study. Recent

backtracking in reforming state-owned enterprises (SOEs) and partial reversal of a

privatisation may entail fiscal risks. As structural consolidation in Portugal requires a durable

reduction of the high level of public expenditure, a comprehensive spending review with a

clear political mandate and a set target for savings would be crucial.

4. P

ROPOSED NEW FISCAL ADJUSTMENT PATH

Table 3 summarises the main elements from the Commission 2016 spring forecast that

underpin the new adjustment path.

Table 3 – Forecast of key macroeconomic and budgetary variables under the baseline scenario

2015

Real GDP growth

Output gap

General government balance

Structural balance

Change in structural balance

Source: Commission 2016 spring forecast

2016

1,5%

-1,1%

-2,7%

-2,2%

-0,2%

%GDP

pps

1,5%

-2,3%

-4,4%

-2,0%

-0,6%

Taking into account the available time span and heightened risks to the macro and

budgetary outlooks, additional measures of 0.25% of GDP could be considered in order

to ensure that the public deficit remains under the 3% reference value.

Under heigthened

risks to the outlook and a still fragile financial system, an adjustment higher than the one

envisaged in the authorities' budget would be warranted to ensure a durable correction of the

excessive deficit for 2016. Taking into account the time span available for the correction and

considering the possible secound round effects of a fiscal adjustment in the current economic

context, the Commission is of the view that an adjustment that entails an unchanged structural

balance with respect to 2015 would realistically bring the deficit durably below 3%.

Compared to the baseline of the spring forecast, the proposed adjustment path would imply a

reduction of the headline deficit to 2.5% of GDP. This adjustment path would be consistent

with 0.25% of GDP additional measures to those implied in the baseline scenario. Taking into

account the second-round effects on economic growth of the additional consolidation

measures needed, GDP growth would reach about 1.3%. Besides the measures included in the

2016 Budget, Portugal shall consider the expenditure control mechanism in the procurement

of goods and services, which is currently highlighted in the 2016 Stability Programme. In

addition, Portugal should focus on revenue side measures aiming at increasing the yields of

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indirect taxation by broadening the tax base and reducing tax expenditures. One way to

achieve this could be by adjusting the still broad use of reduced VAT rates.

Table 4 – Forecast of key macroeconomic and budgetary variables under the EDP scenario

2015

Amount of measures

Real GDP growth

Output gap

General government balance

Structural balance

Change in structural balance

Source: Commission 2016 spring forecast

2016

0,2%

1,3%

-1,3%

-2,5%

-2,0%

0,0%

% GDP

%GDP

pps

1,5%

-2,3%

-4,4%

-2,0%

-0,6%

5. C

ONCLUSIONS

On 12 July 2016, in compliance with Article 126(8) TFEU and following a Commission

reccomendation, the Council issued a decision establishing that no effective action had been

taken by Portugal in response to the 2013 Council recommendation. Hence, as prescribed by

Article 126(9), the Council upon Commission reccomendation, shall give notice to the

country to correct its excessive deficit, indicating the adjustment path.

Within this context, and taking into account the country's current macroeconomic conditions,

achieving an unchanged structural adjustment which entails 0.25% of GDP of additional

measures appears justified. This would lead to a headline deficit of 2.5% in 2016.

kom (2016) 0520 - Ingen titel

NNEX

– S

TANDARD TABLES

Table 5 – Forecast of key variables for the computation of the fiscal effort under the baseline

scenario

2016

Enters top-down

Structural expenditure (% of potential GDP)

Potential GDP growth (%)

Current revenue (national currency)

Discretionary measures wih impact on current revenue (national currency)

Nominal GDP growth (%)

p.m Elasticity on current revenue

p.m Output gap (% of Pot. Output)

Discretionary measures wih impact on total revenue net of one-offs and

other temporary measures (national currency)

Total expenditure net of one-offs and other temporary measures (national

currency)

Interest expenditure (national currency)

Total unemployment

Unemployment benefits (national currency)

45.7

0.3

79,355.8

-257.0

2.8

1.0

-1.1

-252.0

86,033.0

8,221.4

594,900.0

2,684.5

Source: Commission calculations based on spring 2016 forecast

Enters bottom-up