Portugal: 2015 Article IV Consultation-Staff Report; Press Release; and Statement by the Executive Director for Portugal

EXECUTIVE SUMMARY The recovery is addressing flow imbalances from past current account and fiscal deficits, but stock vulnerabilities from public, private, and external debt remain high. The unemployment rate has retreated from its crisis peak, growth has resumed, and the current account is posting surpluses for the first time in decades. At the same time, a durable rebalancing of the economy has not taken place and the nontradable sector is still dominant. The strength of the economic recovery remains modest, the labor market slack large, and there are still material vulnerabilities, notably, high leverage in the public and corporate sectors, and high external debt. Portugal is benefiting from favorable cyclical tailwinds, but growth is projected to moderate in the medium term. The initiation of ECB's expanded asset purchase program pushed sovereign yields to record lows and effectively eliminated any remaining financing concerns. It should also help to raise inflation over the forecast horizon. A sharply weaker euro and lower oil prices have improved the short-term outlook. In the medium term, growth is projected to moderate, as several remaining challenges, notably low investment, high leverage, and structural bottlenecks still need to be decisively addressed. The authorities should use this opportunity to strengthen the economy's resilience and raise its growth potential. Fiscal adjustment should continue, with an emphasis on expenditure rationalization by way of a comprehensive reform of public sector wages and pensions. To maintain financial stability and allow for an efficient allocation of resources in the economy, the authorities should adopt a more proactive approach led by banks to the deleveraging process. Finally, in the context of rigid labor markets and limited domestic competition, the authorities must implement additional structural reforms to absorb the large labor slack and spur economic growth.