Portugal: A Eurozone Turnaround

Tourism is booming in Portugal and exports are strong, as are investments in the economy as a whole. After its deepest economic crisis in four decades, Portugal is doing much better, helped by neighboring Spain, and seems on its own way to becoming a rare turnaround story at the eurozone periphery.

“Several factors are supporting economic activity,” notes Carlos Andrade, chief economist at Novo Banco in Lisbon. “The country is taking advantage of a cyclical recovery in Europe, with most exports going to its euro-area partners.” Its main trading partner, Spain, has GDP growth of 3%, well above the EU average of 1.7%, bringing its GDP back to precrisis levels.

Portugal’s gross domestic product posted positive growth for 13 consecutive quarters and in 2016 expanded by a yearly rate of 1.9%, the highest reading in more than six years. In its latest outlook, Bank of Portugal raised its forecast for 2017 economic growth to 1.8% from an earlier 1.4%, saying that rising investment and strong exports will sustain economic expansion. Private estimates are betting on even higher growth for this year and next.

“We expect GDP to grow 2.6% in 2017, the fastest pace since the mid-2000s, supported by private consumption but mainly by strong export and investment growth,” António Vieira Monteiro, CEO of Banco Santander Totta, tells Global Finance. “These two drivers will keep pushing the economy during the next few years, with estimated growth around 2% in 2018 and 2019.”

The recovery is also powered by Portugal-specific elements. Tourism revenues rose 12.4% in the first quarter of 2017. “I believe there is something structurally new in the tourism sector,” Andrade says. “Demand has increased significantly, and supply has responded to this in both quantity and quality. There are more investments and more people working [in the industry].”

Media reports that Italian actress Monica Bellucci bought a house in Lisbon and that pop star Madonna bought a historic 18th-century mansion in the resort town of Sintra are sparking public interest. Portugal appears to be in fashion in recent years, helped by an income tax treatment that attracts retirees from the rest of Europe and the world. “Non-Habitual Residents”—defined as those who live there more than 183 days a year and whose income is from a non-Portuguese source—do not pay taxes on their pensions for 10 years after moving to Portugal.

A less fashionable but nonetheless solid factor in Portugal’s economic recovery has been the government’s strong fiscal discipline. Led by Socialist prime minister António Costa, the government ran a budget deficit of just 2% of GDP last year—despite an increase in public pensions and wages—down from 11.2% in 2010. The news prompted the European Commission’s decision that Portugal be allowed to exit the Excessive Deficit Procedure.

“The decline in the public deficit in Portugal was a strong signal given to investors, a move that reinforced confidence in our country,” says Santander Totta’s Vieira Monteiro. “If we can maintain this trend, I am sure that a balanced budget will be a reality.”

Moderately expansionary fiscal policy in 2015 and 2016 tamped down the structural primary surplus (the budget balance before the payment of interest on debt) but also gave some support to economic activity, according to economists. The government is expected to continue with moderate spending, maintaining its solid support from two leftist parties—the Left Bloc and the Communist Party—that might otherwise be inclined to agitate.

“The lack of this traditional confrontation between the extreme left and the unions on one side, and the government on the other side, has softened the news flow, which I guess also results in improved confidence indicators,” says Andrade.

A vulnerability remains in Portugal’s weak banking system. In 2014 and 2015, the state had to rescue two lenders: the largest private lender, Banco Espirito Santo (BES), whose healthy business was repackaged under Novo Banco; and Banco International do Funchal (Banif). The latter was eventually bought by Santander Totta. Still, a high stock of nonperforming loans (NPL) and assets weighs on investor perception. “Although the prospects for the Portuguese economy have improved … the high public- and private-sector indebtedness and low potential growth continue to pose risks to financial stability,” the Bank of Portugal commented in a financial stability report in June.

Analysts say that banks have progressed and will soon be ready to finance economic recovery. First, their liquidity and capital reserves are higher. The loan-to-deposit ratio was above 150% in 2010, at 135% in 2011 and is now around 100%. On the capital front, not only did Portugal’s largest listed bank, Millennium bcp, complete a €1.33 billion ($1.5 billion) capital increase earlier in February, but the fully state-owned Caixa Geral de Depositos reinforced its capital position by €4.4 billion.

From a structural point of view, Portuguese banks are prepared to provide financing support to the country’s economic expansion. However, loan growth will remain subdued in the coming quarters due to nonperforming loans.

“There is still some work to be concluded on the nonperforming loans, as there are some areas on the corporate side where NPLs are close to 30%. The average NPL ratio for the corporate sector is 15%,” says André Rodrigues, analyst at Caixa - Banco de Investimento, a subsidiary of Caixa Geral de Depositos. “It is clear that the focus of the banking sector is the reduction of these problematic assets.”

He says Portuguese banks are willing to support the country’s economic expansion, but a few hurdles will keep that support muted in the near term. “As time goes by, the stock of NPL will decline and the coverage ratios will continue to increase,” he explains, “so banks will become more willing to give new loans.”

The decline in lending hasn’t been even across sectors. Total loans have declined over time, since the end of 2014 when the recovery gained momentum. But main economic sectors, including manufacturing, have seen a lesser decline in loan availability; while others, such as real estate, have seen a more massive decrease of loans.

For some, it’s good timing for reform. “It is the right moment to implement the reforms we need, such as more labor market flexibility, less red tape and less state intervention,” said Jose Brandao de Brito, chief economist at Millennium bcp. “It would be a good time to review all these supply-side elements.”

Such impetus could help Portugal attract more investment from abroad. Lisbon has often been tapped as a new hub for tech start-ups in Europe, and businessmen are trying to leverage the low cost of educated labor and land to turn the economy around.

“Portugal has been developing its capacity to innovate in several areas. We have in our country an enviable number of university students with the training, creativity and willingness to develop this potential for innovation and entrepreneurship,” says Vieira Monteiro at Santander Totta. “This is why we have emerged, in recent years, as one of the most attractive countries in Europe for the incubation and acceleration of start-ups. Our attractiveness has to do with the quality of our human resources and the excellence of our higher education.”

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