Portugal: Selected Issues

June2023 PORTUGAL SELECTEDISSUES IMFCountryReportNo.23/219 ThispaperonPortugalwaspreparedbyastaffteamoftheInternationalMonetaryFundasbackgrounddocumentationfortheperiodicconsultationwiththemembercountryofPortugal.ItisbasedontheinformationavailableatthetimeitwascompletedonJune1,2023. Copiesofthisreportareavailabletothepublicfrom InternationalMonetaryFundPublicationServicesPOBox92780Washington,D.C.20090Telephone:(202)623-7430Fax:(202)623-7201 E-mail:publications@imf.orgWeb:http://www.imf.orgPrice:$18.00perprintedcopy InternationalMonetaryFundWashington,D.C. ©2023InternationalMonetaryFund June1,2023 PORTUGAL SELECTEDISSUES PreparedByKamilDybczak,IppeiShibata,VolodymyrTulin,andLauraValderrama,withresearchsupportfromPaulTershakovec. ApprovedBy RupaDuttagupta CONTENTS INFLATIONINPORTUGAL,RECENTTRENDS,DRIVERS,ANDRISKS3 A.StylizedFacts3 B.DriversofInflation-ThePhillipsCurve5 C.InflationProjections8 D.IsThereaRiskofaWage-InflationSpiral?10 E.Conclusions11References12 ANNEXES I.ComponentsofHICPInflationinPortugalandEA13 II.InflationDifferentialbetweenPortugalandEAacrossComponents15 III.HICPInflationWeightsinPortugalandEA17 OPTIMALFISCALPATHCONSIDERATIONS19 ANNEX I.ModelDetails22References24LABORMARKETANDDIGITALIZATIONINPORTUGAL25 FIGURES 1.AggregateLaborMarketDynamics25 2.EmploymentImpactDuringCOVID-19byWorkerandJobTypes26 3.DigitalEmploymentinPortugal27 PORTUGAL 4.COVID-19ImpactonDigitalEmploymentShare28 5.ShareofSkilledWorkers29References30 HOUSEHOLDVULNERABILITIES,FINANCIALSTABILITY,ANDTHEROLEOFPOLICIESIN PORTUGAL31 A.Introduction31 B.StressTestingHouseholdBalanceSheets32 C.ImpactonBankCapital35 D.TheEffectofPolicies35 E.ConcludingRemarksandPolicyImplications37 FIGURES 1.VulnerabilityIndicatorsintheResidentialRealEstateMarket39 2.RisingInterestRatesareHurtingAffordability40 3.TenureStatusandBorrowers’Vulnerability41 4.VulnerableHouseholdsAreatDefaultRisk42 5.SimulationResults–HouseholdVulnerabilitybyIncomeandTenure43 6.SimulationResults–TheEffectofPolicies44References45 ANNEXES I.AssessingHousePriceOvervaluation46 II.TechnicalAspectsoftheModel47 2INTERNATIONALMONETARYFUND INFLATIONINPORTUGAL,RECENTTRENDS,DRIVERS,ANDRISKS1 A.StylizedFacts 1.Beforetherecentenergycrisis,inflationinPortugalwasrelativelylow.Forthemostpartofthelastdecade,headlineandcoreinflationhoveredbelow2percent.Adisinflationtrendwaspresentinsomeofthecomponentsoftheharmonizedindexofconsumerprices(HICP,AnnexI).2 2.Whilebelowaverageeuroarea(EA)levels,inflationhasbeenstronglycorrelatedwiththerestoftheEA.Since2010,untiltheenergycrisis,Portugal’sheadlineandcoreinflationwerebelowtheEAlevelmorethanhalfthetime,mostlydrivenbynon-energyindustrialgoodssuchasclothingandfootwear.ThesetrendscontinuedduringtheCovidpandemic,partlyreflectinganalmost10percentdeclineintourism-relatedprices—e.g.,transport,andhotels,cafés,andrestaurants—andhigherweightoftheseitemsinPortugal’sHICPbasket,resultinginPortugal’sinflationfallingfurtherbelowtheEAlevel(AnnexII). 1PreparedbyKamilDybczakandIppeiShibata 2Wedefinecoreinflationasheadlineinflationexcludingenergyandunprocessedfoodprices. INTERNATIONALMONETARYFUND3 3.However,theinflationdifferentialwiththeEAcannotbefullyexplainedbydifferencesinweightsofindividualHICPitems.ThestructureofPortugal’sHICPbasketissimilartothoseinotherEAcountriesandtheweightsarebroadlycomparableacrosscountries,despitesomedifferences(AnnexIII).Forexample,theweightoffoodandnon-alcoholicbeveragesinPortugal’sHICPbaskethasbeenabovetheEAlevelsince2012(atover20percent),whiletheweightofhousing,water,electricity,andgasrepresents10percentincaseofPortugal,itis16percentfortheEA.Despiteallthesedifferences,assumingtheaverageEAweightswereimputedtoPortugal,inflationinPortugalwouldbeonlyabout0.2ppaboveitsactuallevelin2021and2022.3 4.Inflationpickedupslowlyin2022H1,reflectingdelayedpassthroughfrominternationalcommoditypricestoheadline,butacceleratedquicklyin2022H2.Thepassthroughfromrisingenergyprices(betweenend2021toearly2022)toPortugal’spriceswaslesspronouncedthaninaverageEAcountry(about9percentincreasey/yinPortugalcomparedtoabout47percentforEAinMarch2022).Thismainlyreflectedpolicymeasures,suchasthereductioninnetworkaccesstariffsandotherpolicies(taxexemptionsonfuelexcisesandVAT,andtheIberianpricecapwereannouncedinmid-2022andcameintoeffectinH2).Eventually,headlineinflationacceleratedandafterpeakinginOctober2022(10.6percenty/y),ithasbeenonagradualdownwardpath.Incontrast,coreinflationexceededEAlevelinearly2022,andhashoveredaround8percentsinceSeptember2022,pointingtoastickierandmoreentrenchedinflationarypath. 5.Consumerpriceexpectationshavefollowedtrendssimilartothoseinheadlineinflation,4pickingupfromearly2021,and eventuallyexceedingEAaveragesbyend-2022.Theystarteddecliningduring2022H2,keepingrisksofsecondroundeffectsfromtheinitialcommoditypriceshockwellcontained. 6.TherestofthisnoteanalyzesdriversofpricedynamicsthroughthelensofaPhillipscurveestimation.Theanalysisprovidesamodel-basedforecastofheadlineandcoreinflationusingassumptionsfromtheJanuary 2023WEOandconductssensitivitya