Temporary fiscal support has been extended to cushion the inflation shock. Electricity, gas and fuel price subsidies have been raised, alongside social transfers and temporary energy tax cuts, some of which are targeted to low-income households. To maintain strong incentives for energy savings and the green transition, it will be important to increasingly target support to the most vulnerable households and phase out energy support measures.

Strong revenues from the rebound in activity and surging prices have improved the budget balance. The public debt ratio to GDP has fallen and Portugal’s relatively long debt maturity structure and the rollover of high-interest bonds are containing financing costs in the short term.

Inflation reached historical highs in 2022 as supply pressures broadened. Large increases in energy and food prices drove inflation to the highest level in over a quarter-century. Capacity use and input costs remain high. Yet, headline and core inflation started to decline in late 2022 (Figure 1).

Wage growth has picked up following the increase in inflation. Workers whose skills are in high demand, such as in the ICT and construction sectors, are experiencing stronger wage growth. The minimum wage increased by 7.8% in 2023 and is set to increase by 6.6% in 2024. This will support wage growth and the real incomes of many households, provided that the high level of employment of the recent past endures.

Bank lending to households and businesses has slowed and the quality of loan portfolios should continue to be watched closely. Gross household debt, mostly housing loans, was 90% of gross disposable income in 2022. Households are vulnerable to rising interest rates, with 89% of mortgages subject to variable rates. Risks surrounding corporate loan portfolios are also likely to rise with higher interest rates. Restructuring or insolvency processes have increased from a low level, and the planned implementation of a new insolvency framework has strong potential to support medium-term growth, especially in combination with efforts to accelerate judicial proceedings.

Public debt relative to GDP has declined below its 2019 level, although it remains high. More efficient spending will be key to face mounting fiscal pressures from population ageing and strong investment needs, notably to support the green and digital transitions.

The RRP includes reforms and investments with strong potential to support growth and more effective public sector management. Implementation has started, but supply-side disruptions, inflation, the size of the planned investments and the ambitious timeline present challenges. A rapid execution of projects should boost investment.

Looking ahead, Portugal needs to design and implement a credible and transparent medium-term fiscal consolidation strategy. Over the past decade, underinvestment in education, health and infrastructure has weighed on potential growth (Figure 2). Rising pension entitlements have outpaced other social expenditures, while the low level and coverage of minimum income benefits hold back progress on reducing poverty. Tax expenditures amounting to 6.2% of GDP often fail to support long-term growth, including many reduced value-added tax rates.

Improvements in fiscal governance would help to better prioritise public spending and ensure cost-effective investments. The modernisation of the budget framework, including the implementation of performance budgeting, is crucial to ensure an efficient use of public funds. The full implementation of the 2015 Budget Framework Law and of new accounting standards, one of the objectives of the RRP, needs to accelerate. The implementation of regular spending reviews should also help to shift spending to more growth-enhancing uses. The implementation of the national anti-corruption strategy for 2020-24 has made significant progress, and efforts need to continue to alleviate corruption risks and better monitor lobbying activities.

Potential growth and productivity gains have declined. Skill shortages have emerged and the working-age population is set to decline. Low investment weakens productivity and firms’ ability to seize new opportunities from the digital and green transitions.

Productivity growth will be key to improve future living standards (Figure 3). Micro firms account for close to 40% of business employment, and their limited management skills and low investment have held back productivity gains, while increasing R&D support did not generate the expected increase in innovation. Streamlining complex administrative processes as part of the public sector’s digitalisation efforts can improve the business environment. Reviewing regulations in professional services and retail trade will reduce costs and improve productivity for enterprises. Strengthening active labour market policies that focus on smaller firms, such as pre-screening candidates for vacancies, would improve the match between jobseekers and employers. Improving counselling to guide student’s study choices and adults’ reskilling and upskilling decisions would better align skill development with labour market needs.

Investment in the green transition should continue to reduce greenhouse gas emissions and strengthen climate resilience, in line with Portugal’s carbon neutrality goal. Strengthening carbon pricing, including by removing distorting tax benefits, while protecting vulnerable groups, and gradually tightening regulations on the use of fossil fuels and energy efficiency can provide policy certainty. This will be crucial to guide investments and productive capacities through this extended transition. Making buildings more energy efficient also promises large energy savings but requires a new mix of regulation, grants and loans, as well as sizeable upfront investments.

Recent increases in employment need to continue for Portugal to achieve more inclusive growth. Despite recent progress, 17% of workers and 59% of 15–24-year-olds were on temporary contracts in 2021. Enhancing the balance of protection across contract types by continuing efforts to restrict the use of temporary contracts and reducing the cost of dismissals would allow more workers to move into permanent contracts. The authorities should also closely monitor the effects of the planned increases in the minimum wage and, if needed, consider reducing employer social security contribution for low-wage workers to mitigate the impact of increases in labour costs.

Health gains have been impressive over recent decades and life expectancy is now amongst the highest in the OECD. At the same time, structural challenges include staff shortages, weak investment, an ageing population and high out-of-pocket payments. Improving spending efficiency and strengthening primary care and prevention would be ways to address these challenges.

The government has initiated key reforms for the health sector. The RRP and the 2022 framework law for the universal National Health Service reforms aim at moving away from a largely hospital-based system to one that will better integrate primary, community and long-term care. Effective implementation will be key to manage the rising impact of population ageing (Figure 4). Healthcare governance reform, also in the RRP, financial reporting and management should be based on sound accounting standards and multi-annual budgets, balancing medium-term health priorities with available fiscal space.

Investment spending and remuneration in the healthcare sector will have to rise. Waiting times are long, with complementary private insurance giving higher-income households better access to private providers. Past underinvestment in buildings and equipment is slowly being corrected but will take time to overcome fully. Long hours and low wages in the public sector have made it increasingly difficult to attract and retain medical staff.

Promoting prevention and cost-efficient behaviour through primary care providers will become a rising priority. Spending on prevention amounts to less than 2% of health spending. Around 12.8% of the population is not registered with a dedicated general practitioner and the excessive use of emergency rooms drives up costs without promoting better health outcomes. In addition, the organisation of primary care is fragmented with various public care centres and payment schemes that fail to encourage a systematic follow-up of patients from disadvantaged groups. Expanding the number of general practitioners and streamlining the different payment schemes for primary care centres would improve both access and quality.