The direct and indirect policy support helped weather the economic shock. Job retention measures limited job losses. At 6.3% in the third quarter of 2021, the unemployment rate stands below its pre-crisis level (6.5% in 2019). Supportive monetary policy in the euro area, and a broad range of measures, including state loans guarantees, grants, tax deferrals, and the moratorium on credit repayments of firms and households affected by the pandemic prevented a sudden rise in insolvencies and credit defaults.

The economic outlook critically hinges on the evolution of the pandemic, especially the effectiveness of vaccines against virus variants. While the vaccination rate is the highest in the OECD, the recovery is fraught with high uncertainties (Table 1). Persistently weak economic activity due to supply disruptions and restrictions to contain the pandemic may trigger further job losses and bankruptcies of financially vulnerable firms.

Fiscal and monetary policies need to remain supportive until the recovery is firmly underway. Agile policy responses to fast changing economic developments will be key to limit losses in productive capacity and negative hysteresis effects on the labour market. Further grants and equity injections into distressed but viable firms can support the recovery. An effective and rapid implementation of the Next Generation EU Plan can sustain economic activity while addressing long-lasting vulnerabilities of the economy. Projects that have the strongest positive economic and social impact should be prioritised.

The crisis risks increasing poverty and inequality and puts huge pressure on the healthcare system. Ensuring an inclusive recovery will require strengthening health and labour market policies.

The pandemic has disproportionately hit contact-intensive sectors employing a high share of workers with precarious work contracts, and limited access to social protection (Figure 2). Public employment services need to adapt to new circumstances surrounding the labour market, including higher unemployment among youth. Capacity to reach out those detached from the labour market, especially the youth, needs to strengthen, as the share of jobseekers using employment services is among the lowest in the OECD. Improving the coverage of unemployment benefits by further easing strict eligibility conditions can help. Further efforts to expand training programmes and adapt them to labour market needs will also be key to facilitate labour mobility and improve employability of displaced workers. The inclusion of measures to address youth unemployment and precarious employment conditions in Portugal’s Recovery and Resilience Plan is thus welcome.

The pandemic has exposed important vulnerabilities in the healthcare sector. During the third wave of the outbreak around the end of 2020, public hospitals almost reached full capacity, delaying access to healthcare. Staff shortages of nurses and long-term care workers are large and workload on healthcare professionals has increased substantially. The pandemic has accentuated mental health problems, calling for a rapid strengthening of policies in this area.

Policy action needs to tackle new financial and fiscal risks. Efforts to establish the foundations for a greener economy should be strengthened.

Insolvencies risk surging after the phase out of public support. A large share of Portuguese firms are small, undercapitalised, and vulnerable to economic shocks. The moratorium on credit repayments covered around a third of bank loans to non-financial corporations before being phased out in September 2021. Quasi-equity instruments or provision of non-refundable grants can reduce the risk of a surge in defaults and debt overhang. Past reform of the insolvency regime improved its effectiveness and should facilitate firms’ restructuring. The use of out-of-court procedures has remained limited though, and a large backlog of cases poses the risk of court congestion in the future.

Increases in credit defaults can weigh on banks’ profitability and curtail credit supply needed to finance investment. The regulator and the supervisor have strengthened incentives for banks to limit the accumulation of non-performing loans in their balance sheets. Measures supporting the development of secondary markets for non-performing loans would also help with the disposal of impaired assets. Policy options include establishing a national asset management company.

Once the recovery is well established, Portugal needs to announce a credible and transparent medium-term fiscal consolidation strategy. Public debt exceeds 130% of GDP and is one of the highest in the OECD. Fast population ageing weighs on public finance and risks to sustainability have accentuated with the rise of contingent liabilities. The pension system needs to adapt to contain future increases in age-related costs.

The modernisation of the budget framework, including the implementation of performance budgeting, is crucial to ensure an efficient use of public funds, including those provided by the EU. Enforcement of the 2015 Budget Framework Law, one of the objectives of the Recovery and Resilience Plan, needs to accelerate and the capacity to monitor and evaluate policies needs to improve to shift spending to productive uses.

The Next Generation EU is a unique opportunity to put growth on an environmentally sustainable path. Reducing water abstraction remains a key priority, calling for further investments in upgrading existing water infrastructure. Reaching the ambitious target of becoming a carbon neutral economy by 2050 requires, as envisaged in the National Energy and Climate Plan 2030, a significant acceleration in emission abatement, including by further increasing electricity supply from renewables and greening the transport sector. Policy action must combine incentives to reduce environmental damages, investment support in less polluting activities and compensation measures for low-income households affected by the measures.

Intensifying the fight against corruption can foster inclusive growth. Preventing economic crimes has been high in the government agenda and the on-going implementation of the new national anti-corruption strategy is welcome. Strengthening the prosecution mechanisms and raising the accountability and integrity of senior public officials are priority.

A higher uptake of digital technologies – through better infrastructure and skills development – can boost potential growth. EU support could help speed up this change.

Digital technologies can contribute to speeding up the recovery, by boosting productivity and offering innovative solutions to adapt to behavioural changes triggered by the pandemic. Portugal has achieved impressive progress in the digital transition, but disparities in ICT adoption across firms and people remain large. The 2020 Digital Transition Action Plan that aims at tackling the digital divide is welcome as delays in technology diffusion, especially in small firms, hurt productivity growth and inclusiveness.

Communication infrastructure is of good quality but fibre deployment and coverage in rural areas should be improved. While fast-broadband subscriptions are among the highest in the OECD, there is room to expand the use of mobile broadband. Broadband prices are high by international standards, including for basic services, reflecting low competition pressures among service providers. Reducing barriers to consumer mobility between suppliers can improve market contestability.

Equipping the population with digital and foundational skills is crucial to embrace the digital transformation. A relatively large share of the population has low education levels and only one third of Portuguese have above basic digital skills (Figure 3). The lack of digital skills is particularly pronounced among older workers and low-educated people. Despite some progress in the past, more women could graduate in ICT fields. The scope of the comprehensive and ambitious initiative to develop digital competences “Incode2030” will expand with the implementation of the 2020 Digital Transition Action Plan.

Reform of the education and training systems needs to accelerate. A large share of schools and teachers are not well equipped to use and teach ICT. Inequality issues in education have accentuated with the pandemic. Efforts to develop teachers’ training and equip schools should continue. Despite ambitious measures to develop adult education, participation has remained relatively low, suggesting the need for increased incentives to uptake training, especially for workers in jobs more affected by the digital transformation. Policy avenues to promote adult education include providing personal training accounts with more generous vouchers for low-skilled workers, together with expanding the training offer by developing online courses and flexible pathways between qualification programmes further.

There is large room to increase investment in digital technologies and in complementary intangible assets in small firms. A range of measures is in place to foster the adoption of ICTs and to promote partnerships between firms and research institutes to stimulate innovation. Their scope should expand with the implementation of the Recovery and Resilience Plan. The multiplication of initiatives poses some risk of dispersion and efficiency losses, calling for a thorough evaluation.