Portugal’s boom and bust: lessons for euro newcomers

The Portuguese economy has shown a rather striking evolution in the last ten years. In the run-up to EMU in the second half of the 1990s, Portugal posted impressive results in both the real, budgetary and monetary areas. Its GDP per capita grew faster than the EU average and met the Maastricht criteria for EMU in good times. However, from 1999 the economy started to slow down and in early 2002 entered recession. Economic activity shifted from the tradable to the non-tradable sector with a corresponding loss of competitiveness, while public finances deteriorated: since 2001/2 Portugal has mostly been in excessive deficit. Inflation has remained above the EU average, unemployment was rising until recently, and households' indebtedness increased significantly in the first few years of the century. The strong demand stemming from the sharp fall in interest rates was fuelled further by budgetary policy in the nineties and early this decade. Demand was not followed by a parallel increase in potential supply, mainly due to insufficient reforms preventing productivity growth from supporting catching-up dynamics. Imports rose substantially, leading to high external deficits and debt. Over time higher external indebtedness led to lower domestically available income. The Portuguese example of demand led real convergence relative to supply side catching-up in EMU may provide important lessons for new Member States joining EMU.