Portugal must comply with EU budget spending rules

Mário Centeno, perhaps the best Governor of the Bank of Portugal the country has seen in 25 years, warned that continued uncertainty over tariffs could undermine growth in the Portuguese economy this year and next at a luncheon organised by the International Club of Portugal (ICPT) on Friday.

Text: Chris Graeme; Photos: Fernando Bento (ICPT)

Portugal’s economy is in better shape compared to a decade ago during the Great Recession (2011-2014) because of the past efforts of its governments and central bank governor to employ disciplined public spending, encourage a well-capitalised banking system with high levels of deposits, sufficient levels of savings to leverage investment projects, and a notable sovereign debt reduction, but nevertheless needed to use “all the instruments at its disposal” for this to continue to be the case.

However, Portugal could not afford to go back to the bad old ways of the past when it failed to keep to the EU’s strict budgetary spending rules by as much as 80% of days in the year since 2007.

Member States are  subject to fiscal rules under an EU Treaty, which require them to keep their budget deficits below 3% of GDP and their public debt below 60% of GDP. These rules are designed to ensure the financial stability of the Eurozone and to prevent excessive borrowing by the Member States.

Portugal’s average budget deficit between 2000 and 2019 was approximately -4.18% of GDP. This means that on average, the government spent more than it collected in revenues over that period. The deficit peaked in 2010 at -11.40% of GDP and improved to a surplus of 1.20% of GDP in 2023, a pattern which Mário Centeno is keen to preserve.

This was the message from the governor of the Bank of Portugal who addressed business leaders at a lunch-debate organised by the International Club of Portugal (ICPT) at the Sheraton Lisboa Hotel & Spa on Friday (June 6).

Crunching the Bank of Portugal’s forecast numbers for Portugal’s GDP economic growth published in its economic May bulletin that morning, which now is projected at 1.6% in 2025, compared to an estimated 2.3% stated in its March bulletin, and a forecast of 2.4% that the government had suggested in its progress report sent to Brussels, Mário Centeno warned that even this downwards revision for Portugal’s growth would be difficult to achieve by the end of the year unless month-on-month growth remained fairly strong for the rest of the year.

And this would be a tough call as Mário Centeno warned that the prospects for Portugal’s economy were enveloped by uncertainties, not least from the fallout from US tariffs.

Portugal’s economy susceptible to exterior factors

In terms of economic policy Portugal – and the aim of economic policy was to create predictability – had unfortunately been dependent on exterior factors beyond its control that had created this uncertainty, including the War in Ukraine, while monetary policy had been geared towards countering inflationary pressures that had not been seen in economies for over 40 years.

“More than half of our population has never experienced inflation and its effects on daily life, and this has created more uncertainty,” said the former Minister of Finances and Eurogroup head.

However, Europe had succeeded in effectively and successfully responding to inflation, bringing it down to ECB targets of 2%, but at a cost. “When you raise base interest rates by 4% (since 2020) you cannot expect this not to have an effect,” he said.

Fortunately, unemployment did not increase, he added, while the cost was contained. But now the Portuguese economy was faced with a new wave of challenges generating tension, such as the United State’s position over Europe, trade, and even the situation with the  US dollar.

The European Central Bank on Thursday cut its main interest rate again, citing slowing price rises. The widely anticipated move takes the ECB’s main rate to 2%, from 2.25% previously, and marks the eighth time the central bank has slashed borrowing costs since last June as inflation has tumbled from four-decade highs.

Portugal’s growth outperforming Europe

And the euro had appreciated against the dollar, up 0.18% after rising to as high as US$1.1495, a fresh six-week high against the dollar, not far from the more than 3-year high of US$1.1573 touched on April 20, bucking the usual trend.

This leads one to ask how from a financial point of view the world will be in a few months time and Europe has “a unique opportunity to have a stronger role on the international financial system that it didn’t have”, he suggested.

“I’m not saying that it (the euro) will replace the dollar, but it opens the possibility for the euro to broaden its influence internationally and this would be an advantage”, he continued.

And Portugal has had an economic growth performance that has exceeded the rest of Europe over the past decade.

“Our labour market and employment rate during this period had grown more than Europe, creating a million jobs, growing from 4 million to 5 million in the labour market because companies created jobs and increased salaries, enabling the Portuguese economy and society to enjoy a performance that has been greater than the rest of Europe”.

The Governor of the Bank of Portugal admitted that Europe had a growth problem due to a lack of investment; investment that wasn’t growing partly because of an increase in interest rates and a lack of confidence.

In Portugal economic growth was negative (1.6% from 2.8% in 4Q of 2024) while in the second quarter the country would likely suffer from some difficulty in growing the economy.

This 1.6% forecast for 2025 is being achieved because of a rapid recovery on the 1 Q fall,  but keeping growth was not an easy task because of these external factors providing a lack of clarity and putting the brakes on European economies in general.

80% of days in non-compliance

The challenge lies in Portugal’s capacity in the coming months to prolong the positive labour situation before the weak performance of the economy kicks in and jeopardizes it. Portugal also achieved its growth because of a reduction in the sovereign debt. Portugal’s gross government debt to GDP ratio was at 95.3% in 2024, according Bank of Portugal figures.

This was the lowest level in 14 years. The World Bank’s data shows the ratio at 91.79% in 2025, with a projected decrease to 75.85% in 2030. In 2024, Portugal’s general government balance recorded a surplus of 0.7% of GDP, according to economy-finance.ec.europa.eu

“We had to do it (cut the national debt) because of the financial crises that we had had and that were caused by the (sovereign) debt crisis that we had, but today we are now in a more advantageous situation”, he said.

The focus for the future, said Centeno, had to be on “education and qualifications and a continued renewal of the workforce”, as well as “continued efforts (at fostering) financial stability”.

“Portugal spent 80% of annual days in non-compliance of EU budget rules to May 2007. “This is an inheritance and situation that was extremely negative for the country and its image and showed the great divergence that we had with the EU”.

“It was very important to invert this situation and ensure that it never happens again, and we’re aware of this. Our exports during this period have risen from 30% to over 50%, but this makes us more vulnerable to these fluctuations from trade tensions that we are experiencing now, but against which we have been able to display some resilience”, he remarked.

The opinion was timely since that same day Mário Centeno had warned that current State spending was growing at a pace that could again put Portugal on a track to non-compliance of European rules by causing a deficit in public accounts.

On the positive side Mário Centeno said the cycle of interest rate fluctuations was stabilising. “I think we can say with some certainty that interest rates will stabilise at around 2% and that investment plans can be made with some predictability.”

European investment bonds?

Fielding questions from the floor on the impact of tariffs, Mário Centeno said that they had negative impacts on the economic scenario with inflationary impacts for the US, but also Europe which, if it didn’t react to the bait, would end up with a greater slice of international trade with the US having a reduced presence in this trade balance.

“This has brought some new mechanisms that have brought some uncertainty regarding their durability. For example, demand for assets in euros has increased, outstripping the sum of assets demand in euros seen in the previous two years (2023-2024). There is more interest in the euro globally. There is a separation historically that hadn’t happened between exchange rates and the increased value in the market for US sovereign bonds”, said Mário Centeno.

To really leverage this we would have to issue European sovereign bonds which is tricky. The EU does not issue sovereign bonds (meaning bonds directly backed by the authority of the entire Union), because its funding is primarily derived from contributions from its Member States, not through borrowing in capital markets.

“We did it in 2020 (Recovery and Resilience Facility), but it would be difficult to do so again against the context of increased defence spending”, he warned.

“If we did issue truly European bonds we could benefit from this gap (with the US) to our benefit because all of the money leaving the US would seek secure assets in Europe,” said Mário Centeno.

On the question of whether Social Security funds should be channelled into investment funds during a period of uncertainty to increase its capital returns, the Governor of the Bank of Portugal said the answer was not an easy one.

Some argue that investing in private assets like stocks could yield higher returns and reduce the need for future tax increases or benefit cuts. Others express concerns about potential risks, including market volatility and the possibility of interference with private markets.

Europe funnels many billions of euros of its savings in investments outside of Europe. In the domain of social security funds and private savings there are many European savings funds investing in the US.

“We must impose specific regulatory requirement criteria in this area, but we must complement this by creating in Europe the necessary conditions for savings to be invested in Europe and this question has been discussed for many years as part of a European Capital Union”, explained Mário Centeno.

The question is particularly timely since a former Minister of Finances, Maria Luís Albuquerque – currently the European Commissioner for Financial Services and Union for Savings and Investments – has suggested that Eurofi (a European think-tank for financial services) members and the current EU Commission could decide to invest European savings within Europe or on the stock market while offering tax incentives. The money could be invested, for example, on armaments production, as European NATO countries have to up their defence spending to around 5% of GDP.

“This challenge (to invest in Europe) should be taken seriously, because Europe saves a significant part of its revenues, but we don’t have these savings at the service of Europe but in the US on data centres and artificial intelligence,” said the mathematician and economist.

“This has to be done without putting the financial balance of social security systems at risk, and currently we have very significant social security surpluses which are public funds for the future to be saved, invested and spent in the future.”

On monetary and budgetary policy the Governor of the Bank of Portugal said that fortunately today – unlike the time of the sovereign debt crisis – there was a coordination (if not cooperation) of budgetary and monetary policies in Europe that was much more effective than int had been 10 years ago.