2. Compared to the previous projections published in the Economic Bulletin of April 2014, GDP growth was revised slightly downwards for 2014 (-0.1 pp) and slightly upwards for 2015 (+0.1 pp), remaining unchanged for 2016. This revision takes into account actual information for the first quarter of 2014, with a less favorable outcome than projected. These recent developments were partly conditioned by temporary factors that should be reversed in the following quarters. The inflation projection was also revised downwards for 2014 (-0.3 pp). This pattern of forecast revisions for economic activity and prices is also common to other euro area economies.

3. The moderate recovery in economic activity reflects a more dynamic domestic demand and the maintenance of a strong growth in exports. Domestic demand will continue to be constrained by fiscal consolidation and the need to reduce private sector indebtedness. In turn, exports of goods and services should benefit from a recovery in global economic activity, particularly in the euro area, and are expected to reach about 45 percent of GDP in 2016 (12 pp more than in 2008).

4. The Portuguese economy will continue to strengthen its net lending vis-à-vis the rest of the world, with an expected improvement of the current and capital account to 2.8, 4.0, and 4.3 percent of GDP in 2014, 2015, and 2016, respectively. These surpluses should allow improving the negative international investment position.

5. The risks surrounding the projection for economic activity are on the downside, reflecting external factors (including the possibility of less buoyant external demand, higher oil prices or euro depreciation) and internal ones (especially lower gains in export market shares). In turn, the overall balance of risks is slightly on the upside in relation to inflation, particularly for 2015 and 2016, due in particular to upside risks on oil prices.

6. For the coming years, the potential growth of the Portuguese economy will continue to be conditioned by some structural constraints. At the present context it is critical to:
- Ensure a level of consumption consistent with income in an intertemporal horizon;
- Ensure public policies targeted to create incentives for innovation, factor mobility and investment in physical and human capital. In particular, create attractive conditions for new FDI projects incorporating technological progress to enhance the productivity and competitiveness of the tradable goods sector;
- Continue the fiscal consolidation process, with strict adherence by the authorities to the commitments under the Stability and Growth Pact and the "Fiscal Compact".

7. Only a long-term perspective ensuring the intertemporal consistency of the full set of policies, as well as a stable institutional framework, which anchors the agents’ incentives for an extended period, can provide the necessary conditions for sustainable growth and for the resumption of the real convergence process between Portugal and the euro area average.

This Bulletin includes a Special Issue focusing on "Main issues on the sustainability of public finances in Portugal in the medium term". The results of the analysis make clear that:

1. Notwithstanding the significant consolidation effort in the past three years, which allowed achieving a primary balance close to balance, the adjustment of public accounts is not yet complete. Indeed, the public debt ratio reached a value close to 130 per cent of GDP in 2013, and its reduction requires a sustained accumulation of primary surpluses over several years. Additionally, the pressures on the public finances in the near future, in particular the increasing interest expenditure and the elimination of measures of a transitory nature, are very significant.

2. Additional fiscal consolidation measures have to ensure the downward trend in public debt and simultaneously take into account the pressures on public finances. The estimates identify the need of an additional adjustment of around 4 percentage points of GDP by 2019, which corresponds to about half of the fiscal consolidation effort in 2011-2013. About a quarter of this necessary adjustment refers to substitute measures to wage cuts in the public sector and to the Extraordinary Solidarity Contribution on pensions. Moreover, in the medium to long term, Portugal will face, due to demographic developments, increasing pressures on public expenditure, which require additional fiscal buffers.

3. The commitments undertaken at the European level are the appropriate guidelines for national fiscal policy: the fulfillment of these commitments allows the public debt ratio to move to a downward trend, though very gradual. Still, the savings in interest expenditure resulting from the decrease in the debt stock in this scenario allow accommodating the pressure coming from the age-related expenditure.

As usual, the Economic Bulletin includes four signed articles, authored by Banco de Portugal economists or co-authored with external researchers. The articles, which are the sole responsibility of the authors, are the following:

• "The 3D Model: a framework to assess capital regulation", by Laurent Clerc, Alexis Derviz, Caterina Mendicino, Stephane Moyen, Kalin Nikolov, Livio Stracca, Javier Suarez and Alexandro Vardulakis;
• "Financial frictions and shock transmission: the Portuguese case," by Gabriela Castro, Ricardo M. Félix, Paulo Júlio and José R. Maria;
• "Grade retention during basic education in Portugal: determinants and impact on student achievement" by Manuel Coutinho Pereira and Hugo Reis;
• "Forecasting Portuguese GDP with factor models", by Francisco Dias, António Rua and Maximiano Pinheiro.

Lisbon, 11 June 2014