Portugal’s membership in the European Union (EU) contributed to stable economic growth, largely through increased trade and an inflow of EU funds for infrastructure improvements. Until recently, average annual growth rates consistently exceeded those of the EU average. Due to slow economic growth, Portugal has lost ground relative to the rest of the EU since 2002. In 2002, Portuguese per capital GDP was 70.9% of the EU-15 average. In 2005, it is expected to be 65.1%. Portugal’s per capital GDP is behind that of new members Slovenia, Malta, and Cyprus and, since 2002, Greece.

In order to enter the European Monetary Union (EMU) in January 1999, Portugal agreed to cut its fiscal deficit and undertake structural reforms. The EMU brought exchange rate stability, lower inflation, and lower interest rates. Falling interest rates, in turn, lowered the cost of public debt and helped the country achieve its fiscal targets. However, private sector borrowing increased dramatically. By 2001, the economy was in serious external imbalance, with a large current and capital account deficit. Portugal was the first country to breach the Eurozone’s Stability and Growth Pact budget deficit target of 3%, with a gap equal to 4.2% of GDP. The Government of Portugal (GOP) met the 3% target in 2002 and 2003, but only with substantial one-off revenues. Despite a hiring freeze and other measures, the Portuguese government had a structural budget deficit in 2004 projected at 4.9%. In 2004, public spending is expected to equal 47.9% of GDP. Despite EU requirements to maintain fiscal austerity, the 2005 budget presented by the new Santana Lopes government in October 2004 projects a structural deficit in excess of 3.0%, and violates the 60% limit on public debt.

The Portuguese economy experienced a 1.3% decline in 2003 but has shown a slight recovery in 2004. The recovery is expected to continue through 2005 with growth projected at 2.2% by the European Commission. The government hopes that labor reform legislation, which took effect in early 2004, corporate and personal tax cuts in 2004 and 2005 and other changes will support a strong economic recovery and a return to faster growth.

Portugal’s economy is based on traditional industries such as textiles, clothing, footwear, cork and wood products, beverages (wine), porcelain and earthenware, and glass and glassware. In addition, the country has increased its role in Europe’s automotive sector and has a world-class mold-making industry. Services, particularly tourism, are playing an increasingly important role. Portugal will be forced into greater self-sufficiency when EU funds are either discontinued or substantially cut in 2006. EU expansion into eastern Europe has erased Portugal’s historic competitive advantage and low labor costs. The government is working to change Portugal’s economic development model from one based on public consumption and public investment to one focused on exports and private investment.