Portugal: Persistent Political Fragmentation to Test Growth and Fiscal Prospects

The general election in Portugal confirmed the centre-right Democratic Alliance (AD) as the country’s leading political force, but, with just 32% of the national vote and 89 out of 230 seats in parliament, it lacks an absolute majority to govern.

With the Socialist Party losing political ground largely to the far-right Chega party, two parties with which the AD has ruled out holding coalition talks, the AD will need the support from either of these two parties (at the minimum their abstention) to pass next year’s budget law.

Even if AD were to gain the support from all other smaller parties, such an arrangement would still fall short of a majority if Chega and the Socialist Party vote against it (Figure 1).

Figure 1: Portugal’s fragmented parliament complicates policy making

While Portugal has a history of minority governments and a confidence vote is not needed to form a government, passing the annual budget law will be the first critical test for the next administration.

Failure to pass a budget, thereby activating a temporary budget rule, would have important political repercussions, from the possible resignation of the prime minister to intervention by the president in dissolving parliament and calling new elections. Even if a budget is passed, a minority government would need ad hoc support from other political parties to pass new legislation.

The efficient deployment of EUR 22.2bn in EU Recovery and Resilient Funds (around 8% of GDP) is critical to sustaining a favourable growth outlook, as is addressing economic and social issues such as affordable housing, better quality healthcare and improved welfare for immigrants.

Portugal’s Public Debt-to-GDP Ratio Remains On a Firm Downward Trajectory

Volatile politics contrasts with Portugal’s strong economic growth and significantly improving public finances. The economy has proven resilient in recent years, even though higher inflation and interest rates have weighed on private consumption and investment. Real GDP grew by 2.6% in 2023 and 1.9% in 2024, well above euro area averages of 0.4% in 2023 and 0.8% in 2024.

This out-performance reflects rising economic and export diversification, as well as success in attracting foreign direct investment, particularly in high value-added sectors such as information technology, business and professional services.

Buoyant economic growth together with constantly high GDP deflator inflation and prudent fiscal policy drove the decline in the general government debt-to-GDP ratio by around 39pp to 94.9% in 2024 from 134.1% in 2020. The government has run a primary surplus of 2.5% of GDP in 2024, 3.1% in 2023, and 1.5% in 2022.

Scope Ratings (Scope) expects Portugal’s debt-to-GDP ratio to continue to decline, falling by an additional 16pp to around 75% by 2030, a trend which compares favourably with southern euro area sovereign peers (Figure 2).

In the context of higher financing rates, declining debt-to-GDP will help contain the rise in interest expenses, which will likely remain stable at around 4% of revenues in the medium term. The relatively long average weighted maturity of government debt at 7.7 years is another mitigating factor.

Figure 2. Portugal’s general government debt-to-GDP continues to decline
2019-2030F, % of GDP

Fiscal Discipline Improves Primary Balance, Creates Flexibility to Address Social Pressures

The fiscal discipline demonstrated in the recent years enabled successive governments to accumulate budgetary headroom, creating some flexibility to gradually implement growth-enhancing measures. The previous AD-led government took some initiatives aimed at increasing salaries for public sector employees and other selected professional categories. It also introduced a 1.25% permanent increase for the lowest pensions, raised social benefits and extended fiscal benefits for young people, and reduced the corporate income tax rate to foster business competitiveness.

A new AD-led minority government will likely continue to balance fiscal prudence with pro-growth measures to guarantee compliance with new EU fiscal rules. To secure support from the main opposition parties, AD will likely have to consider a mix of tax cuts for lower-income households, tighter immigration policies (at the centre of Chega’s political agenda) and the reversal of corporate tax cuts or the revision of tax benefits for younger workers, advocated by the Socialist Party.

While compromises are needed and will likely loosen the fiscal stance somewhat, Scope still expects the government to continue to run primary budgetary surpluses in coming years, at about 1.6% of GDP by 2030.

External and Domestic Political Uncertainties Pose Risks for the Future

Gradually easing financing conditions, lower inflationary pressures, and the expected acceleration in the implementation of the National Recovery Plan should support real economic growth in coming years, which Scope projects at 2.1% this year and 1.9% in 2026, the latter in line with the economy’s medium-run growth potential.

Key risks include domestic political stalemate delaying reforms and hindering the deployment of EU funds, and the volatile global trade environment. While the direct impact of higher tariffs applied by the US on imports is limited for Portugal, as goods exports to the US account for less than 7% of total good exports, the country is vulnerable to the indirect impact of higher tariffs and the related uncertainties leading to slower economic growth among Portugal’s main trading partners.

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Alessandra Poli is an Analyst in Sovereign and Public Sector ratings at Scope Ratings. Alvise Lennkh-Yunus, Managing Director of Sovereign and Public Sector ratings at Scope, contributed to writing this commentary.