sector: recent developments VÍTOR CONSTÂNCIO

The economy and the banking sector: recent developments VÍTOR CONSTÂNCIO January 2006

Recent performance of the economy and prospects Factors behind the period of slow growth Challenges to the Banking Sector Regulatory changes and effects of the economic environment Risk management (credit, liquidity, capital) Structural problems and long term economic potential

5 4 3 2 Portugal Euro Area(*) GDP growth rates (%) 1 0-1 -2 Diferential Portugal vs. Euro Area 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Factors behind the period of slow growth Cyclical pattern of slight overheating and subsequent deceleration associated with joining a monetary union coming from a regime of higher inflation Pro-cyclical fiscal policy External demand shocks Significance of the oil shock Competitiveness problems in the context of enlargement and globalisation

Investiment and domestic savings rate (% of GDP) 35 30 25 20 15 Investment rate Savings rate 30 28 26 24 22 20 18 16 14 12 10 10 93 94 95 96 97 98 99 2000 2001 2002 2003 2004 2005

Macroeconomic policy stance Short term interest rates 20 18 16 14 12 10 8 6 4 2 0 1991 1990 1992 1993 1995 2001 2000 1997 2002 2003 1999 2004-3 -2-1 0 1 2 Primary deficit (ciclical adjusted without one-off measures)

3,0 Stability and growth programme Main direct effects of consolidation measures (a) 2,5 As a percentage of GDP 2,0 1,0 0,0-1,0-2,0 0,5 1,1 Revenue 0,4 0,3 Expenditure 0,2-0,1-0,3-0,3-0,6-0,5-1,8-3,0 2005 2006 2007 2008 2009 Accumulated Source: Stability and growth programme, June 2005 (a) Yearly, direct effects of discretionary measures included in the SGP.

Growth rates of GDP, Domestic Demand and External Demand directed to the Portuguese economy 15 13 11 External demand 9 Domestic demand 7 5 3 GDP 1-1 90 91 92 93 94 95 96 97 98 99-3 -5 2000 2001 2002 2003 2004 2005

Growth rates of external demand and portuguese exports 14 12 10 8 External Demand 6 4 2 0-2 -4 96 97 98 99 2000 2001 2002 2003 2004 2005 Exports market quota Exports -6

Competitiveness Indicators: relative ULC s, CPI and export prices with the 13 main trading partners (1995=100) 120 115 ULC's (total) 120 115 110 ULC's (manufacturing) 110 105 100 95 90 85 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 (Source: BP AMECO e OECD) CPI Relative export prices 105 100 95 90 85

Technological content of Exports (% of total ) Low technology High technology 1985-89 2000-01 1985-89 2000-01 Variation Euro Area 38 30 14 21 7 Ireland 49 14 30 46 16 Holand Finland 42 59 31 38 19 9 35 32 16 23 Germany 26 21 15 21 6 France Austria 38 51 28 37 14 12 21 18 7 6 Portugal Italy Belgium 82 47 54 61 44 41 5 12 9 14 13 12 9 1 3 Spain 57 41 6 11 5 ECB Occasional Paper Competitiveness and export performance of the euro area No. 30, 2005

Composition of Exports 1985-1989 2000-2004 Variação Agriculture & Food, Wood,Cork, Paper, Leather, Textiles, Clothing, Footwear Electronics, Machines, Transport equipment, Chemicals, Energy Other 61,1 % 40,2% -20,9 p,p 27,0 % 45,8% +18,8 p,p 11,8 % 14,0% +2,2 p,p

Bank of Portugal s Economic Forecasts Growth rates (%) 2004 2005 2006 GDP 1.3 0.3 0,8 2007 1,0 Private Consumption Public Consumption Gross Fixed Investment Domestic Demand Exports of goods and services Imports of goods and services 2.3 2.6 0.2 2.1 5.4 6.8 1.8 1.1-3.1 0.6 1.8 2.4 1.2 0.7-1.1 0.6 4.0 2.8 1.1 0.4-0.8 0.6 5.2 3.2 Inflation rate (HICP) 2.5 2.1 2.5 2.3

Credit to households and non-financial firms

18 Return on Equity (ROE) (a) 16 Percentagemg 14 12 10 8 6 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 (a): ROE defined as net profit over average own funds (consolidated accounts)

2004 2004 2003 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 Net Interest Inome (in % of average Total Assets) 1995 1996 1997 1998 1999 2000 2001 2002 Fees and commissions in % of average Total Assets 1995 1996 1997 1998 1999 2000 2001 2002 2003 1994 1994 % 0.80 0.75 0.70 0.65 0.60 0.55 0.50 0.45 0.40 0.35 Percentageage

2003 2004 1.5 1.4 1.3 1.2 1.1 1.0 0.9 Staff Costs in % of average Total Assets 1994 1995 1996 1997 1998 1999 2000 2001 2002 Consolidated accounts

Cost / Income Ratio (in %) 64 63 62 61 60 59 58 57 56 55 1998 1999 2000 2001 2002 2003 2004

10 Interbank liabilities (net of interbank assets) In % of Total Assets 9 8 7 6 Total Banking Sector 5 4 3 Domestic Banks 2 1 0 1999 2000 2001 2002 2003 2004

Ratio of high liquid assets over interbank liabilities 140 130 120 124.6 131.8 121.6 130.6 110 106.6 104.3 100.7 98.9 100 101.4 93.4 88.7 90 91.5 86.8 87.4 80 Dez. 1998 Dez. 1999 Dez. 2000 Dez. 2001 Dez. 2002 Dez. 2003 Dez. 2004 Note: High liquid assets include Interbank Assets (Banks and Central Banks) and Public Sector securities.

Non Performing Loans in % of Total Credit 7.0 6.0 5.0 Total Households - total Households - housing Non Financial Firms 7.0 6.0 5.0 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0 0.0 Dez-97 Dez-98 Dez-99 Dez-00 Dez-01 Dez-02 Dez-03 Dez-04 0.0

120 100 HOUSEHOLDS INDEBTEDNESS AND INTEREST PAID As a percentage of disposable income Indebtedness Interest paid (right-hand scale) 7.0 6.5 80 6.0 Per cent 60 5.5 Per cent 40 5.0 20 4.5 0 1998 1999 2000 2001 2002 2003 2004 2005E 4.0

The aggregate debtto-assets ratio increased but net wealth is estimated at a comfortable 400 percent of disposable income. Household debt is mainly comprised of housing mortgages, with direct coverage by nonfinancial assets (housing in particular for owner occupation).

10 8 HOUSE PRICES IN PORTUGAL year-on-year growth rates House prices - nominal year-on-year growth rates House prices - real year-on-year growth rates 6 Percentage 4 2 0 Dez-94 Dez-95 Dez-96 Dez-97 Dez-98 Dez-99 Dez-00 Dez-01 Dez-02 Dez-03 Dez-04-2 -4 Source: Confidencial Imobiliário New sletter.

Total Provisions in % of Non Performing loans 150 140 130 120 110 100 90 80 70 Dez.95 Dez.96 Dez.97 Dez.98 Dez.99 Dez.00 Dez.01 Dez.02 Dez.03 Dez.04

15 Regulatory Capital Ratio (own funds) 14 13 12 11 10 9 8 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Capital Access Index (2005) 1. U.K. 2. Hong-Kong 3. Singapore 4. USA 5. Sweden 6. Denemark 7. Australia 8. Norway 9. Finland 10. Ireland 10. Canada 12. Switzerland 13. Netherlands 14. New 15.Germany 16.Malasya 17. Spain 18. Chile 19.Japan 20.France 21.Estonia 22.Austria 23.South Korea 24.South Africa 25.Taiwan 26.Portugal 27.Israel 28.Belgium 29.Greece 30.Thailand 31.Italy Source: Milken Institute, USA 8,01 7,84 7,77 7,75 7,62 7,61 7,6 7,47 7,46 7,42 7,42 7,39 7,2 7,04 6,93 6,88 6,8 6,78 6,76 6,62 6,59 6,41 6,37 6,36 6,34 6,31 6,19 6,17 5,85 5,71 5,66 «Ranks 121 countries according to the ability of new and existing entrepreneurs to finance their strategies and investments for job creation and capital formation»

Growth competitiveness index ( WORLD FORUM 2005) Total Quality of Institutions Technological absortion Macroeconomic environment Finland 1 5 2 4 USA 2 18 1 23 Sweden 3 17 4 12 Denmark 4 2 5 3 Taiwan 5 26 3 17 Singapore 6 4 10 1 Iceland 7 3 9 11 Switzerland 8 9 6 13 Norway 9 6 13 2 Australia 10 10 14 14... Portugal 22 15 20 37 Spain 29 38 27 24 Ireland 26 13 31 7 Greece 46 43 37 51

World Bank Indicators of «Governance» (2004) 0 20 40 60 80 100 Voice and accountability Political stability Government efficiency Quality of regulation Rule of law Control of corruption Germany Portugal Spain Poland Germany Portugal Spain Poland Germany Portugal Spain Poland Germany Portugal Spain Poland Germany Portugal Spain Poland Germany Portugal Spain Poland Source: World Bank Governance Indicators for 1996-2004, 2005

Index of economic freedom (Fraser Institute 2003) Hong Kong Singapore USA New Zealand Switzerland U.K. Canada Ireland Australia Luxembourg Unit. Arab Estonia Netherlands Iceland Austria Denmark Finland Germany Belgium Chile Costa Rica Sweden Bahrain Taiwan Norway Botswana Japan Spain Portugal Cyprus France Greece Lithuania Malta 34º in127 countries 0 1 2 3 4 5 6 7 8 9 10

OECD Regulation Index (1998-2003) Source:OECD «PRODUCT MARKET REGULATION IN OECD COUNTRIES: 1998 TO 2003»