Santander Totta. Portugal Economic Review. Simple Personal Fair. A prolonged slow recovery. General Information. Real GDP (2015) Population

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1 Santander Totta Simple Personal Fair Portugal Economic Review General Information Real GDP (2015) EUR 171 Bn Population 1 mn Form of State Parliamentary Democracy Head of government António Costa (Socialist Party) Next elections September/October 2019 Strengths Improvement of the current account with a positive trajectory and a surplus since 2013 Growing industrial exporting sector with continuously technological advances Public finances with primary balance surplus since 2013 Tourism continues with positive outlook Weaknesses High public and private debt Changes in some structural reforms are having some impact on investors confidence, reflected in a slowdown of the investment dynamics Still high unemployment rate, with a stabilization trend

2 Economic Review 1st Semester of 2016 Slow and prolonged global growth Global economic growth is showing signs of slowing down, specifically in economies like the USA, China and the Euro Area, which represent around 2/3 of global growth. 3,6 1,3 4,0 4,1 1,3 1,4 Global Growth Contributors (real GDP in dollars corrected of exchange rate effects) 3,9 4,3 1,5 6,0 1,0 0,0-0,1-1,4-1,6-3,2 - -3,4 3,5 3,7 0,0 1,6 2,3 1,2 1,1 1,6 1,4 0, ,1-1,2-1,2-1,0-1,1-2,6-1,5 - -2,1 4,1 1,7 2,8 2,3 2,5 3,1 3, USA European Union China Rest of World Exchange Rate Effect World Source: World Bank, Santander Totta The United States of America are expected to grow 2.5% in 2016, contributing with 0.7pp to global growth. The risks of a possible slowdown should come from transitory factors such as inventories, which negatively affected GDP in the 1Q2016. The employment, income and private consumption positive dynamics supported the favorable evolution of industrial output. Nevertheless, the low levels of inflation allow the Federal Reserve to maintain an accommodative monetary policy as well low interest rates levels, despite the increase of 25bp in December Behind this decision has been the positive evolution of the labor market, which employment rate could be getting closer of the levels of full employment. However, recent events, such as Brexit referendum results, motivated an adjustment in expectations for future changes in monetary policy in the near term. The perspectives of growth in the Euro Area point to a positive but still moderate trajectory. Growth has been unequal within the EMU, reflecting the intrinsic weaknesses of individual countries. Following the financial crisis in the US and the sovereignty crisis in the euro area, some economic disequilibrium s have emerged, namely, the high levels of private and public indebtedness, the low marginal productivity of investment, the elevated long term unemployment and progressive aging population. Consequently, productivity decelerates and potential growth GDP decreases. The accommodative monetary policy conducted by the ECB, characterized by low interest rates and acquisition of financial assets, is expected to stimulate investment, job creation and ultimately support GDP growth. Although, political instability (most recently the Brexit event) and terrorist attacks might offset economic activity recovery as economic agents feel less confident to invest and consume. China is growing at a more moderate pace compared to pre-crisis levels. The recession in advanced economies has been pressuring China to transform its economic growth model, mostly supported by investment and external demand. Currently, fiscal and investment policies have been oriented to stimulate consumption and the development of the services sector, by increasing disposable income and labor market conditions. Thus, the deceleration of the Chinese economy is in line with expectations as the excess installed capacity is gradually offset by growth in domestic demand and in the services sector. 7,7 1,5 0,2 Global Growth (real PIB) 2,5 1,4 8,2 3,7 1,9 3,4 3,1 3, USA (PIB em $) European Union (PIB em ) Rest of World (PIB em $) World (PIB em $) China (PIB em RMB) Source: World Bank, Santander Totta Global growth sustainability is essential to correct some imbalances from the past, namely the high levels of indebtedness. The recent outcome from the Brexit referendum (Leave the European Union) on June 23 brings a new set of uncertainties that are hard to quantify. These uncertainties may lead to a sharper slowdown of the British economy with impacts all over the world, albeit more accentuated in Europe. Portugal will not exception, since Portuguese exports of goods and services to the UK represented 9% of total exports in 2015 (6.7% of total goods exported and 14.8% of services exports, mostly from tourism). Besides services, sectors like textile and agri-food are specially exposed to British imports. 6,9 2,0 6,7 2,5 Santander Totta 2

3 Economic Review 1st Semester of 2016 A required Adjustment In all moments of economic crisis the confidence and expectations of economic agents are negatively affected, slowing down the internal and external economic and financial dynamics. Consequently, investment decisions are postponed and economic activity declines. Companies accumulate stocks due weak demand; leading to output reduction and its installed capacity usage declines. Naturally the work force demand decreases, contributing to an increase of the unemployment rate. Portugal was naturally affected by the crisis and its high levels of public indebtedness and recurrent deficits in the current and capital balance made investors wary of the General Government s ability to meet its financial obligations, leading to an increase of external financing costs. The subsequent difficulties in accessing financial markets forced the Government to request a financial assistance from international institutions in order to assure the economy would performed normally, in terms of the State s financial commitments and stability of the financial system. The rebalancing of public finances was accompanied by structural reforms with the goal of regaining competitiveness. This gain aims to develop the tradable sector so it can increase its weight in the Portuguese business output. Since 2009 exports have accelerated strongly, while imports evolved at a more moderate pace, allowing net exports contribute positively to growth Exports Imports Exports / Imports (% Real PIB) The improvement of tradable sector competitiveness ultimate goal is to transform the Portuguese economic growth model, so it becomes more supported by exports and investment and less private consumption dependent , ,1-2,7-4,6-5,0-5,4-5,3-5,4-6,4-8,5-10,2-9,7-9,3-8,4-7,5-8,7-9,3-8,5-8,2-9,3-8,7-8,8-4, Economic Growth Components Real GDP Priv. Con. Pub. Com. Inv. Net. Exp. -1,2-2,2 In order to achieve this transformation Portugal went through a fiscal shock with two specific objectives: (1) to correct the fiscal imbalances and; (2) to redirect the economy towards the tradable goods and services sector, in an effort to increase the competitiveness of exports. For this it was necessary to reduce labor costs and improve productivity (in both public and private sectors). The Government increased taxes on households that had to adjust their consumption patterns, and consequently increase savings. Additionally, all civil servants faced a wage pay cut. Pensions were also cut and ceiling over the highest were implemented. 11, ,3 9,8 7, , ,1 4,2 3,4 4,2 0, ,0-3, ,0-5,0-2, ,1-9,4-12,0-13,4-13,9-13, Portuguese Competitiveness Difference between Productivity and ULC Unit Labour Costs (real, 2005+=100) Labour Productivity Index (real, 2005=100) The short window period during which such measures were implemented, and the recession period in most advanced economies, retracted Portugal economic activity, but partially offset by the rapid growth in the main emerging economies, namely oil exporters economies, which beneficiated of an historical high oil price. Santander Totta 3

4 -1,3 - -0,1 0,1 0,1 0,1 0,2 0,2 Employment rate fev/13; 54,4 Unem ployment rate 0,9 1,0 fev/13; 17,3 Economic Review 1st Semester of 2016 Economic growth was affected by investment stagnation and retracted exports due to the economic crisis in Brazil and Angola Since the 3 rd quarter of 2015, economic growth has slowed down in counter cycle with the euro area dynamics. In the 1 st quarter of 2016, Portugal GDP grew 0.2% quarter on quarter, a pace which is just 1/3 of the euro area growth, in a context of accommodative monetary policy and relatively low commodities prices. Real GDP quarterly growth Decreasing trend of nonperforming loans depends upon a sustainable improvement of employment The labor market conditions have been improving along with economic activity, especially since mid-2013 when the unemployment rate exceeded 17%. The stabilization of the levels of unemployment, around 12%, is in line with the cooling down of the economy since mid Labor market & Economic activity mar/16; 12, mar/16; 57, jun/10; 2,5 3 mar/15 jun/15 sep/15 dec/15 mar/16 Portugal Germany France Italy Spain Greece Euro Zone Source: Bloomberg, Santander Totta Investment, which had initiated a positive moderate trajectory in mid-2013, contributed negatively to economic growth in the 1 st quarter of The general elections of last October and the ensuing political uncertainty are contemporaneous with the slowdown of investment, indicating a possible lack of confidence by economic agents, namely corporates. Moreover, the negative contribution from net exports results from a more expressive growth of imports than exports, this last one influenced by the reduction of exports to Angola and Brazil, by 30% and 13% respectively. GDP growth contributors (Homologous ) 52 GDP (YoY) 50 Employment rate - Total Unemployment rate - Total mar/09; -4,3 dez/12; -4, Nonperforming loans (NPL) are still increasing but at a smoother pace, with the NPL ratio at around 10% in March of 2016, divided 30%/70% between private individuals and companies, respectively. The improvement of the labor market has been crucial to the moderate pace of increase or even decrease of the NPL ratio in some credit segments. 12,0 10,0 8,0 6,0 4,0 Nonperforming loans & Unemployment Private individuals Companies NPL ratio Unemployment rate ,4% % 0,0% % 1,5% % 1,2% 1,7% 1,4% 1,3% 0,9% % 1,9% 1,3% 1,7% 2,1% 1,5% 1,5% 1,9% - -0,1% -0,1% - -% -0,9% -1,1% -1,1% -1,1% -2,2% 2,0 0, Source: INE, Bank of Portugal, Santander Totta set/14 dez/14 mar/15 jun/15 set/15 dez/15 mar/16 Net EXP Investment Public Con. Private Con. Real GDP Santander Totta 4

5 Indebtness Ratio as % of GDP x10^ 9 Economic Review 1st Semester of 2016 High levels of private and public indebtedness are a constraint to new investment The deleveraging process of the economy began in 2011, particularly in the private sector. Companies are responsible for 64% of total private debt and households for 36%. Since the peak of indebtedness in 2011, non-financial corporates reduced their debt by 21pp of GDP, of which 12pp come from the financial sector and 9pp from other financing sources. Households reduced their debt by 12pp of GDP, of which 14pp come from the financial sector, partly offset by an increase of 2pp from other financing sources. From 2010 onwards the public debt to GDP ratio accelerated, due to the reclassification of debt from state owned companies as public debt, in accordance with the Maastricht criteria , , ,4 71, ,9 246,8 248, ,6 Public and Private Debt , , , ,5 227,3 225, ,2 129,0 130,2 129,0 128,9 dez/07 dez/08 dez/09 dez/10 dez/11 dez/12 dez/13 dez/14 dez/15 mar/16 EC Limit to Private Debt Maastricht Limit to Public Debt Public Debt ( bn) Non-Financial Private sector Debt ( bn) Source: Bank of Portugal, Santander Totta The challenge to reinforce the levels of recurrent positive primary balance remains crucial for public debt sustainability The financial assistance program initiated in mid-2011 aimed for the Portuguese Government to progressively reduce the deficit of the public finances and to put in action a set of structural reforms across all areas of the economy, and increase competitiveness. Between 2010 and 2013 tax revenues weight increased from 40% of GDP to 45%, while expenditure was reduced from 52% of GDP to 50%. The progressive, yet fast, reduction of the public deficit resulted from the combination of tax increases over households and corporates and a pay cut on civil servants and pensioners (around 60% of total expenditure), plus a reduction of public investment. Naturally, the economy was negatively impacted by these measures, enhanced by the recessionary effects of the sovereign crisis in the euro area ,9% 68,8% 0,1% % 1,4% -2,9% -3,1% -3,0% -2,9% -4,3% -4,9% -4,9% -4,9% -4,6% -0,1% -3,0% -% -3,8% 79,8% -6,8% -9,8% Saldo Global e Dívida das Adm. Públicas (% PIB Nominal) 96,2% -8,2% -11,2% 111,4% -3,0% -7,4% 126,2% 129,0% ,8% % -5,6% -4,8% -2,8% -7,2% Novo Banco - resolução 3,9 bn Banif - resolução 2,25 bn -1,3% -4,4% Efeitos one-off Saldo Primário (ajustado one-offs) Juros Saldo Global Debt %GDP Between 2010 and 2013 the fiscal balance improved by 6.4pp of GDP, and the primary balance went from a deficit of 8.4% of GDP to a surplus of 0.1%. The debt service represents 5% of GDP (and 90% of the global balance). Public finances undertook a reversal in 2014, with a negative primary balance (including one offs) as a result of an increase in expenditures by 2pp of GDP, largely the result from the resolution of BES into Novo Banco. In 2015 there was a balanced primary balance despite the recapitalization of Banif. Excluding these two one-off events, the primary balance was in a surplus of around 0.6% and 1,4% of GDP, in 2014 and 2015, respectively. 11,6 6,5 4,0 3,3 9,7 9,6 Global Balance Dynamics Revenues & Expenditures ( billions) 11,4 11,1 11,6 12,2 12,9 13,1 5,2 5,9 6,5 6,1 6,0 6,1 6,6 7,1 2,7 3,7 3,8 4,5 4,9 4,9 4,7-1,0-1, ,3-1,6-1,8-1,7-2,5-3,1-3,0-2,6-2,8-2,9-3,7-3,7-4,8-4,6-12,6-13,4-13,3-13,0-12,9-13,3-13,2-13,5-13,5-13,9-14,5-14,2-13,8-14,2-14,6-14,9-15,7-16,0 abr-08 abr-09 abr-10 abr-11 abr-12 abr-13 abr-14 abr-15 abr-16 Global balance Primary balance Total Revenues Total Expenditures Direct taxes revenues Indirect taxes revenues Expenditure excl. Interest Source: Direção Geral do Tesouro, Santander Totta Until April 2016 the fiscal balance evolved in line with the homologous period. However the explanatory variables have changed: revenues from indirect taxes increased by 8% (i.e. a result from an increase in taxes on tobacco, oil and vehicles), while revenues from direct taxes reduced slightly. Primary expenditure remained unchanged compared to the homologous period, despite the partial reposition of salaries of the civil servants. However, total expenditure increased, due to an increase of expenditure with interests. Although, the major set of expenditure increases will surge during the 2 nd half of Santander Totta 5

6 Weight 2015 & Change % Economic Review 1st Semester of 2016 Sustainable growth takes a lot of work Economic growth should be more moderate than previously estimated, with GDP expanding around 1.5% in 2017 (previously estimated growth of 1.7%). This adjustment reflects the slowdown of the world economy, in particular in the USA and China, which represent 50% of the world growth. Risks are biased downwards, and recently intensified by the outcome of the UK referendum. Exports to the USA and China represented 5.4% of total Portuguese exports in 2015 (i.e. exports of goods contributed 3.8pp and services 1.6pp). The joint financial and sovereign crisis forced Portuguese companies to adapt and look for new markets to export theirs goods and services. Between 2009 and 2015 real exports grew a cumulative 42% (nominal exports grew 52%) whereas real imports grew 15% (nominal imports grew 19%). 3,0% 2,0% 2,5% 1,7% 1,9% 2,1% 0,0% 2,1% 1,6% 1,5% 1,3% 1,4% 1,5% 1,9% 2,2% 1,7% 2,1% 1,4% 1,2% 1,1% 1,2% 1,2% 1,4% 1,5% 1,9% 1,1% 1,8% 0,1% -7,0% -8,0% -8,2% -6,9% -8,0% -9,2% -8,8% -8,2% -7,3% -10,1% -10,1% -9,4% -10,9% -% -3,7% -5,4% -6,6% -9,4% -9,0% Capital Account Current Account Current and Capital Account (% GDP) -5,1% -6,6% -6,5% -8,4% -9,4% -8,6% -6,7% -7,1% -9,2% -8,8% -3,7% -4,5% -11,0% Income Balance Current and Capital Account As a result, the current balance became positive since 2012, in particular due to a significant growth of export of goods and a higher diversification of commercial partners. Portugal exports of goods and services to the TOP 4 clients (Spain, France, Germany and the UK) grew 33% and 50%, respectively, between 2009 and While imports of goods and services from the TOP 4 providers (Spain, United Kingdom, France and Netherlands) grew 16% and 22%, respectively, between 2009 and Portugal, TOP 4 commercial partners in terms of positive current balance (France, UK, Angola and USA) represent around 6% of GDP, partially offset by the TOP 4 commercial partners in terms of negative balance (Spain, Italy, China and the Netherlands). The most exported goods are wood, cork, paper, clothing and footwear. Tourism represents 45% of total services exported and in 2015 net exports of tourism represented 3.3% of GDP. 0,2 1,3 1,4 1,1 0,9 1,3 1,3 0,9 1,0 1,0 1,6 1,1 1,0 1,3 1,5 1,5 1,8 1,8 1,5 2,0 2,1 2,0 2,1 2,1-4,5-4,0-4,0-4,0-3,9-3,6-3,9-3,7-3,3-0,9-9,7 TOP 4 Countries Net Exports (% Nominal GDP) -4,3-6,9-7,6-0,9-0, , Netherlands China Italy Spain USA Angola United Kingdom France Source: INE, PORDATA, Santander Totta To ensure a sustainable economic growth is of the utmost importance that Portugal keep increasing the weight of exports in GDP, supported by a more diversified commercial base both in terms of partners and products and services. Is crucial, Portugal exports enhance its relevance in terms of final products exports, in order to deliver the major stake of the add-value to customer. To achieve this, it is crucial that unit labor costs evolve in line with productivity, as well high technological products / services become gradually more present. This steps, are fundamental to Portugal continuously reduce unemployment and external indebtedness. - PORTUGAL: Macroeconomic Projections (Santander Totta Economic Research June 2016) Population Millions ,9 10,9 Nominal GDP GDP per capita ,77 16,04 16,56 16,95 17,43 17,95 Real GDP Var % -1,1% 0,9% 1,5% 0,9% 1,5% 1,7% Private Con. 66% -1,2% 2,2% 2,6% 1,5% 2,1% 2,3% Public Con. 20% -2,0% -% % % 1,0% 1,3% Investment 19% -5,1% 5,5% 4,2% 1,4% 2,0% 2,2% Exports 34% 7,0% 3,9% 5,2% 2,3% 3,0% 3,2% Imports -39% 4,7% 7,2% 7,6% 3,2% 3,8% 4,0% Unemployment % 16,2% 13,9% 1% 12,1% 11,6% 11,2% CPI % % -% % 0,9% 1,5% 1,7% Public Debt % GDP 129,0% ,2% 129,5% 128,5% 127,2% Global Balance % GDP -4,8% -7,2% -4,4% -3,1% -2,8% -2,6% Current Balance % GDP 1,9% 1,1% 1,8% 1,4% 1,4% 1,5% Santander Totta 6

7 PORTUGAL Economic Review 1st Semester 2016 June 16 Rui Constantino Bruno Fernandes Helena Marques João Pires João Leitão FINAL DISCLOSURES This document has been prepared by the Economic Research Department of Banco Santander Totta, SA and is made available exclusively for general information purposes. The information and opinions contained in this report have been obtained from, or are based on, public sources believed to be reliable, but no representation or warranty, express or implied, is made that such information is accurate, complete or up to date and it should not be relied upon as such. Furthermore, this report does not constitute a prospectus or other offering document or an offer or solicitation to buy or sell any securities or other investment. Information and opinions contained in the report are published for the assistance of recipients, but are not to be relied upon as authoritative or taken in substitution for the exercise of judgment by any recipient, are subject to change without notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any reference to past performance should not be taken as an indication of future performance. This report is for the use of intended recipients only and may not be reproduced (in whole or in part) or delivered or transmitted to any other person without the prior written consent of SIB. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report, under the regulatory norms of the supervisory authorities, namely Comissão de Mercado de Valores Mobiliários (CMVM). The material in this research report is general information intended for recipients who understand the risks associated with investment. It does not take into account whether an investment, course of action, or associated risks are suitable for the recipient. To the fullest extent permitted by law, no Grupo Santander Totta company accepts any liability whatsoever (including in negligence) for any direct or consequential loss arising from any use of or reliance on material contained in this report. All estimates and opinions included in this report are made as of the date of this report. Unless otherwise indicated in this report, there is no intention to update this report. Grupo Santander Totta may make a market in, or may, as principal or agent, buy or sell securities of the issuers mentioned in this report or derivatives thereon. Grupo Santander Totta may have a financial interest in the issuers mentioned in this report, including a long or short position in their securities and/or options, futures or other derivative instruments based thereon, or vice versa. This report may be copied or redistributed, subject to acknowledgment of the source. Banco Santander Totta, S. A. Rua da Mesquita, Lisboa Portugal Tel: (+351) Fax: (+351)