| Summary: | This Selected Issues paper on Portugal focuses on how could the coronavirus disease 2019 pandemic affect firm productivity and the speed of the recovery. The pandemic eroded equity positions of Portuguese firms with varying impacts across firms’ size and sectors. The authorities’ swift policy response went a long way in addressing immediate liquidity shortages. The pandemic, however, has left a large share of Portuguese corporates with a debt overhang and at risk of insolvency. Our estimates suggest that the share of zombie firms has risen from about 1 percent prior to the pandemic to 4 percent. The Banco Portuguese de Fomento managed recapitalization scheme—Strategic Recapitalization and Consolidar Programs—have many promising features but may need augmentation and enhanced incentive structures. Broad-based economic recovery underpinned by structural reforms would help spur firm dynamism, productivity growth, and strengthen financial health metrics. Continued strong growth would bolster the operational environment across the spectrum and help reduce balance sheets vulnerabilities. Nonetheless, past crisis recoveries reveal that zombie firms chip away at aggregate productivity, irrespective of the performance of non-zombie incumbents, thereby congesting reallocation. Strong restructuring and insolvency regimes would facilitate effective reorganization and exit of business and optimizing resource reallocation without overwhelming the financial system
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