Economic developments in Portugal have been uneven since the middle of the 1990s. This paper highlights the adjustment processes in the Portuguese economy during the early years of EMU.

The paper argues that the easing of monetary conditions implied by the convergence of interest rates were at the origin of a demand boom, which was further fuelled by pro-cyclical domestic policies. In the process, private sector indebtedness increased markedly. A correction of the resulting financial and macro-economic imbalances started in 2000, leading to a sharp deceleration of domestic demand and, in turn, to an economic recession in 2003. Domestic demand growth might trail output growth for some time to come. The recovery will thus rely on a revival of export growth. This requires significant efforts to regain external competitiveness lost during the years of strongly demand-driven growth and relative high inflation.