DBRS Confirms the Republic of Portugal at BBB (low), Changes Trend from Negative to Stable

DBRS Ratings Limited (DBRS) has confirmed the Republic of Portugal’s long-term foreign and local currency issuer ratings at BBB (low) and short-term foreign and local currency issuer ratings at R-2 (middle). The trends on all ratings have been revised from Negative to Stable.

The rating confirmation reflects: (1) Portugal’s political commitment to pursue sustainable public finances and implement structural reforms, as demonstrated during the Economic and Financial Assistance Programme (EFAP), (2) the benefits of euro area membership and (3) the moderate estimated fiscal impact of age-related expenditures on the public finances over the long-term. However, these supportive factors are balanced by significant challenges, including elevated levels of public and private sector debt, an uncertain growth outlook over the medium-term, and the high unemployment rate.

The change in trend to Stable principally reflects two factors: (1) DBRS’s assessment that Portugal has made progress in narrowing the fiscal and the current account deficits, and (2) the build-up of sizeable cash buffers, amounting to EUR15.3 billion at the end 2013, which reduce rollover risk as the government exits its EFAP.

The ratings could be subject to upward pressure if Portugal’s fiscal consolidation proves durable and growth does not underperform expectations over the medium-term. Conversely, downward pressure on the ratings could materialise if growth significantly underperforms relative to current expectations or the commitment to fiscal consolidation weakens, thereby adversely impacting public debt dynamics over the medium-term. The materialisation of contingent liabilities emanating from the country’s State Owned Enterprises (SOEs), Public Private Partnerships (PPPs) or a requirement for further capital injections into the banking sector, beyond the EUR6.4bn remaining in the Banking Sector Stability Fund (BSSF), could also add pressure to the ratings.

Portugal has made considerable progress toward restoring the sustainability of its public finances. The fiscal deficit declined from 9.8% of GDP in 2010 to 4.9% in 2013. Even when the effect of one-off measures is taken into account, the 2013 deficit was at 5.3% of GDP, below the ceiling set under the EFAP. Moreover, the country’s structural primary balance also improved from a deficit of 5.9% of GDP in 2010 to a surplus of 1.5% of GDP in 2013. Additional measures totalling 2.9% of GDP over 2014 and 2015 aim to reduce the deficit to 2.5% of GDP by the end of next year. DBRS expects the emerging economic recovery to provide some cyclical support for the fiscal consolidation.

In addition, Portugal has experienced some success rebalancing the economy towards the tradable sector. The current account balance shifted from a deficit of 2.0% of GDP in 2012 to a small surplus in 2013. This was the first current account surplus in 20 years and represented a marked improvement on the 2000-08 period when the average deficit was nearly 10% of GDP. The external adjustment reflected a significant decline in the goods deficit and an improvement in the services surplus. While this is partly explained by substantial import compression, exports have performed well, supported by gains in market share and greater product and market diversification.

The relatively benign outlook for the long-term sustainability of age-related spending also underpins the ratings. The European Commission estimates age-related expenditure in Portugal will increase from 26.0% of GDP in 2010 to 26.1% by 2060. This compares favourably with the 3.7 percentage points projected increase in age-related expenditure for the EU27. However, there is substantial uncertainty regarding these long-term projections. Given the updated population forecasts, Portugal’s position is likely to worsen, although some of the expected deterioration is likely to be offset by policy measures.

Notwithstanding the positive developments, Portugal’s public debt dynamics are exposed to several risks. Failure to implement fiscal consolidation measures in the run-up to the 2015 general election could result in larger than expected deficits. Growth prospects are also vulnerable to domestic and external shocks. In particular, a growing reliance on exports as a key driver of growth makes Portugal more vulnerable to a loss in growth momentum from its main trading partners, notably Spain. Moreover, state-owned enterprises (SOEs), the public-private partnerships (PPPs), and banking sector constitute contingent liabilities which could materialize on the public sector balance sheet. The banking sector, in particular, continues to be under pressure as deteriorating asset quality and increased provisioning weigh on profitability.

DBRS notes however, that the risks emanating from contingent liabilities have considerably subsided. This reflects the introduction of new expenditure controls, the renegotiation of some PPP contracts, the ongoing privatization process and the adoption of concession schemes in the transport sector which should significantly reduce the size of the government’s guarantees. In addition, the availability of EUR6.4bn worth of funding in the BSSF also provides some reassurance with respect to any additional banking sector funding needs which may require state financing.

Notes:
All figures are in euro (EUR) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

These can be found on www.dbrs.com at:
http://www.dbrs.com/about/methodologies

The sources of information used for this rating include IMF, OECD, BIS, European Commission, European Central Bank, Statistical Office of the European Communities, and Ministry of Finance of the Republic of Portugal, IGCP, Bank of Portugal and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period, while reviews are generally resolved within 90 days. DBRS’s outlooks and ratings are under regular surveillance.

For additional information on this rating, please refer to the linking document under Related Research.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Carla Clifton
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 10 November 2010
Most Recent Rating Update: 13 December 2013

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