DBRS Confirms Republic of Portugal at BBB (low), Stable Trend

DBRS Ratings Limited has confirmed the Republic of Portugal’s long-term foreign and local currency issuer ratings at BBB (low) and its short-term foreign and local currency issuer ratings at R-2 (middle). The trend on all ratings remains Stable.

The rating reflects Portugal’s Eurozone membership, favourable public debt maturity structure, and reduced vulnerabilities, following a substantial correction of the current account deficit over the past few years. However, Portugal faces significant challenges, including elevated levels of public sector debt, ongoing fiscal pressures, low potential growth, and high corporate sector indebtedness.

The Stable trend reflects Portugal’s ongoing economic recovery, progress in reducing the fiscal deficit, and the incipient decline in the government debt ratio. Risks to growth prospects could intensify from political uncertainty, reversals in structural reforms, and financial volatility in the EU. There are also risks to the fiscal outlook, largely emerging from optimistic growth assumptions and the government’s limited ability to pursue a tight fiscal strategy in the medium term, given its weak mandate. The new centre-left minority government has shown commitment to adhere to the EU fiscal rules, by adjusting its 2016 Budget following talks with the European Commission. However, the ratings could come under downward pressure if there is a weakening in the political commitment to sustainable economic policies or if growth markedly underperforms, leading to a deterioration in public debt dynamics. Specifically, a reversal of structural reforms that threaten a return of large macroeconomic imbalances or policy inaction to deal with fiscal pressures would indicate weak political commitment and raise concerns about the durability of the fiscal adjustment.

Conversely, the ratings could be upgraded if the improvement in public finances is sustained and the economic recovery strengthens and proves durable, thereby improving the outlook for public debt sustainability.

The ratings for Portugal are supported by its membership of the Euro area. As a member of the Economic and Monetary Union (EMU), Portugal enjoys the strong credibility of Euro area institutions, in particular that of the European Central Bank (ECB). Its adherence to the EU economic governance framework has allowed the country, including the banking sector, to benefit from the ECB’s facilities and policy tools. Over the past few years, the ECB’s programmes have helped ease tensions in financial markets and kept government borrowing costs low. The political response at the euro area level to preserve the Eurozone remains strong and DBRS believes that additional EU financial support to Portugal would likely be available if necessary.

A favourable debt maturity structure is another credit strength. Active debt management operations combined with favourable market conditions have lowered the government’s funding costs and improved the debt maturity profile. Since returning to debt markets in 2013, the government has extended debt maturities, which has resulted in the average debt maturity reaching 8.8 years at the end of March 2016. Portugal has also repaid 36% of its total IMF loans since last year, which will translate into interest cost savings.

Portugal has made substantial progress unwinding macroeconomic imbalances. The current account shifted from a deficit of 12.1% of GDP in 2008 to a small surplus in 2013, driven in part by improved export performance. The surplus has been maintained over the past two years. The fiscal adjustment has also been sizable, with the deficit narrowing from 11.2% of GDP in 2010 to 4.4% in 2015 (including one-offs). The 2016 Budget approved in March and the 2016-2020 Stability Programme presented in April indicate the government’s commitment to further fiscal consolidation. Overall, improved external and fiscal balances put Portugal in a better position to support sustainable growth.

However, these positive credit factors are counterbalanced by important credit challenges. Although the gross general government debt ratio fell in 2015, it remains high at 129%. As a result, fiscal flexibility is very limited and the country is vulnerable to adverse shocks, including a negative growth shock and changes in investor sentiment. Further fiscal adjustment is needed to firmly place debt dynamics on a downward trajectory.

Fiscal pressures are another challenge. Some austerity measures implemented under the EU/IMF programme are being reversed, although their budgetary impact is set to be offset by restraint in public expenditure and higher excise taxes. However, reducing expenditure in a lasting way is likely to be challenging and the government’s growth forecasts could prove optimistic. Moreover, the government’s reliance on support from left-wing parties could impede the adoption of additional fiscal measures, if needed, thus increasing the risk of slippage. DBRS would be concerned if durable growth fails to materialise and if fiscal slippage turns persistent.

Dealing with fiscal concerns is crucial because Portugal’s potential growth is low. Insufficient competition in the non-tradable sector, low levels of investment and rigidities in the labour market constrain economic growth. Moreover, structural reforms implemented during the EU/IMF programme to improve labour market flexibility could be at risk from policy reversals. This could adversely affect growth prospects and competitiveness. On the other hand, the government has proposed reforms to increase education levels and efficiency in the public administration.

In addition, Portugal faces high levels of indebtedness in the non-financial corporate sector. Corporate sector debt, at 103% of GDP at end-2015, weighs on investment and is adversely affecting asset quality in the banking sector.

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 Ministry of Finance of the Republic of Portugal, IGCP, Bank of Portugal, Statistics Portugal (INE), European Commission, European Central Bank, Statistical Office of the European Communities, IMF, OECD, World Economic Forum, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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

This rating included participation by the rated entity or any related third party. DBRS had access to accounts, management and other relevant internal documents for the rated entity or a related third party.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

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

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: Adriana Alvarado, Assistant Vice President
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer
Initial Rating Date: 10 November 2010
Last Rating Date: 13 November 2015

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