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

On October 21, 2016 DBRS Ratings Limited 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 and its adherence to the EU economic governance framework, which helps foster credible macroeconomic policies. A favourable public debt maturity structure and a balanced current account also support the rating. However, Portugal faces significant challenges, including elevated levels of public sector debt, low potential growth, ongoing fiscal pressures, and high corporate sector indebtedness.

The Stable trend reflects Portugal’s progress in reducing the fiscal deficit and proactive measures to strengthen the banking sector. Growth underperformed in the first half of 2016, as investment contracted and exports slowed, and is expected to remain modest in the near term. Downside risks to the fiscal outlook also remain significant. Nevertheless, budget execution through September appears to be on track, with the deficit expected to fall below 3% of GDP this year. The centre-left minority government continues to demonstrate commitment to comply with the EU fiscal rules and important structural reforms are not expected to be reversed. Moreover, the government is taking steps to address vulnerabilities in the banking sector.

After missing the fiscal deficit target in 2015, the Portuguese government agreed with the European Commission a deficit target of 2.5% of GDP for 2016. Portugal has already achieved a substantial reduction in the fiscal deficit since 2011 and DBRS expects the government to continue its fiscal consolidation strategy over the coming years, in line with its commitments to the EU Stability and Growth Pact.

As a member of the Economic and Monetary Union (EMU), Portugal benefits from the strong credibility of Euro area institutions. Its adherence to the EU economic governance framework has allowed the country to benefit from the European Central Bank’s (ECB) facilities and policy tools. DBRS believes that additional EU financial support to Portugal would likely be available if necessary.

Active debt management operations and extension of EFSF loans have improved the debt maturity profile. Average debt maturity has declined marginally since February 2016 but remains favourable at 8.4 years. Portugal has also repaid 36% of its IMF loans since last year, which should translate into interest cost savings. On the external front, Portugal has maintained the correction of the current account deficit over the past three years. Driven in part by improved export performance, the current account shifted from a deficit of 12.1% of GDP in 2008 to a small surplus in 2013. While soft external demand could affect export growth and additional competitiveness gains seem unlikely, DBRS does not expect the external adjustment to reverse.

However, Portugal faces important credit challenges. Although the general government debt ratio peaked in 2014, it remains high at an expected 129.7% of GDP in 2016, and forecast to decline only gradually. As a result, the country is vulnerable to adverse shocks, particularly much weaker-than-expected growth. Further fiscal adjustment is needed to firmly place debt dynamics on a downward trajectory. Moreover, 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. While not expected, reversals of structural reforms implemented during the EU/IMF programme could adversely affect growth prospects. The government has proposed reforms to increase education levels and efficiency in the public administration, but these could take time to yield results.

Fiscal pressures continue to pose a significant risk. Some austerity measures implemented under the EU/IMF programme have been reversed, and some measures adopted in 2016 could prove temporary. A tax amnesty programme announced in October could provide a one-off boost to tax revenues. The use of frozen appropriations has also been intensified to control expenditure. However, reducing expenditure in a lasting way could be challenging, as pressures to ease austerity could rise in a low growth environment. The initial official growth assumptions have indeed proved optimistic. In the draft 2017 Budget, the government revised its growth forecasts to 1.2% and 1.5% in 2016 and 2017, respectively, from 1.8% for both years set out in the Stability Programme. Moreover, the government’s reliance on support from left-wing parties in Parliament could impede the adoption of more durable measures.

In addition, highly indebted non-financial corporates weigh on investment and the banking sector. Corporate sector debt amounted to 103% of GDP at the end of 2015. The non-performing loans ratio in the corporate sector is elevated at over 20%. Banks’ profitability remains weak, limiting their internal capital generation capacity. The recently announced plan to increase capital in state-owned bank CGD and other banks’ potential capital strengthening, together with clarity on banks’ future contributions to the Resolution Fund, are encouraging steps to improve confidence in the banking sector.

RATING DRIVERS
The ratings could come under downward pressure if there is a weakening in the political commitment to sustainable economic policies or a deterioration in public debt dynamics, resulting from markedly lower growth or a prolonged period of elevated interest rates. Specifically, a reversal of structural reforms that threaten a return of large macroeconomic imbalances or policy inaction to deal with budget pressures, would raise concerns about the commitment to sustainable policies. Conversely, the ratings could be upgraded if the improvement in public finances is sustained and medium-term growth prospects strengthen, thereby improving the outlook for public debt sustainability.

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, Agência de Gestão da Tesouraria e da Dívida Pública - IGCP, Bank of Portugal, Statistics Portugal (INE), Portuguese Public Finance Council, European Commission, European Central Bank, Statistical Office of the European Communities, IMF, OECD, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be 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 no access to 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 historical default rates published by the European Securities and Markets Authority (“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, Vice President
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer
Initial Rating Date: 10 November 2010
Last Rating Date: 29 April 2016

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