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

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 trend on all ratings remains Stable.

The ratings reflect Portugal’s Eurozone membership and its adherence to the EU economic governance framework, which help foster credible macroeconomic policies and make available financial facilities from European institutions. A favourable public debt profile and a sound current account position, in part supported by improved trade competitiveness, also support the rating. However, Portugal faces significant challenges, including elevated levels of public sector debt, low growth potential, high non-performing loans (NPLs) and corporate sector debt, and potential public spending pressures.

Portugal’s fiscal deficit reduction has continued in 2017, demonstrating the government’s ongoing commitment to comply with the EU fiscal rules. Economic growth has also gathered strength over the past year, and government borrowing costs have fallen to low levels again in recent months, as investor sentiment has improved. Continuation of these favourable trends is important to improve the country’s prospects, especially as these developments are not yet reflected in a reduction of the high government debt-to-GDP ratio. Therefore, the trend on the ratings remains Stable.

Importantly, the Portuguese economy has continued to grow at a robust pace in 2017. After underperforming in the first half of 2016, growth strengthened in the second half and was higher than expected for the full year. Growth has gathered further momentum in the first half of 2017, with real GDP growth accelerating to 2.9%. Growth is forecast at 2.5%-2.6% for the full year, before moderating to some extent in 2018. A continuation of such strong growth could be an important factor in improving Portugal’s position, as the country’s growth potential is estimated to be lower.

Ongoing efforts have resulted in a significantly lower fiscal deficit. The headline fiscal deficit fell to a lower-than-expected 2.0% of GDP in 2016, and the primary surplus reached 2.2%, one of the highest in the Eurozone. The headline deficit target for this year, revised in the draft 2018 Budget to 1.4% from 1.5%, also looks achievable, if tax revenues continue to perform strongly and public spending remains contained. DBRS expects the government to maintain the fiscal adjustment, in line with its commitments to the EU Stability and Growth Pact. As a result, DBRS believes that Portugal will continue to benefit from the credibility of Euro area institutions and the range of available EU financial facilities.

The public debt profile is also favourable. Fixed-rate debt accounts for 87.6% of total debt. The public debt maturity structure also provides resilience to temporary rises in interest rates, making the impact from higher bond yields on interest costs more gradual. Through active debt management operations and extension of EFSF loans, debt maturities have been extended in recent years.

However, Portugal faces important credit challenges. The government debt-to-GDP ratio remains very high, standing at 130.1% in 2016. This leaves public finances vulnerable to adverse shocks. The debt ratio is projected to start declining from this year. Sustained primary surpluses and steady growth over time are needed to firmly place debt dynamics on a downward trajectory.

In addition, growth potential remains relatively low. Although the near-term growth outlook is strong, there is some degree of uncertainty over the durability of robust growth in the longer term. This is because of Portugal’s growth potential, with estimates ranging from 1.2% to 1.6%. Still low levels of public and private investment, and low labour productivity continue to constrain potential growth. Reforms to raise education levels and efficiency in the public administration are being implemented, but these could take time to yield results.

In the private sector, challenges stem from banks’ high NPLs and still highly indebted non-financial corporations. Although in decline, corporate debt weighs on investment and on the performance of the banking sector. Banks’ NPLs fell to a still high 15.5% of total loans in Q2 2017, with the NPL ratio in the corporate sector at 27.5%. Nevertheless, the recapitalisation of state-owned Caixa Geral de Depositos (CGD) and the capital increases by the other largest banks in 2017 have placed the banking sector in a better position. More sustained progress in reducing NPLs would be positive.

While abating, potential fiscal pressures could still pose a challenge. In structural terms, the improvement in the 2016 deficit was relatively modest as some measures were temporary. The use of frozen appropriations also contributed to control spending, while capital expenditure was restrained sharply. All this raised some concerns about the durability and quality of the consolidation. Moreover, some austerity measures have been reversed, which could add pressure to expenditure in the longer term. On the other hand, ongoing spending reviews and incentives to find savings in the public administration, to be implemented from next year, are important efforts.

RATING DRIVERS
The ratings could be upgraded if the improvements in public finances and economic growth become more durable, resulting in a downward trajectory in the public debt ratio in line with current projections. More sustained progress in reducing NPLs could also be positive for the ratings. Conversely, 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. While not currently expected, this would most likely result from markedly lower growth, material fiscal slippage, or a prolonged period of elevated interest rates without corresponding economic growth.

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 (BdP), Instituto Nacional de Estatistica Portugal (INE), Portuguese Public Finance Council, European Commission, European Central Bank (ECB), Statistical Office of the European Communities (Eurostat), IMF, OECD, United Nations Development Programme (UNDP), 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 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 and US regulations only.

Lead Analyst: Adriana Alvarado, Vice President, Global Sovereign Ratings
Rating Committee Chair: Alan G. Reid, Group Managing Director, Financial Institutions and Sovereign Group
Initial Rating Date: 10 November 2010
Last Rating Date: 21 April 2017

DBRS Ratings Limited
20 Fenchurch Street
31st Floor
London
EC3M 3BY
United Kingdom
Registered in England and Wales: No. 7139960

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