DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Portugal’s Long-Term Foreign and Local Currency – Issuer Ratings at BBB (high). At the same time, DBRS Morningstar confirmed Portugal’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on all ratings is Stable.
KEY RATING CONSIDERATIONS
The disruption to the Portuguese economy brought on by the current global health crisis has been severe. The economy contracted by 16.3% year-over-year in the second quarter of 2020 due to the rapid spread of the Coronavirus Disease (COVID-19) and the subsequent containment measures. The magnitude of the shock reflects the small and open nature of the economy as well as the contribution to output from tourism. There is elevated uncertainty surrounding the outlook, with the pace of the recovery contingent on the interaction between the pandemic, policies implemented in Portugal and around the world, and possible shifts in global consumer demand. The impact on Portugal’s credit profile will depend on the duration of the shock and whether it structurally alters medium-term growth prospects and weakens government finances.
Confirmation of the Stable trend balances the abrupt health and economic shock with the improvement of key rating indicators in the years prior to the crisis. The Portuguese economy has diversified into higher quality exports and increased private sector investment. Years of primary fiscal surpluses and a declining government debt-to-GDP ratio have given the government space to provide temporary fiscal stimulus to cushion the impact of the shock on the economy. There is also a commitment across political parties for rebalancing fiscal accounts once conditions improve. Moreover, credit fundamentals among major Portuguese banks strengthened prior to the COVID-19 shock.
The ratings are supported by Portugal’s Euro area membership and its adherence to the EU economic governance framework. Both help foster credible and sustainable macroeconomic policies. However, legacies of the euro area crisis continue to pose vulnerabilities, including elevated public debt, high albeit declining levels of non-performing loans (NPLs) in the financial system, and relatively low economic growth potential. These legacy issues could become even more challenging to manage if the adverse consequences of the current crisis prove to be long-lasting.
Ratings could be downgraded if the crisis significantly diminishes growth prospects or weakens the political commitment to sustainable macroeconomic policies, resulting in a significantly worse outlook for public finance.
Conversely, ratings could be upgraded if macroeconomic conditions improve and authorities are able to return the public debt ratio to levels observed prior to the COVID-19 shock. Continuation of the progress made strengthening the financial sector could also be credit positive.
Portugal’s 2020 Economic Contraction Will Be Deep; External Sector Uncertainty Could Weigh On Future Performance
Portugal’s economy in 2020 will experience a deep recession, as the pandemic has weakened both domestic and global demand. The strict confinement measures adopted in March 2020 resulted in a sharp decrease in economic activity across most sectors in the second quarter. Stalled private consumption and investment accounted for most of the contraction in the first half of the year. The near-total collapse in tourism also caused a significant decrease in service exports. The European Commission (EC) expects the shock to contract the Portuguese economy by 9.8% in 2020.
The easing of confinement and government support measures have already caused a partial rebound in economic activity. DBRS Morningstar expects the recovery in domestic demand to continue through the end of the year and into 2021. In August 2020, consumer confidence indicators increased and the economic climate indicator began to recover across all sectors. The government has aimed to support firms by offering deferred tax payments and state-guaranteed credit lines, and to support households via employment protection schemes. Support to employment limits the decline in household disposable income, creating conditions for a future recovery in private consumption. In addition, the potential windfall from European funds accompanied by favourable financing conditions and higher private sector savings could spur a rebound in investment. The EC expects 6% growth in 2021.
The main risk to Portugal’s economy stems from potential structural change in external demand. In recent years, the importance of exports to the economy has increased – accounting for 44% of GDP in 2019, up from 30% in 2010 – and broadened its sector and geographical diversification. However, diversification is unlikely to fully protect exports from a long-lasting and broad-based demand shock, especially from tourism. Tourist spending is an increasingly more important component of service exports. The country registered 672,342 travellers in tourist accommodations in the second quarter of 2020, a decline from 7.7 million a year earlier. While that decline has already started to improve, it is unclear whether there will eventually be a full revival. A structural downward shift in demand for activities related to tourism, culture, and entertainment could result in lasting destruction of productive capacity. The Banco de Portugal calculates the level of economic activity in 2022 to be roughly 6% below the output level expected in December 2019.
External sector accounts will deteriorate slightly over the coming years. The IMF expects Portugal’s balanced current account position to revert to a small deficit in 2021. This might temporarily stall progress made in reducing the net liability position, which remained elevated at 102% of GDP in 2019. However, the rising share of direct investment (versus portfolio inflows) has improved the composition of Portugal’s international liabilities in recent years, thereby reducing external vulnerabilities
The Coronavirus Shock Will Significantly Deteriorate The Fiscal Deficit, Reversing Years Of Balance Sheet Repair
Portugal’s sustained commitment to fiscal consolidation substantially improved Portugal’s fiscal position in the years leading up to 2020. Driven by strong tax revenues and contained spending, the headline deficit steadily improved from 7.4% of GDP in 2014 to a surplus position last year. The 2019 surplus included the EUR 1.149 billion capital transfer to Novo Banco via the Resolution Fund. Prior to the current crisis, the 2020 State Budget expected a surplus in each year of the forecast period.
The Covid-19 shock and large government spending measures in 2020 will deteriorate Portugal’s balance sheet. The government announced its first set of measures in mid-March that aimed to contain the outbreak and support the economy. The restrictions imposed as part of the State of Emergency lasted from March 22 to May 2, 2020. In June 2020, the government announced an additional policy package that aimed to support employment (approximately 1.2% of 2019 GDP), enhance social welfare (0.4% of GDP), and increase corporate capital and liquidity with state-guaranteed credit lines (6.1% of GDP) and tax deferrals. The government expects the deficit to widen by no more than 7% of GDP in 2020 to accommodate revenue loss from lower economic growth, higher automatic stabilizers, and increased crisis-related expenditures.
The degree to which the deficit improves next year depends on the economic shock, whether government support measures are temporary, and fiscal policy decisions made at the EU level. DBRS Morningstar considers the fiscal impulse necessary at this moment of crisis, even if it temporarily derails the fiscal consolidation effort. Budget consolidation over the medium-term is key, as adverse demographic trends are likely to put upward pressure on pension and healthcare spending. That said, DBRS Morningstar assumes Portuguese authorities will remain committed to returning its fiscal accounts to balance once crisis conditions have passed.
Progress Made In Recent Years To Reduce Portugal’s Debt Ratio Will Reverse In 2020
Portugal’s debt-to-GDP ratio was improving prior to the pandemic. General government debt declined from 132.9% of GDP in 2014 to 117.7% in 2019. Primary surpluses, moderate economic growth, and low interest rates put the debt ratio on a firm downward trajectory. However, the COVID-19 shock in 2020 will reverse the progress made in the debt ratio over the last five years.
The IMF expects the debt ratio to increase to 135% in 2020, among the highest in Europe. Portugal’s high debt-to-GDP ratio leaves public finances vulnerable to negative growth and interest rate shocks or the crystallization of contingent liabilities. Following the last crisis, the government effectively reduced contingent risks by reclassifying various public entities onto the general government balance sheet and by fortifying the troubled banking sector. Nevertheless, COVID-19 related government support thus far includes EUR 13 billion in state guarantees. Thus, contingent risk to the government balance sheet increases the longer the pandemic endures.
Despite the increase in the debt-to-GDP ratio, the debt burden is relatively stable due to lower interest rates. Portugal had taken advantage of favourable market conditions in recent years to improve its debt profile and to reduce interest costs. This includes early repayments of IMF loans and early partial repayment of EFSF loans. Debt maturities have also been extended through active debt management operations. Low interest rates – as a result of improved market confidence in Portugal’s fundamentals combined with the European Central Bank’s asset purchase programmes – are contributing to lower debt servicing costs. General government interest costs are projected to increase only slightly in 2020 to 3.1% of GDP, from 3.0% in 2019. This supports DBRS Morningstar’s assessment in the “Debt and Liquidity” building block.
Financial Stability Risks Gradually Receded Prior To The COVID-19 Shock; Asset Quality Likely To Deteriorate
Capital increases and higher cash leverage levels placed the banking sector in a better position at the start of the year. Bank profitability in recent years was supported by lower cost of risk and improved efficiency. Risks to financial stability from the high levels of NPLs and corporate sector debt also receded. Non-financial corporate debt fell from 145% of equity in 2012 to 97% as of the first quarter of 2020. After reaching a peak of 17.9% in mid-2016, the banking system’s NPL ratio declined to 6.0% in the first quarter of 2020. NPLs among corporates declined to 11.9% of total loans in the first quarter of 2020, down from above 30% in 2016.
However, these improvements could reverse if the COVID-19 crisis drastically affects household and corporate solvency. While loan moratoria and state guaranteed loans protect asset quality for the time being, asset quality deterioration will be more pronounced with the loosening of these support measures in 2021. Almost two thirds of the banking system’s total NPLs relate to non-performance in the corporate sector. The NPL ratio among corporates points to unresolved financial system stress that could be intensified by the COVID-19 shock – a feature that weighs on DBRS Morningstar’s assessment in the “Monetary Policy and Financial Stability” building block.
DBRS Morningstar Expects Policy Continuity From The Minority Government
Portugal is a stable liberal democracy with strong public institutions. Following the October 2019 election, the Socialist Party (PS) formed a minority government without renewing the pact it held with previous coalition partners. The PS must now negotiate majority support for legislation bill by bill. Despite this, DBRS Morningstar expects policy continuity. Portugal’s centrist politics, including its commitment to EU institutions, helped the country navigate the last debt crisis. All major parties took part in the commitment to fiscal repair over the last decade. (See DBRS Morningstar commentary, Portugal Election: Expect More of the Same). Furthermore, policy decisions in recent years have put Portugal in a stronger position going into this crisis than the previous one. (See DBRS Morningstar commentary, Why Portugal is Better Positioned to Manage this Crisis).
Human Rights and Human Capital (S) were among the key ESG drivers behind this rating action. Portugal’s per capita GDP is relatively low at $23,000 in 2019 compared with its euro system peers. This factor has been taken into account within the “Economic Structure and Performance” building block.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments:
EURO AREA RISK CATEGORY: LOW
All figures are in EUR unless otherwise noted. Public finance statistics reported on a general government basis unless specified.
The principal methodology is the Global Methodology for Rating Sovereign Governments https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments (July 27, 2020).
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
The sources of information used for this rating include Ministry of Finance of the Republic of Portugal (Stability Programme, May 2020), Agência de Gestão da Tesouraria e da Dívida Pública (IGCP Note: Portugal Key Facts July 2020), Banco de Portugal (BdP: Economic Bulletin, June 2020), Instituto Nacional de Estatistica Portugal (INE), Portuguese Public Finance Council (CFP), European Commission (Spring and Summer 2020 Forecasts), European Central Bank (ECB), Statistical Office of the European Communities (Eurostat), OECD, IMF, World Bank, UNDP, BIS, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.
DBRS Morningstar 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 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/366852.
Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.
Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer – Global FIG and Sovereign Ratings
Initial Rating Date: November 10, 2010
Last Rating Date: March 20, 2020
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