Morningstar DBRS Confirms Republic of Portugal at A (high), Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Republic of Portugal's (Portugal) Long-Term Foreign and Local Currency - Issuer Ratings at A (high). At the same time, Morningstar DBRS confirmed Portugal's Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (middle). The trends on all ratings are Stable.

KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects Morningstar DBRS' view that the risks to the credit ratings are balanced. Portugal's economic growth and fiscal balance is expected to outperform the eurozone average over the next two years, despite risks associated with escalating global trade and geopolitical tensions. Portugal's medium-term economic growth prospects remain favourable, underpinned by the strength of domestic demand. Healthy real income growth, lower interest rates, and increased spending from Portugal's Recovery and Resilience Plan are expected to support growth in 2025 and 2026, although trade tensions and increased trade uncertainty limit growth and pose downside risks to the economic outlook. Portugal's current fiscal position is among the strongest in the eurozone, posting fiscal surpluses in 2023 and 2024. The new government remains committed to generating small surpluses over the medium term, however, this could be increasingly difficult given the growing spending pressures and planned tax cuts. The renewed push for higher military expenditure will weigh on public finances over the next decade. Still, Portugal's fiscal position and favourable debt dynamics provide valuable space to gradually absorb these pressures. Portugal's public debt ratio declined sharply from 116.1% of GDP in 2019 to 94.9% in 2024 driven mainly by high primary surpluses and nominal output growth. The public debt ratio is on track to fall below 90.0% of GDP over the next two years, which could place Portugal's debt ratio below the eurozone average.

Portugal's credit ratings are underpinned by the country's euro area membership and its adherence to the EU economic governance framework. These factors help foster credible and sustainable macroeconomic policies and complement the country's strong governing institutions. Portugal's strong fiscal performance since 2016 and the strengthened position of the Portuguese banking system also underpin the country's credit rating. Key vulnerabilities include the elevated level of public debt, high external debt, and relatively low economic growth potential. Nevertheless, public finance concerns and external imbalances have receded significantly over the last decade and, unless there are additional shocks, these trends are expected to continue.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if Portugal's public debt ratio falls to significantly lower levels or there is persistent evidence that the country improves its economic resiliency and growth potential.

The credit ratings could be downgraded if a worsening of Portugal's growth outlook or a weaker commitment to fiscal discipline leads to a significant increase in its public debt ratio over the medium term.

CREDIT RATING RATIONALE

The New Centre-Right Government Received a Stronger Mandate, but Its Durability Could be Challenged Over Time

Portugal held three parliamentary elections in the past four years, the last two triggered by political scandals, and had relatively short-lived governments. Following snap elections in May 2025, the leader of the Democratic Alliance (AD), Luís Montenegro, was reappointed as prime minister. The new government once again has only the support of a minority in parliament and will have to rely on other parties to pass laws and govern. However, the mandate of this minority government seems stronger, given the gains of seats both for AD and for right-wing parties in parliament and the poor results of the Socialist Party, which no longer is the second largest party in parliament and was overtaken by the far-right Chega in number of seats. These shifts in the balance of power between the main parties could contribute to greater stability compared to the previous legislature and increase the likelihood that the government will advance its agenda. Even so, more turbulence is not ruled out throughout the legislature given the absence of an absolute majority in parliament.

Despite the recent political turbulences, Portuguese governments have remained firmly committed to public debt reduction. The new government program includes plans to further reduce personal and corporate taxes, strengthen defence capabilities, partial privatization of TAP, a reform of public administration, strengthen migration and security, improve financing conditions for small businesses, and improve the provision of housing and health. Portugal is a stable liberal democracy with strong public institutions as reflected by its strong performance in the World Bank's Worldwide Governance Indicators. Portugal significantly outperforms the EU average in terms of the Rule of Law and Voice and Accountability, compares favourably in terms of Government Effectiveness, and marginally underperforms in terms of Control of Corruption and Regulatory Quality.

The Portuguese Economy to Keep Growing Against a Challenging External Backdrop

After a strong recovery from the pandemic, the Portuguese economy is expected to continue to outperform the eurozone in the coming years. Portugal's real economy expanded 1.9% in 2024 on the back of private consumption and investments. The government's real growth forecast of 2.4% for this year, included in its 2025 Annual Progress Report, looks more difficult to reach following the unexpected contraction in the first quarter. The European Commission forecasts Portuguese real GDP growth of 1.8% in 2025 and 2.2% in 2026, above the 0.9% and 1.4% of the euro area, respectively. Similarly, the Bank of Portugal forecasts real GDP growth of 1.6% in 2025, weighed down by escalating global trade tensions. The central bank forecasts real GDP growth to accelerate to 2.2% in 2026 as investments benefit from the ramp-up of RRP investments and lower interest rates, before coming down to 1.7% in 2027 as the impulse from the RRP fades. Solid increases in real disposable income, supported by a strong labour market and less restrictive financial conditions, are expected to sustain healthy private consumption growth during 2025-2027. On the other hand, a weaker external environment because of rising trade tensions and uncertainty is expected to dampen exports and investment growth.

Portugal's favourable growth prospects in the coming years are subject to downside risks, mainly related to an escalation of global trade tensions and protectionist measures. This could have a significant impact on global supply chains and negatively affect external demand for European and Portuguese exports. On top of this, the increasing housing affordability issues in Portugal if sustained could put pressure on competitiveness and limit growth over time. On the other hand, the strong real disposable income gains pose upside potential to consumption and a full implementation of investments and reforms under Portugal's RRP could feed into stronger growth. Portugal's RRP amounts to EUR 22.2 billion (8.3% of GDP of 2023's GDP) in grants and loans, which comes on top of the EUR 33.6 billion (12.6% of GDP) in grants from the Multiannual Financial Framework 2021-27. Also, Europe's, and in particular Germany's, planned defence and infrastructure push pose upside opportunities.

Portugal's Steep Public Debt Ratio Reduction Lowers Underlying Credit Vulnerabilities

Portugal significantly reduced its public debt ratio thanks to strong nominal growth and high primary surpluses. The debt ratio decreased to 94.9% of GDP in 2024, which is 39.2 percentage points below the peak reached in 2020 and 21.2 percentage points below 2019. The government projects that the public debt ratio will decline to 91.5% of GDP in its 2025 Annual Progress Report and fall further to 83.2% in 2028 in its 2025-2028 National Medium-Term Fiscal-Structural Plan. This decline is principally driven by the conservation of primary surpluses and nominal GDP growth. Moreover, this trend could be reinforced by the government's planned asset sales. Similarly, the IMF projects that the public debt ratio will decline more rapidly over the medium term to 75.8% in 2030, with an average reduction of 3.2 percentage points per year during 2025-2030. This steep downward debt trajectory reduces sustainability concerns related to the high debt stock and supports the positive qualitative adjustment in the "Debt and Liquidity" building block assessment. Morningstar DBRS welcomes such significant debt reduction, as Portugal's still comparatively high level of debt increases the vulnerability of public finances to negative growth and interest rate shocks or the crystallization of contingent liabilities.

Prudent debt management also helps mitigate the risks associated to its still high debt ratio. Interest costs as a percentage of GDP stood at 2.1% in 2024 and are expected to remain contained over the medium term and below the 2.9% level recorded in 2019. The average maturity of outstanding debt at 7.7 years as of March 2025 limits refinancing risk and helps to cushion the increase in debt servicing costs in a higher interest rate environment. Floating rate represented 13.0% of the outstanding debt stock; however, the refixing risk is controlled by the presence of caps for savings certificates (e.g., 2.5% for the most recent series). Furthermore, the tightening of credit spreads against German bonds since mid-2022 suggests that financial markets have improved their perception of the credit quality of Portuguese sovereign debt in recent years.

Portugal Recorded Strong Fiscal Results in 2023-2024, but Maintaining Fiscal Surpluses Will Become More Difficult Over Time

Portugal's fiscal position is currently among the strongest in the eurozone following the rapid recovery from the pandemic and energy crisis. Portugal recorded a fiscal surplus of 1.2% of GDP in 2023 and 0.7% of GDP in 2024, the third and fifth best results in the eurozone, respectively. The strength of revenue growth, albeit decelerating, and the reversal of pandemic and energy support measures have compensated for the rapid growth in spending, driven by higher public wages and social transfers, and tax cuts over the last two years. The government projects the fiscal surplus to narrow further to 0.3% of GDP in 2025, as the increase in public wages and pensions, the further reduction of personal income tax rates, and the revision of the personal tax scheme for young people will only be partially offset by revenue growth and the unfreezing of the carbon tax and further reduction of the energy measures in 2025. The new government approved an additional personal income tax cut worth EUR 500 million for 2025, which could add to fiscal pressures.

Portugal's National Medium-Term Fiscal-Structural Plan 2025-2028 projects the headline fiscal surplus to narrow further to 0.1% of GDP in 2026, before increasing to 1.1% in 2027 and 1.3% in 2028. The fiscal adjustment planned by the government for 2025-2028 is driven principally by a reduction of primary expenditures of 3% of GDP, with approximately half linked to the phase out of the Portugal's Recovery and Resilience Plan (RRP) implementation and the rest linked to gradual decline in inflation and the dissipation of one-offs. The IMF projects small surpluses until 2030, while both the European Commission and the Central Bank expect a more marked deterioration in public finances in their projections leading to fiscal deficits. Over the medium term, the budgetary impact from Public-Private Partnerships (e.g., Porto-Lisbon high speed train project), national defence expenditure commitments with NATO, and social expenditures around health care could add pressure on public expenditures. While maintaining the overall fiscal balance in surplus will likely become more challenging over time, Morningstar DBRS views the risk of Portugal deviating significantly from its commitment to prudent fiscal policy as relatively low.

Portugal's Stronger External Accounts Helps the Country Better Withstand External Headwinds

The marked improvement in Portugal's external accounts in the last decade, also reflected in the strong deleveraging in the private and public sectors, puts the country on a better position to withstand external headwinds. Portugal's net international investment position (NIIP) reflects an elevated net debtor position but has improved sharply from -124.4% of GDP in 2014 to -57.6% in Q1 2025. The improvement was driven by current account surpluses and nominal economic growth. Similarly, net external debt has declined from 107.7% of GDP in 2014 to 44.0% of GDP in Q1 2025. These trends are expected to continue over the medium-term. Furthermore, Portugal's favourable NIIP structure, with non-defaultable instruments representing around 70% of the NIIP, mitigate the risks associated with its external position.

The tariffs imposed by the US on goods exported by the EU, amid risks of further escalation, will dampen Portugal export outlook. Portugal's good exports exposure to the US market (6.7% of goods exports) is commensurate to the eurozone one. Portugal's exposure to the U.S. market is heavier on the services side (10.3% of total service exports), which are not subject to the current tariffs. The current account balance has remained positive since 2013, except for the 2020-22 period due to the pandemic and the energy crisis. After a small surplus of 2.2% of GDP in 2024, the IMF projects current account surpluses of 1.5% of GDP for the period 2025-2030. The greater diversification of its export base, internalization and the increase in market share in recent years suggest an improvement in competitiveness. In addition, Portugal has benefited from a structural improvement in its energy trade balance, reflecting the increased share of renewables in the country's power generation. Portugal's membership of the euro system, the expectation for continued current account surpluses, and the structure of its external position mitigate risks and support the positive qualitative adjustment for the "Balance of Payments" building block assessment.

Portugal's Strengthened Banking Sector is Well Position to Face a More Challenging Operating Environment

The Portuguese banking system weathered the succession of shocks in recent years well, supported by stronger balance sheets, government support measures, and a strong labour market. In aggregate, the Portuguese banking sector compares favourably to the European average in terms of capitalisation and liquidity metrics. Profitability improved markedly during 2023 and 2024 due to the rapid repricing of loan books to higher interest rates given the predominance of variable interest rate mortgages. While net interest income is expected to gradually decline as the ECB's normalises policy rates, Morningstar DBRS expects structurally higher lending rates and a recovery in lending volume to support profitability (please see Portuguese Banks Q1 2025: Strong Profits Persist Despite Lower Net Interest Income). The nonperforming loan ratio continued declining to 2.3% in Q4 2024 from its peak of 20.1% in mid-2016, according to the European Banking Authority. This remains slightly above the European average of 1.9%. Rising geopolitical and trade tensions could put pressure on Portuguese household and corporations but strong labour markets and less restrictive monetary policy should keep any deterioration of asset quality limited.

The rapid rise of house prices, which more than doubled since start of 2016, has continued despite tighter financial conditions in the euro area. The pass-through from lower monetary policy rates and the government support measures (e.g., benefiting young buyers) are driving a sharp recovery in mortgage lending growth, transactions, and prices in the first months of the year. Housing supply bottlenecks, amid strong domestic and foreign demand, mitigate the risks of a sharp correction in prices. The financial stability risks from the residential real estate exposure are mitigated by the rapid deleveraging of the household sector and a small fraction of mortgage loans with loan-to-value ratios of more than 80%. The borrower-based macroprudential measures, introduced in 2018, and the most recent introduction of a sectoral systemic risk buffer on exposures secured by residential real estate (effective in October 2024) and a countercyclical capital buffer of 0.75% (effective January 2026) should help contain further build-up of risks and strengthen the resiliency of the banking sector against future shocks.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

ESG Considerations had a significant effect on the credit analysis.

Social (S) Factors
The following Social factor had a significant effect on the credit analysis: Human Rights and Human Capital. Portugal's GDP per capita, estimated at USD 28,918 in 2024 according to the International Monetary Fund, remains relatively low compared with its euro system peers. Morningstar DBRS has taken this into consideration in the "Economic Structure and Performance" building block.

There were no Environmental or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (16 May 2025) https://dbrs.morningstar.com/research/454196.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at https://dbrs.morningstar.com/research/458999.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euros 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 (9 July 2025) https://dbrs.morningstar.com/research/457952. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/454196 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Ministry of Finance of Portugal (Annual Progress Report 2025, April 2025; Medium-Term Fiscal-Structural Plan 2025-2028, October 2024; MoF Presentation, June 2025), Agência de Gestão da Tesouraria e da Dívida Pública (IGCP Investor Presentation, June 2025), Banco de Portugal (BdP: Economic Bulletin, June 2025; Financial Stability Report, May 2025), Instituto Nacional de Estatística Portugal (INE), Portuguese Public Finance Council (CFP), European Commission (Spring 2025 Economic Forecast, May 2025; 2025 Country Report - Portugal, June 2025), Portuguese Environment Agency (National Energy Plan and Climate 2021-2030, October 2024), European Banking Authority, European Central Bank, Statistical Office of the European Communities, International Monetary Fund (WEO and IFS), World Bank, Bank for International Settlements, and Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: YES
With Access to Management: YES

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

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/458998.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Javier Rouillet, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 10 November 2010
Last Rating Date: 17 January 2025

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