- We expect Portugal to achieve its program fiscal deficit target of 5.5% of GDP in 2013 as the economy stabilizes.
- In our view, the coalition government remains committed to the EU/IMF program.
- We are therefore removing our long-term sovereign credit rating on Portugal from CreditWatch with negative implications, and affirming the ratings at ‘BB/B’.
- The outlook is negative, reflecting what we view as ongoing social and political risks associated with deleveraging efforts by Portugal’s highly indebted private and public sectors, as well as financing uncertainties related to Portugal’s exit from the EU/IMF program, expected in May 2014.
On Jan. 17, 2014, Standard & Poor’s Ratings Services affirmed its ‘BB/B’ long- and short-term foreign and local currency sovereign credit ratings on the Republic of Portugal. At the same time, we removed the long-term ratings from CreditWatch where they were placed with negative implications on Sept. 19, 2013. The outlook is negative.
The affirmation and removal from CreditWatch reflect our expectation that, despite potential legal and political impediments, Portugal should achieve its fiscal targets of 5.5% of GDP in 2013 and approach its 4.0% target in 2014. We base this expectation partly on indications that the economy has been showing signs of stabilization since mid-2013, after 10 consecutive quarters of contraction. Stronger-than-expected export performance, and an expected bottoming-out of private consumption, amid a modest decline in unemployment, should support Portugal’s fiscal performance in 2014.
Portugal’s economic outlook continues to depend on competitiveness and external demand for Portuguese goods and services, in our opinion. Domestic demand components are likely to remain subdued as both the private and public sectors continue efforts to reduce high debt burdens. The Portuguese central bank estimates nonfinancial private-sector debt at 284% of GDP in September 2013, marginally down from the peak in December 2012 (287%).
Under our current growth and deficit assumptions, we expect Portugal’s net general government debt to peak in 2014 at around 122% of GDP, and to decline only gradually to below 120% by 2016. The trajectory of debt to GDP will depend heavily on real and nominal GDP performance. We project the Portuguese net general government debt-to-GDP ratio will remain one of the highest of all rated sovereigns in 2014. We forecast that the effective nominal interest rate of the central government will fall to 3.5% in 2014, from around 4.5% during the 2008-2009 crisis, partly supported by considerable interest-rate reduction and maturity extension to the Portuguese government via the European Financial Stability Facility (EFSF) and the European Financial Stabilisation Mechanism (EFSM).
Risks to our baseline projections for net government borrowing requirements–and hence debt sustainability–remain material. Constitutional Court rulings have added further uncertainty by forcing the government to adjust elements of its fiscal consolidation plan for both 2013 and 2014. Most recently, in December 2013, the Court rejected the pension alignment of public sector workers with private sector workers (worth 0.2% of GDP in 2014 budget, but another significant setback in public administration reform). In August 2013, the Court rejected a key government reform: the termination of permanent contracts for public-sector workers with contracts agreed before 2008. This followed the Court’s April 2013 rejection of fiscal measures amounting to 0.8% of GDP. Opposition members of parliament have also challenged some of the government’s 2014 budgetary measures on constitutional grounds, leading to an extended period of fiscal policy uncertainty. We expect the government to find alternative measures to offset any fiscal gaps created by potential adverse rulings, as it has done in the past.
Continued renegotiation of fiscal and structural measures could also damage political stability, as we saw in July 2013 when ministerial resignations delayed program reviews. We believe this is symptomatic of diminishing political backing for further fiscal and structural reforms. The Constitutional Court’s deliberations over further fiscal measures could coincide with Portugal’s planned EU/IMF program exit in the second quarter of 2014. We also anticipate that political tensions could increase in the run-up to 2015 parliamentary elections.
We assess contingent liabilities to the Portuguese government as “moderate,” as defined in our criteria. We believe these contingent liabilities stem from potential capital needs from the banking system in a stressed scenario, public enterprise debt that is not yet consolidated in the general government, and net charges related to public-private partnership projects. Standard & Poor’s Banking Industry Country Risk Assessment (BICRA) ranks Portugal’s banking system in group 7 on a scale from 1 (strongest) to 10 (weakest), with negative risk trends related to both the industry and economic risk components of the BICRA.
On the financing side, the recent debt exchange and issuance of a €3.25 billion five-year bond will address part of the government’s borrowing requirements in 2014. We expect the government’s gross financing requirement (including short-term debt) for 2014 to be €45.5 billion (28% of GDP), of which €7.9 billion will likely be provided by the EFSF, EFSM, and IMF. We expect that the remainder of the requirement will be covered by domestic debt issuance targeted to the retail sector and the purchase of government debt by social security funds, as well as by the 100% rollover of outstanding treasury bills. We also believe the central government’s single treasury account cash deposits, estimated at about €15 billion at end-2013 (9% of GDP), will likely reduce in 2014 to fullfil financing needs.
Portuguese banks are deleveraging (loans to residents excluding the public sector contracted by 6.1% year-on-year in October 2013, having fallen by 13.7% from their peak in second-quarter 2011) and asset quality continues to deteriorate. Banco de Portugal reported a broad definition of nonperforming loans (“credit at risk”) at 10.6% of the banks’ loan book at June 30, 2013, up from 9.8% at end-2012. At Oct. 31, 2013, private sector customer deposits were flat, compared with end-2012, with household deposits increasing slightly. Other nonbank private sector deposits have continued to shrink.
As banks continue to delever, we expect depository corporation claims on the resident nongovernment sector to decrease further in 2013 and 2014, to reach about 140% of GDP by 2017, from the 175% peak in 2009. The European regulator has already approved the restructuring plans of all other banks apart from Banif, which received a capital injection from the government of about 0.7% of GDP early in 2013.
We believe banks are deleveraging because loan demand is weak and banks’ management is husbanding capital. Asset quality has suffered, in our view, partly from an impaired transmission mechanism within the eurozone. We believe this is the result of the disintegration of financing flows between eurozone countries since 2010. Despite low European Central Bank (ECB) base rates, Portuguese entities face higher interest rates compared to most other eurozone countries. According to ECB data, Portuguese corporate borrowers pay about 200 basis points more on new loans than the eurozone average.
We believe external financing risks remain a key ratings constraint for Portugal, despite a faster-than-anticipated turn around in its current account. We estimate external debt, net of liquid assets, at about 300% of current account receipts (CARs) at the end of 2013. Public sector external financing has been almost entirely met by official lending over the past few years, but is likely to move toward market funding during 2014 as Portugal exits its EU/IMF program.
Portugal’s large banks will also likely try to increase their borrowing in the international capital markets. Banco de Portugal’s Target2 balances with the Eurosystem have remained almost unchanged (around 40% of GDP) since the ECB’s announcement of Outright Monetary Transactions, while other peripheral central banks have been able to markedly reduce their balances.
However, we view both public- and private-sector access to the markets as vulnerable to domestic shocks and to an external downturn. Portugal’s creditworthiness appears to us, therefore, to continue to depend on the support and flexibility of its official creditors. Under our current baseline assumptions, we forecast that the government will exit its EU/IMF program in mid-2014, perhaps with a contingent line of credit provided by the European Stability Mechanism.
We removed our ratings on Portugal from CreditWatch negative because the risks that could have led us to downgrade Portugal did not materialize in the fourth quarter of 2013. However, the negative outlook reflects our opinion that there is at least a one-in-three possibility that we could lower our ratings on Portugal during 2014.
We could lower the ratings if factors affecting Portugal’s government debt sustainability markedly worsen due to lower-than-expected growth, slippage in the primary fiscal balance, or the materialization of contingent liabilities. These outcomes could be prompted, for example, by judicial or opposition challenges to the 2014 budget, political tension within the coalition, a noticeable weakening of the institutional and governance environment or social contract, as well as renewed turmoil in the eurozone. We could also lower the ratings if we observe that official support is waning.
We could lower our ratings on Portugal by more than one notch if we perceive–contrary to our current expectations–that the prospect of private sector involvement via debt restructuring has increased.
On the other hand, the ratings could stabilize at the current level if the government maintains key program commitments in a timely and predictable manner, such that it can exit its current program and continue to refinance its government debt in the market, with or without continued official support.