Fitch Affirms Portugal at 'BB+'; Outlook Stable
KEY RATING DRIVERS
Portugal's 'BB+' ratings are constrained by high indebtedness, weak economic growth and legacy problems in the financial system. Government debt, at 129% of GDP at end-2015, is almost three times the 'BB' median. Positively, the ratings are supported by high GDP per capita compared with rated peers, a solid institutional framework and a strong business environment.
Portugal's 'BB+' IDRs reflect the following key rating drivers:
Fiscal figures for 1H16 have been broadly consistent with the government's original expectations. Revenue has been lifted by new levies on indirect taxes such as tobacco and vehicles, while spending has been contained via capital expenditure cuts. Nevertheless, risks to the 2.2% deficit target for 2016 persist, including uncertainty as to the full effect of various fiscal policy measures to be implemented throughout the year and the impact of weaker growth. In this context, Fitch is maintaining its cautious deficit forecast of 2.7% of GDP for this year.
Despite potential political pressures to ease consolidation over the medium-term, we continue to expect a modest narrowing of the deficit in 2017-18. This will help meet some key EU fiscal targets and reduce high public debt. We currently forecast public debt/GDP to fall to 122% by 2020. There are, however, key downside risks to our forecast, reflecting mainly the prospect of further capital injections in state-owned Caixa Geral de Depositos (CGD, Portugal's biggest bank).
Financial institutions continue to suffer from poor asset quality, affected by exposure to weak mortgage credit and rising non-performing loans (credit at risk stood at 12.2% of total loans in 1Q16 according to the Bank of Portugal), particularly on their corporate portfolio. This remains a drag on profitability and has put pressure on the capital position of some institutions such as CGD. The authorities aim to conclude the restructuring of the system by mid-2017 (including the sale of Novo Banco) although delays to this schedule cannot be ruled out.
Economic growth continues to disappoint, constrained by a weak export performance and a slowdown in investment. GDP growth was only 0.2% q-o-q in 1Q and 2Q, well below the authorities' expectations and the eurozone average. Private consumption remains the most dynamic growth component (although it slowed in 2Q), helped by improving labour conditions.
The unemployment rate stood at 10.8% in 2Q16, the lowest figure in five years. With external headwinds likely to continue in 2H, Fitch now expects GDP to grow only 1.2% in 2016 (compared with 1.6% previously and the 'BB' median of 3.3%), with downside risks.
A pick-up in external demand and rising household income will help the economy gain some momentum from 2017 onwards. Stronger medium-term growth performance, however, will be ultimately determined by progress in tackling the economy's main structural constraints. A major impediment remains high levels of corporate indebtedness, which have fallen but at 143% of GDP (non-consolidated) in March 2016 remain a significant hindrance to investment. Ongoing problems in the financial sector also act as a constraint on investment and consumer confidence.
Portugal's trade balance deteriorated in 1H16, as merchandise exports contracted 2% y-o-y. This is the result of weaker demand from key non-EU markets such as Angola (exports there fell by 42% in 1H16) and one-off effects such as temporary disruptions in key sectors.
However, the impact on the external accounts has been limited, as tourism receipts continue to rise sharply and interest expenditure falls. With domestic demand pressures remaining moderate, we expect the current account to remain in surplus in 2016-18, helping to reduce external indebtedness gradually. According to Fitch's estimates, net external debt stood at 150.9% of GDP in 2015, compared with 16.4% for the 'BB' median.
Portugal ranks well above its similarly rated and 'BBB' peers, in terms of human development and governance, highlighting the strength of its institutions and their resilience during the recent crisis.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Portugal a score equivalent to a rating of 'A-' on the Long-Term FC IDR scale.
In accordance with its rating criteria, Fitch's sovereign rating committee decided to adjust the rating indicated by the SRM by more than the usual maximum range of +/-3 notches because: in our view the country is recovering from a crisis.
Consequently, the overall adjustment of four notches reflects the following adjustments:-
-Macro: -1 notch, to reflect high corporate indebtedness, low investment, adverse demographic trends and financial sector weakness that constrain the medium-term growth outlook.
- Public Finances: -1 notch, to reflect very high levels of government debt. The SRM is estimated on the basis of a linear approach to government debt/GDP and does not fully capture the higher risk at high debt levels.
- External Finances: -2 notches. The model gives a 2-notch enhancement for reserve currency but one-notch uplift is more appropriate for Portugal given the country's recent crisis and need for an IMF programme. Moreover, net external debt as a percentage of GDP is one of the highest in the world.
Future developments that could individually or collectively result in negative rating action include:
- Renewed stress in the financial sector requiring further financial support from the state.
- Failure to make progress in reducing the general government debt/GDP ratio or in unwinding external imbalances.
- Weaker economic growth prospects with a negative impact on the banking sector or public finances.
Future developments that could individually or collectively result in positive rating action include:
- Improved fiscal performance consistent with a downward trend in general government debt/GDP levels.
- An improvement in medium-term economic growth prospects.
In its debt sensitivity analysis Fitch assumes a primary surplus averaging 1.5% of GDP, trend real GDP growth averaging 1.4%, an average effective interest rate of 3.5% and deflator inflation of 1.7%. On the basis of these assumptions, the debt-to-GDP ratio would fall to 117.2% by 2025. Our debt dynamics do not include any government bank asset disposals as the timing and values of such operation remain uncertain.