ARC Assigns BBB- Rating to Portugal
ISSUER
RATINGS DATE
Republic of Portugal
May 1, 2015
ISSUER RATINGS - FOREIGN CURRENCY
ISSUER RATINGS - LOCAL CURRENCY
BBB-
A-3
Medium and Long Term
(BBB(BBB-, Stable)
Short Term
(A(A -3)
COUNTRY CEILING - FOREIGN CURRENCY
A
Foreign Currency
(A)
(A )
BBB-
A-3
Medium and Long Term
(BBB(BBB-, Stable)
Short Term
(A(A -3)
COUNTRY CEILING - LOCAL CURRENCY
A
Local Currency
(A))
(A
FIRST TIME RATING ACTION
London, May 1, 2015, ARC Ratings S.A. (ARC), a global rating agency, has assigned a long-term foreign currency issuer
rating to the Republic of Portugal (Portugal) of “BBB-”. The agency also assigned a long-term local currency issuer
rating of “BBB-” to Portugal. The outlook on both ratings is stable. In addition, the agency assigned foreign currency
and local currency country ceilings of “A” to Portugal, and short-term sovereign ratings of "A-3”. All ratings assigned
are unsolicited.
RATING RATIONALE
The key rating drivers supporting Portugal’s “BBB-” investment-grade foreign and local currency ratings are:
1. Institutional strengths that have underpinned Portugal’s crisis management successes in stabilizing its economy.
2. An economic recovery that is more reliant on exports as Portugal is slowly becoming more productive and
competitive.
3. Stable politics and policy continuity with broadly similar policy platforms among the main political parties including
during the current election season (national elections are due in the fall).
4. Proactive debt management that contains the risks associated with Portugal’s large government debt of 130% of
GDP.
5. Falling unemployment (about 13.5% at present), and rising employment, although not to pre-crisis levels.
6. A policy environment in the Eurozone that is increasingly cognizant of deflation risks. The beginning of a
quantitative easing program by the European Central Bank is helping to counter growth-retarding deflationary
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pressures in Portugal as well as in other Eurozone economies.
7. Eurozone membership that provides the institutional framework for economic management, and also has been a
proven source of emergency liquidity.
The key constraints on Portugal’s credit ratings are:
1. A history of lackluster growth performance even in the pre-crisis period when liquidity (and borrowing) was buoyant.
2. A generally uncompetitive economy that has manifested itself in large current account deficits in the years leading
up to the crisis period. While Portugal’s current account deficits have been eliminated, thanks to recession and also
the improved performance of the export sectors, economic dynamism does not appear to be firmly entrenched.
3. A large government debt that renders the country vulnerable to swings in market confidence. The combination of a
large debt and possibly weak growth prospects means Portugal’s vulnerabilities are likely to remain high.
4. An over-leveraged economy with high levels of corporate indebtedness and a bias towards debt accumulation
rather than equity financing. Corporate indebtedness and the rising level of non-performing loans (19% of the total
among corporate loans) dampen prospects for investment, and in turn, growth.
5. Contagion risks associated with a possible Greece exit from the Eurozone, or about the durability of the Eurozone
project itself, which could cause a renewal of formidable liquidity pressures.
SUMMARY OF KEY RATING CONSIDERATIONS
(1) ARC’s credit assessment is based on the expectation that Portugal will grow by 1.5
1.5.5 -2% on average over the
medium term. This projection considers that credit growth conditions will likely remain weak, due to substantial nonperforming loans and high corporate leverage. Continued fiscal restraint that aims to reduce the government deficit
below 3% of GDP, and to stay on a declining path, will also be a drag on growth. Portugal’s growth momentum will
increasingly come from exports, with export growth in the past few years performing better across a broad array of
sectors. The reform program – still incomplete -- meant to address the root causes of Portugal’s weak growth story and
overdependence on the inefficient allocation of leverage will help unleash somewhat faster-paced growth especially if
accelerated.
(2) Government debt is expected to fall very moderately
moderate ly from the current level of 130%
130 % of GDP, because of the
slow narrowing of the fiscal deficit and slow, but steady nominal GDP growth projected. The government is by
2016 expected to exit the European
European Union’s Excessive Deficit Procedure, the rulesrules-based framework for EU
countries that post outsized, sustained deficits in excess of 3% of GDP.
(3) The return of investor confidence regarding Portugal’s membership in the Eurozone and in the country’s structural
adjustment and stability has led to the resumption of market access for Portugal. The government is proactively taking
advantage of the more favourable financial market conditions to prefinance some of its obligations for the current year.
It has extended and smoothed the maturity profile of its debts maturing in the next few years, and prepayed in March
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some of its more expensive debt (including EUR 6.6 billion owed to the IMF).
(4) An improved external position with current account surpluses expected for the medium-term and continued
reduction in external debt accumulation. These trends are projected to be reflected in a falling net international
investment position ratio (at about -116% of GDP end-2014). Weak domestic demand will constrain import growth, and
more robust export growth will depend on the completion of the structural reform program that would help boost
productivity and competitiveness. In the near term, low oil prices and the weakening Euro boost the country’s terms of
trade. The current problems in Angola, a destination for about 7% of exports in the past, offset these favorable
developments somewhat.
(5) Stability in Portugal’s financial sector, with non-performing loans continuing to rise (but more slowly) in the
indebted corporate sector. The three Portuguese banks that were subject to the EU’s Asset Quality Review passed, and
the newly created Novo Banco, formed from the spin-off of the performing assets of the failed Banco Espirito Santo, is
in the process of being sold. The tier 1 capital adequacy ratio for the system is over 11% at present and the loan-todeposit ratio has dropped dramatically to 107% (end-2014) from a height of 160% in the midst of the crisis. The
deleveraging of the economy is a tailwind to growth for the economy and profitability for the banking sector.
Continued fiscal restraint is a key consideration for Portugal’s ratings. Portugal has never in the past 20 years run a
deficit below the Maastricht threshold of 3%, although it targets 2015 as the first year it will achieve this goal, with an
official expected outturn of 2.7% for the current year. Even if the target is missed the path towards continued fiscal
restraint is assured over the medium term, given the broad support for fiscal consolidation amongst the main political
parties. Government debt to GDP is expected to fall in tandem to around 124% of GDP in 2015, still very high
compared to Portugal’s peer group of countries of similar credit quality.
The agency noted that the government has been successful in consolidating government finances despite some
setbacks, including Constitutional Court decisions of last year which shot down expenditure cuts on wages and
pensions. Because of constraints in cutting expenditures, there has been an overreliance on revenues to close the size
of the fiscal gap. The government’s revenue yield has climbed to 45% of GDP in 2014 from 39% of GDP in 2010, a
considerable drain from the real economy. Portugal’s impressive fiscal adjustment pared its structural primary deficit by
9.6% between 2010-2014, as a testimony to both its institutional strength and its commitment to stabilize the economy,
even in spite of the negative impact on growth those years.
Portugal’s return to growth is also a key consideration for its investment grade ratings. GDP growth turned positive in
2014 (just 0.9%), and the government has revised upwards its growth forecast for 2015 to 1.6%. It projects growth of
2.0% by 2017. Given the constraints on debt-financed investment-led growth for the economy, Portugal’s export sector
is key to its growth prospects. Falling unit labor costs help improve the competitiveness of Portugal’s industries as does
the recent labor market reform. The tax reform that cuts corporate taxes from 25% in 2013 to 19% in 2016 is also
providing a boost to competitiveness (and government revenues, with taxes expected to increase by 5.5% in 2015
because of economic growth). More progress needs to be made on product market reforms, including opening up
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closed professions and reducing the cost of energy, to unleash faster-paced growth.
ARC’s unified “BBB-” sovereign issuer ratings for both foreign and local currency sovereign instruments reflects
Portugal’s membership in the Eurozone and the fact that the Euro is a reserve currency.
ARC’s “A” country ceiling for foreign and local currency transactions is based on our assessment of transfer and
convertibility risk. While the use of capital controls in the Eurozone is prohibited by EU treaty, ARC believes the risk that
they would be employed to stabilize economies in crisis is not zero for all countries in the bloc, especially those which
have recently experienced crisis conditions. Companies whose operations are immunized at least to some extent from
macro risks in Portugal, and which have strong financial positions, could achieve higher ratings than the sovereign.
ARC’s sovereign ratings of Portugal are determined using a methodology and scorecard that look at the entire
economy’s balance sheet and liquidity profile. Portugal’s strong institutional indicators are important considerations for
its credit ratings, although ARC notes that there is no direct link between institutional capacity and economic growth or
default risk. In Portugal’s case, its strong institutions have enabled it to adhere to crisis management policies that were
critical to its recent achievement of economic and financial stability.
RATING OUTLOOK AND KEY TURNING POINTS
Portugal’s ratings carry stable outlooks, and take into consideration our expectation that growth in the medium term will
be 1.5-2%, based on stronger export performance, and that unemployment will continue to fall from the current level of
13.5%. It also takes into account stability in the policy thrust despite the election season, and the expectation that
broad consensus for fiscal consolidation and structural reform will persist.
The trigger for an upgrade would come from sharply improved competitiveness of the real economy, whereby much
faster paced growth would be achieved, also contributing to the rapid reduction in the country’s government debt
burden. Such a scenario would likely involve a transformation the structure of the economy, including corporate sector
consolidation, as well as sharply improved prospects for investment. The corporate sector in Portugal is characterized to
a significant extent by small and fractured SMEs, many of which are overleveraged, not very profitable, and which do
not generate gains from scale.
Triggers that could prompt a rating downgrade would include a deflationary environment due to the importance of
economic dynamism for growing out of the country’s large debt burden. More fractured politics would also exert
downward pressures on the ratings to the extent they could impede the completion of the country’s still nascent
structural reform program and continued fiscal consolidation necessary to reduce the country’s large government debt
burden. A rise in fiscal arrears – they have fallen to about 0.9% of GDP at end-2014 – would trigger rating pressures
given the impact on the payments system economy-wide and also the negative signal provided about honoring
commitments.
Moreover, should Grexit (Greek exit) rise and/or should membership in the Eurozone for countries including Portugal
come under pressure, ARC would revisit the rating. Possible conduits of transmission of risks could be financial markets
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closure or repricing, and/or deposit flight, which would heighten liquidity risks, perhaps across all Eurozone periphery
countries.
ABOUT ARC RATINGS
ARC is a global ratings agency based in London and Lisbon that was formerly known as Companhia Portuguesa de
Rating, S.A.. ARC has partnered with rating agencies in India (CARE Ratings), Malaysia (MARC), Brazil (SR Ratings), and
South Africa (GCR). ARC is focused on carving out a niche based on the local knowledge and expertise of its partners
across the globe. ARC is registered with European Securities and Markets Authority (ESMA). Please visit
www.arcratings.com for further details.
THIS DISCLOSURE IS FOR INFORMATION PURPOSES ONLY AND DOES NOT
DISPENSE THE READING OF THE RESPECTIVE RATING REPORT.
ARC Ratings, S.A.
180 Piccadilly
London
London W1J 9HF
UNITED KINGDOM
Phone:
+44 (0) 203 282 7594
E -mail:
[email protected]
Site:
www.arcratings.com
Key Contacts:
Joan FeldbaumFeldbaum-Vidra
Head of Sovereigns
+1 201 574574 -5783
E-mail: [email protected]
Registered as a Credit Rating Agency with the European Securities and Markets Authority (ESMA), within the scope of the
REGULATION (EC) Nº 1060/2009 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL, of 16 September, and recognised as
External Credit Assessment Institution (ECAI) for Corporates by the Bank of Portugal. Ratings do not constitute a recommendation to
buy or sell, but only one of the factors to be weighted by investors. ARC’s Ratings are assigned based on information collected from a
wide group of sources. ARC Ratings uses and treats this information with due care and attention. Although all due care was taken in
the collection, cross-checking and processing of the information for the purposes of the rating analysis, ARC Ratings cannot be held
liable for its truthfulness. ARC Ratings must make sure that the information has a minimum level of quality prior to assigning a rating
based on such information.
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