Fitch Affirms Portugal at 'BBB'; Outlook Stable
01 JUN 2018 4:03 PM ET
Fitch Ratings-London-01 June 2018: Fitch Ratings has affirmed Portugal's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
Portugal's rating balances its institutional strengths (human development, governance and income per capita indicators are all above 'BBB' rated peers) and improving macroeconomic and fiscal indicators with very high public and external debt levels and vulnerabilities in the financial sector.
The declining trend of gross general government debt (GGGD) has continued since the last rating review, a two-notch upgrade of Portugal's rating to 'BBB' on 14 December 2017. The GGGD to GDP ratio was 125.7% at the end of 2017, compared with 129.9% at the end of 2016. The recent macroeconomic and fiscal developments have buttressed Fitch's assessment that the debt trajectory is on a firm downward trend and the decline in the GGGD ratio will continue over the medium term.
The cyclical economic recovery reached its peak in 2017 when GDP grew by 2.7%. Fitch forecasts a gradual slowdown to 2.2% in 2018 and 1.8% in 2019, broadly in line with aggregate eurozone growth. Improving labour market conditions underpin the underlying growth momentum, as the unemployment rate fell to 7.5% in March 2018. At the same time, there are no signs of increasing domestic wage and price pressure, thus inflation will remain subdued over the next two years.
Tight fiscal policy, guided primarily by the European fiscal rules, is expected to prevail over the medium term. According to the European Commission's estimates the structural budget deficit declined by 0.9pp of GDP in 2017. This was a strong counter-cyclical fiscal policy effort at the peak of the economic cycle. Fitch forecasts the headline budget deficit to be close to 1% of GDP in 2018 and 2019.
Banking sector vulnerabilities continue to reflect the crisis legacy. The non-performing loan (NPL) ratio is still high, although it declined to 13.3% at the end of 2017, and profitability prospects are weak in the very low interest rate environment. Furthermore, the banking sector recapitalisation costs continue to have a significant impact on the headline budget balance. Eurostat classified the 2017 recapitalisation of Caixa Geral de Depositos, equivalent to 2% of GDP, to be included in the budget deficit, thus the headline deficit in 2017 was 3% of GDP, compared with 2% in 2016. Furthermore, Novo Banco will likely receive additional public support through the contingent capital mechanism in 2018 and 2019. Fitch estimates the fiscal costs to be around 0.4% of GDP in both years.
The external deleveraging of the heavily indebted Portuguese economy will continue over the medium term, driven by a sustained, albeit small, current account surplus around 0.5% of GDP. Improved external competitiveness has helped the economy to maintain a modest current account surplus despite the buoyant recovery in domestic demand, and import-sensitive investment in particular during 2017. Nevertheless, net external debt remains very high at 94% of GDP in 2017, relative to the 3.5% 'BBB' median and its decline will only be gradual. Trade openness remains low compared with the 'BBB' median and especially versus similar sized EU economies.
Financing conditions are favourable by historical standards, but risks have increased more recently. The prudent debt management strategy, including high cash reserves (maintained at minimum 40% of the next 12 months financing requirements) and lengthening average maturities can mitigate financing risks in the short term. The average issuing yield over January-May 2018 was 2.0%, compared with 2.6% in 2017 and 3.0% average interest rate of the total debt stock.
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 Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Public Finances: -1 notch, to reflect the persistently high GGGD level and non-linear risks. The SRM is estimated on the basis of a linear approach to government debt/GDP and does not fully capture the risk at high debt levels.
- Macro: -1 notch, to reflect a relatively weak medium-term outlook, constrained by high private sector indebtedness, adverse demographic trends and prevailing financial sector weakness.
- External finances: -1 notch to reflect the high net external debt, which is not captured in the SRM.