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Ratings On Republic of Portugal Affirmed At 'BBB-/A-3' On Strong Commitment To Reform; Outlook Negative

October 05, 2011 | Standard & Poor's

•We consider that the government of the Republic of Portugal is strongly committed to following through with the EU/IMF program.
•We expect the Portuguese government should achieve something close to the EU/IMF program's fiscal targets by implementing additional austerity measures to partially offset any fiscal slippage.
•We are therefore affirming the 'BBB-/A-3' ratings on Portugal.
•In our view, however, the Portuguese economy is likely to contract in the near term more severely than we previously expected due to weaker external demand and tighter credit conditions.
•Portugal's high levels of public- and private-sector debt, along with its weak external liquidity and high external debt, remain rating constraints.
•We expect net general government debt to peak at 106% of GDP in 2013, but we expect continued funding support from multilateral lenders.
•The negative outlook on the ratings reflects our view of continuing implementation risks related to the EU/IMF program, which could affect our assessment of Portugal's political commitment or the fiscal risks.

LONDON (Standard & Poor's) Oct. 4, 2011--Standard & Poor's Ratings Services today affirmed its long- and short-term sovereign credit ratings on the Republic of Portugal at 'BBB-/A-3'. The outlook remains negative. The 'AAA' transfer and convertibility assessment is unchanged.

The ratings on Portugal reflect our view of the government's strong political commitment to economic reform, anchored by a €78 billion EU/IMF loan program. Although, in our view, Portugal has a mixed record of following through on policies addressing sustainable public finances and balanced economic growth, we believe the EU/IMF program and the recent election outcome give the government a strong mandate to improve Portugal's institutional and policy environment.

Under our criteria, we assess Portugal as having one of the higher political scores among those governments under an IMF program. The June 2011 election resulted in a majority coalition government formed of the center-right Social Democrats Party (PSD) and smaller Democratic and Social Center-People's Party (CDS-PP). Since its formation, the Portuguese government has accelerated the pace of fiscal consolidation and structural reforms under the EU/IMF program that was originally signed by the now main opposition party.

The new government is currently dealing with several serious fiscal challenges, including mitigating the worse-than-expected fiscal outturn in the first half of 2011, restructuring state owned entities (SOEs), and reevaluating and potentially renegotiating Public Private Partnerships (PPPs). In order to achieve its fiscal targets, the government has adopted additional measures to those in the EU/IMF program, including a personal income tax surcharge on Christmas bonuses, an extended wage freeze for public-sector workers, public-sector job cuts, and a change to Portugal's VAT structure. The government is also discussing significant redundancy plans for SOEs aimed at bringing loss-making SOEs to operational balance by 2013.

The near-term forecast for Portugal's GDP performance is uncertain and will likely depend on the capacity of the relatively small and closed Portuguese economy to expand exports from the current base of 30% of GDP. There are emerging signs that the Portuguese tradable sectors are growing more quickly than expected, leading to better-than-anticipated overall economic growth in 2010 and first-half 2011. In our view, however, the Portuguese economy in the near term is likely to contract more severely than we previously forecast due to weaker external demand and tighter domestic credit conditions. Domestic private-sector debt is high, with household debt to GDP at 106% and corporate debt to GDP at 153% at year-end 2010 according to Bank for International Settlements data, highlighting the fragility of the sector. We expect the economy will contract by 0.5% on average between 2011 and 2014, compared to the average contraction of 0.2% we previously expected.

We expect Portugal's general government budget deficit will achieve close to EU/IMF program targets in 2011 and 2012 despite weaker macroeconomic conditions. In our view, quarterly reviews of fiscal performance should provide opportunities for the government to implement additional fiscal measures in order to compensate for any fiscal slippages. We expect, however, that the government net borrowing requirement will be higher than reported deficits due to cash injections into SOEs and possibly banks, in addition to the crystallization of other contingent liabilities (as demonstrated by the recently disclosed higher deficits incurred by Madeira), which are only partly offset by the privatization income. Net general government debt is still rising rapidly, and we expect it will peak at 106% of GDP by 2013. We expect the Portuguese banks will achieve the increased capital requirement as outlined in the EU/IMF program mainly through their own measures. We estimate that the banks would need €5 billion additional capital to reach this target (see related research), and we do not anticipate support from the government will total more than 3% of GDP. However, under our criteria, we view Portugal's contingent liabilities from its banking, SOE, and PPP sectors as moderate, which weakens the overall fiscal score we assign.

The full implementation of the structural reform measures outlined in the EU/IMF program would, in our view, improve Portugal's international competitiveness and strengthen its medium- to long-term economic prospects. We do not expect that minor fiscal slippages or minor delays to implementing the structural measures will derail the program, but the lack of timely responses from the government could result in delays to program disbursements. We forecast support from multilateral lenders will be maintained until at least 2013, and this assumption is factored into our appraisal of Portugal's political, external, and fiscal scores under our criteria.

As the result of continued deleveraging in the economy and the private sector's reduced access to international markets, we project that the narrow net external debt will decline rapidly to below 250% of current account receipts by 2014 from a peak of 400% in 2009. In our view, however, this ratio is still very high and would remain a key ratings constraint on Portugal's ratings. A large proportion of the external debt is short term. The external financing risk currently is partly offset by multilateral lending and Portuguese banks' access to ECB funding, but in the longer term the improvement will depend the reduction in current account deficits and growth in exports.

Portugal's recent export performance as well as its significant contraction in imported goods, in particular durable goods and imported cars, has resulted in improvements to its trade deficit in 2011. However, increased interest costs during the first half of the year resulted in deteriorations in the income balance. With recently announced lower multilateral lending rates, we expect funding costs to moderate and a further improvement in the trade balance to reduce the overall current account deficit to below 10% of current account receipts from 2012.

The negative outlook reflects our view of the significant implementation risks related to the EU/IMF program. The risks, in our view, stem from potential weakening political support for the program, the macroeconomic risks associated with financial sector deleveraging (see related research below), and the likely downward pressure on wages, consumption, and private- and public-sector investment in Portugal.

If, contrary to our baseline assumptions, political commitment toward the EU/IMF program weakens, resulting in the Portuguese government deviating significantly from the fiscal targets and structural agenda specified in the EU/IMF program, our current opinion on the political environment could be revised lower. According to our criteria, such a revision could result in us lowering the ratings, perhaps by more than one notch.

Additionally, if a much weaker macroeconomic environment derails the government's fiscal efforts, or if additional contingent liabilities that are related to SOEs or PPPs are realized, or if bank recapitalization costs for the Portuguese government exceed 3% of GDP, the fiscal deficits and general government debt would be higher than we currently assume. According to our criteria, a further weakening of Portugal's fiscal assessment could result in a downgrade.

On the other hand, if Portugal achieves its fiscal targets, continues to implement growth-enhancing reforms, maintains its current strong pace of export growth, and reduces its external financing gap at a faster pace, the ratings could stabilize at their current levels.

Company: Portugal

Full company nameRepublic of Portugal
Country of riskPortugal
Country of registrationPortugal


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