Portugal: Economic recovery supported by improving budgetary position

Portugal's credit profile and sovereign rating is supported by its ongoing economic recovery and improving budgetary position, according to a leading credit rating agency. 

In a note to its clients, Moody’s said that after three years of moderate growth, real GDP growth had accelerated to 2.7% year-on-year in 2017, taking real GDP close to pre-financial crisis levels. 

The ratings agency expects the pace of GDP growth to ease to 2.1% in 2018 and 1.7% in 2019, as Portugal’s credit challenges include moderate potential growth, still elevated debt and a weak banking sector.

The country is rated Ba1 positive by Moody’s. 

"Portugal's economic growth, together with spending controls and declining interest costs, has supported a marked improvement in the country's budget position," said Evan Wohlmann, a Moody's Senior Analyst. 

"Portugal's return to private capital markets, the economy's diversification, and relatively high average level of wealth compared to Ba1 peers also support its creditworthiness."

Broad-based investment is expected to continue to play a greater role in driving economic activity over the next two years after the false start in 2015, given rising measures for capital utilisation and that gross fixed capital remains significantly below pre-crisis levels.

Portugal's very high institutional strength recognizes its good track record of implementing the three-year economic adjustment programme with the International Monetary Fund, European Union and European Central Bank, which Portugal successfully left in June 2014. 

Over the past few years, Portugal has made progress in improving the business environment to help attract foreign direct investment.

The country's low fiscal strength is based on its very high debt-to-GDP ratio, which remains a key factor constraining the sovereign's credit profile, and moderate debt affordability. Nevertheless, Moody's expects that the budget deficit will remain below 3% of GDP in the coming years.

The debt ratio declined materially in 2017 to 125.7% of GDP, although Portugal's debt burden is forecast to still remain elevated at around 117% of GDP in 2021, one of the highest in the sovereign rating universe and well above that of similarly rated peers, which limits the country's ability to withstand future shocks.

Despite improvements, the banking sector remains the key event risk for Portugal's credit profile. This assessment takes into consideration the system's relatively large size, its high level of non-performing loan levels and still weak profitability.

Portugal's sovereign rating would be upgraded to investment grade should Moody's conclude that the positive economic and fiscal trends are likely to be sustained and the rating agency is confident that the very high debt burden will move to a steady, downward trend.

That conclusion would be supported by sustained fiscal improvements pointing to a more consistent record of primary surpluses going forward and by evidence that economic growth continues to remain broad-based, supporting the economy's resilience to shocks. Further progress in the recapitalisation of the weakest banks would also be positive.

However, the outlook could be stabilised if Moody's were to conclude that the government's commitment to fiscal consolidation and debt reduction, or its capacity to achieve that objective, were to wane.

Weaker than expected economic growth or a sharp rise in interest costs, including from a negative confidence shock, would require further fiscal measures to achieve a consistent reduction in the debt burden, which, if not forthcoming, would undermine the basis for a positive outlook.

The need for unforeseen further recapitalisation support for the weakest banks, beyond the limits agreed with the EC, would also be negative.