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Fitch Affirms Portugal at 'BB+'; Outlook Stable
February 3, 2017 / 9:08 PM / 10 months ago

Fitch Affirms Portugal at 'BB+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, February 03 (Fitch) Fitch Ratings has affirmed Portugal's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'BB+' with a Stable Outlook. The issue ratings on Portugal's senior unsecured foreign and local currency bonds have also been affirmed at 'BB+. The Country Ceiling has been affirmed at 'A+' and the Short-Term Foreign and Local Currency IDRs and short-term debt at 'B'. KEY RATING DRIVERS Portugal's 'BB+' IDRs reflect the following key rating drivers: Portugal's sovereign ratings are supported by sturdy institutions, a strong business environment and one of the highest rates of per capita income in the 'BB' category. These factors are balanced by high levels of public and private indebtedness, a weak growth performance and legacy problems in the financial system. There was a recovery in the economy in 2H16, helped by rising exports and renewed consumer confidence tied to a rise in employment. However, following a weak performance in 1H, Fitch estimates annual growth of 1.3% in 2016, well below the original 1.8% expected in the budget. Higher outlays of EU funds and fewer domestic policy changes should lead to a pick-up in investment this year, with growth reaching 1.5%. This is in line with our eurozone growth projections but well below the 'BB' median of 3.5%. Domestic macroeconomic risks have moderated, but Portugal remains vulnerable to external developments. Exports have proven resilient in the face of a sharp fall in demand from key emerging markets such as Angola, but rising protectionist threats around the world or weaker eurozone growth are still important downside risks. Upcoming elections in key European countries could also lead to political and market volatility, which in turn could increase Portugal's borrowing costs and affect confidence and investment. Fiscal performance improved in 2016, with the general government deficit estimated at close to 2.3% of GDP (compared with our original forecast of 2.7%). Despite relatively weak revenue growth, the government managed to deliver its deficit target by implementing a strict consolidation strategy, with total expenditure estimated at around 46% of GDP, the lowest level since 2008. However, this was partly achieved by restricting public investment, which compounds challenges in boosting medium-term growth. The 2017 budget has a similar consolidation strategy but with fewer changes to the tax framework and more realistic macroeconomic assumptions. However, the deficit may be affected by the upcoming recapitalisation of state-owned Caixa Geral de Depositos (CGD), which requires EUR2.7bn of direct public support. Fitch expects the deficit to be close to 3% of GDP, with the CGD transaction accounting for about 1.1% of GDP. The improvement in the primary balance in recent years should have supported debt dynamics, but recurrent bank recapitalisations mean that public sector debt rose again in 2016, to around 130% of GDP (funds to recapitalise CGD were raised last year). Public debt has remained practically unchanged at this level since 2013 and compares with the eurozone area of 90% and 'BB' median of 51%. We forecast the general government debt/GDP ratio will fall to 123.5% by 2020, broadly in line with official projections (which now exclude positive stock-flow adjustments from disposals of bank assets). The government is revamping its efforts to address the legacy problems of the banking sector. Nonetheless, there has yet to be much progress in key areas such as the sale of Novo Banco (a buyer has been identified but the process is not complete) or the implementation of a systemic solution to impaired portfolios. A recurrent uncertainty is the potential sovereign exposure from these developments, including higher contingent liabilities. Asset quality in the banking sector remains weak, with NPLs (measured as credit at risk) at 12.6% in 3Q16. On the upside, the system's solvency is being upheld by capital increases at the two largest banks. Any policy-driven changes to the banking sector will require a concerted political effort by the government led by Prime Minister Costa to obtain the support of the junior-partners (the Communist Party and Left Block). Thus far Mr Costa has a track record of managing party differences well, which assures political stability. However, the downside is that there is little scope to implement ambitious structural reforms in other economic areas. This includes tackling high levels of private sector leverage, which weigh on medium-term growth. Non-financial corporate debt remained unchanged from end-2015 to 3Q16, at around 110% of GDP. A mild improvement in terms of trade and strong services exports tied to tourism has helped Portugal maintain a current-account surplus in 2016 Fitch expects the surplus to remain steady at an average 0.2% of GDP in 2017-18. Given weak saving ratios (particularly at the household level) a strong pickup in domestic demand could risk a return to current account deficits, but this is unlikely. Portugal's increase export potential is helping reduce net external debt, although Fitch estimates it at around 130% of GDP in 2016, compared with 20.7% for the 'BB' median and 2% for the 'BBB' median. Portugal ranks well above its rating peers, 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 notch. The model gives 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. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES Future developments that could individually or collectively result in positive rating action include: - A sustained downward trend in the general government debt/GDP levels, for example as a result of improved fiscal performance. - Improvement in Portugal's external balance sheet supported by current account surpluses - Stronger long-term growth prospects. Future developments that could individually or collectively result in negative rating action include: - Renewed stress in the financial sector that requires substantial financial support from the state. -Failure to make progress in reducing general government debt/GDP ratios or unwinding external imbalances. -Weaker economic growth prospects that have a negative impact on the banking sector or public finances. KEY ASSUMPTIONS In its debt sensitivity analysis Fitch assumes a primary surplus averaging 1.8% of GDP, trend real GDP growth averaging 1.4%, an average effective interest rate of 3.9% and deflator inflation of 1.7%. On the basis of these assumptions, the debt-to-GDP ratio would fall to 121.6% by 2025. Our debt dynamics do not include any government bank asset disposals as the timing and values of such operation remain uncertain. Contact: Primary Analyst Federico Barriga Salazar Director +44 20 3530 1242 Fitch Ratings Limited 30 North Colonnade E14 5GN, London Secondary Analyst Douglas Winslow Director +44 20 3530 1721 Committee Chairperson James McCormack Managing Director- Head of Sovereigns +44 20 3530 1286 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on Applicable Criteria Country Ceilings (pub. 16 Aug 2016) here Sovereign Rating Criteria (pub. 18 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1018584 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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