Portugal rates investment grade in spite of its bank troubles

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By:
Jeremy Weltman
Published on:

Investors might be worried by the tail-risk implications of the failed Portuguese lender BES but the sovereign is in a much improved state since completing its three-year bailout programme.

Portugal flag-envelope
Portugal - seen better days but still flying high

Lisbon’s ameliorating risk profile was set in train some time ago, according to economists and other country-risk experts taking part in Euromoney’s Country Risk Survey.

The sovereign’s risk score began to improve in Q1 2012, although it only really began to take off at the beginning of this year, when the €78 billion bailout was on course for completion without ongoing creditor support.

Portugal has climbed 13 places in Euromoney’s global rankings in 2014 to date, reaching 52nd in the global rankings out of 186 countries as of August, with a score of 54.7 out of a maximum of 100.

That marks the biggest improvement this year by any sovereign outside ECR’s highest-risk, tier-five category containing the world’s worst investment recommendations.

Portugal’s trend rise within the tier-three (medium risk) category is commensurate with a return to investment grade based on similarly ranked sovereigns.

The credit-rating agencies are slowly cottoning on, but have stopped short of such action in spite of barely more than a point now separating Portugal from Italy:

The failure of Banco Espírito Santo (BES) and constitutional court rulings barring several of the government’s proposed fiscal austerity measures have cast a huge cloud over Portugal’s short-term outlook. Yet a turning point was reached earlier this year that these tail risks are unlikely to reverse.

In spite of these obstacles, plus a public debt burden rising above 130% of GDP, there is a sense the country has finally got to grips with the problems accentuating its investor risks when the three-year bailout was granted in 2010, and which continued for two more years.

That seems clear from the fiscal deficit trend, which in spite of widening two years ago has seen 10.2% of GDP peak deficit in 2009 reduced to 4.9% last year, including bank recapitalization costs amounting to 0.4% of GDP, and is still on course for further improvement in 2014.

With programmed expenditure cuts and pension reform factored in, alongside increased tax revenue, the deficit target of 4% of GDP for 2014 should still be achievable in spite of the BES crisis subsuming almost €5 billion of state support, before it narrows to 2.5% of GDP in 2015 responding to more structural improvement.

Fortunately, Portugal had €6.4 billion-worth of bailout financing set aside in a state fund from its bailout appropriations for just such an eventuality – a figure equivalent to 4.2% of GDP. The central government’s total cash reserves, including this amount, totalled €15 billion – or 9% of GDP – at the end of last year, highlighting the government’s prudence in building up appropriate buffers.

Thankfully, too, with years of structural reform delivering the first current-account surplus in two decades, as Portuguese exporters gain market share, the economy is returning to growth faster than the eurozone as a whole, after three years of recession caused real GDP to slump by almost 6% through to 2013.

Rising factor scores in ECR’s survey highlight the improvement compared with last year:

The BES crisis is undoubtedly an unwanted constraint on investment financing, while household and corporate debt burdens are still uncomfortably high. However, the BES capitalization makes no demands on Portuguese taxpayers, so 1% real GDP growth or thereabouts this year, rising to 2% in 2015, seems plausible, most forecasters believe.

A return to moderate inflation from mild deflation these past months is also expected.

As Giada Giani, Citi’s director of European economics, asserts: “The economy is now on a stronger foot than it was a few years ago and it is better able to withstand theses shocks.

“Private savings are at historically high levels, corporate profitability is strengthening, bank deleveraging has made significant progress [with the loan-to-deposit ratio falling to 120% from 167% in 2010] and real GDP is growing again boosted by improved competitiveness.”

Meanwhile, business confidence improved in July for a fifth successive month, according to the European Commission, driven by the services sector.

An unemployment rate sliding to 14.1% (harmonized) in June is making the European Commission’s May forecasts redundant, as the jobless rate among the under-25s is poised to slip below 33% – which is unpalatable perhaps but some 20 percentage points lower than in Spain, where the national unemployment rate for the entire workforce is also higher at around 25%.

The failure of BES provided a jolt to asset prices, including a widening of Portuguese sovereign spreads, and the euro zone recovery is faltering. However, Portugal’s strengthened fundamentals indicate it is now in better shape to handle such risks. ECR data suggest it should even be reclassified as investment grade. 

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.