Portugal debate: Portugal perks up
The country’s economic recovery continues to gather momentum, underpinned by strengthening domestic demand and robust exports. The government has regained access to the international capital markets and concerns about contagion have receded. There are still vulnerabilities: debt levels are high and the banking system is weak. But Portugal has a spring in its step that it has not had since before the crisis.
• Investor confidence in Portugal is rising
• The low savings rate has constrained the capital market, but companies are becoming less reliant on credit and are moving towards funding projects themselves
• FDI flows are increasing as the labour market evolves
• Doubling the size of the capital market is a realistic target
• The fallout from the Banco Espírito Santo collapse continues, but such an event is unlikely to be repeated
• Contagion from Greece is no longer such a threat
Euromoney Cristina, you’ve just returned from a series of meetings with investors in northern Europe. What feedback did they give you about the prospects for the Portuguese economy?
The early stages of the recovery were driven mainly by net exports, with domestic demand lagging behind. Today, the recovery is more broad-based and the contribution of domestic demand has picked up. Disposable income and consumer confidence have improved, not just because of low interest rates and oil prices but also because labour market conditions have improved significantly, meaning that people are more confident about their job prospects.
The corporate sector is now more comfortable with the outlook for demand. Companies are hiring again and investing in additional capacity, which will be beneficial for exports going forward. Last year, GDP grew by 0.9% and this year the ministry of finance is projecting growth of 1.6%. This growth is on the back of an acceleration in investment, which grew by 2.5% last year and is expected to expand by 3.8% in 2015.
The export sector is now very close to full capacity utilisation. So it needs to continue to add new output capacity in order to allow export activity to gather more traction.
It is clear that the Portuguese capital market has been unable to deliver what a capital market should deliver. In one respect, this is frustrating. But in another it gives us grounds for hope, because I don’t see this as something that we cannot change – provided there is willingness to offer the right incentives and remove the disincentives that have prevented companies from accessing the capital market.
Euromoney Do these incentives need to be improved to generate more supply? Or is demand also a problem in the capital market?
A key priority in recent years has been to make the country credible again. And to make Portugal credible, there was a bill that had to be paid on the revenue side in the form of tax increases. But this should not be incompatible with removing the disincentives for companies to use the capital market.
Another structural problem is that mainly because of the tax regime, companies have not been sufficiently incentivized to retain earnings. We are now seeing the first tentative signs that things are changing, which is making companies a little less reliant on banking products. It is also encouraging them to shore up their capital structures, and finance new projects through retained earnings and own funds.
The limited or constrained capacity of the banks to support the expansion of the economy is not necessarily negative, because it has forced the corporate sector to deleverage. The fact that companies are slightly less reliant on credit and more tilted towards funding projects via their own funds is beneficial, because the ratings agencies have said that the high level of indebtedness is still a drag on potential growth. The issue of indebtedness is now being addressed, with the debt stock of households coming down steadily. The same can now be said of corporates, although their deleveraging came later. The public sector is also now putting a lot of effort into diminishing its debt overhang. So although people may complain that the rate of progress is not as fast as we would like, things are clearly progressing.
We have also been seeing signs that the reforms that have been adopted are attracting rising inflows of FDI. The feedback I have been getting from investors is that the increased flexibility in the labour market, the social security system reforms, and the changes introduced in public administration have all encouraged increased FDI.
To create and sustain those companies, you need capital. If you don’t have a strong enough national capital base, you need to ensure you have access to international capital – wherever it may be. In today’s world, capital flows very easily to wherever it finds the best opportunities. There is no reason why companies based in Portugal should be unable to tap into those capital flows.
One good example of how you can tap into these flows is the recent privatisation of [mail delivery system] CTT. This is the first case we have had of a locally listed company with a 100% free float and an international investor base which has been able to keep its headquarters in Portugal. This is important because it means that the high-value services like consultancies’ and lawyers’ fees are more likely to be kept within the local economy.
The capital market won’t be the solution for everything. But if we can double its size, which I don’t think is unrealistic, it could make a big difference in terms of the quality of growth.
Euromoney Are there other companies like CTT that could come to the market, or was its IPO very much a one-off?
Since Portugal is lagging behind in creating similar structures, neither international nor domestic investors are able to deploy their capital into SMEs in the same fashion as they do in neighbouring countries.
The low yields offered by smaller Portuguese companies compared to their peers elsewhere in Europe means that Portugal is somehow overlooked by international high-yield investors. Bear in mind that Portuguese SMEs are typically less leveraged than, say, their Spanish peers. But when you tell a UK or French institutional investor that a smaller Portuguese company pays 3.5% for five years, they say they can’t even look at an unrated company offering that sort of return.
For those of us working with Portuguese small- and mid-cap corporates, it is very difficult to motivate investors to allocate resources here rather than Spain or Italy, where similar and more liquid deals offer returns in the high single digits.
These funding levels are of course very interesting for the borrowers themselves. On the flipside, the investor base is mostly domestic, which somehow limits these companies’ chances of growing their investor base internationally, developing projects abroad and increasing their exports.
Euromoney Why are yields in Spain so much higher than they are in Portugal?
I think companies should be addressing their medium- and long-term funding needs while yields are so low. Unfortunately, many of these companies are unable to come to the market because they feel they are either too small or because the investor base is just not there for them.
I know that Euronext, together with the government, has been studying models for smaller company funding such as the Spanish Marf [alternative fixed income market], and Italy’s minibond market. There needs to be a push by the government here to encourage a similar initiative in Portugal. On a recent visit to London, the Portuguese finance minister publicly identified this specific issue as part of the efforts of the current government in order to enhance the competitiveness of Portuguese companies within a struggling European economy. I believe that such a platform or market is most likely to be established by a local development bank.
Ideally, we should incentivize the use of the capital market. But if that is not possible, given the constraints, we should look at alternatives such as state guarantees for loans. If that is the case, we should ensure that the same rules and incentives apply to the issuance of bonds.
Euromoney What about the domestic institutional investor base? Is that growing?
Insurance companies have been larger players in the market than pension funds. But they are still relatively insignificant compared to many other European countries.
Everything boils down to the level of savings, which is about 9%. Portugal’s lack of capital dates back many generations. And on top of that, since the revolution of 1974, the welfare state has been catering for the needs of the population, which has not been given the necessary incentives to save. If you don’t have a high savings pool, you can’t expect to build a large capital base to deploy in the capital market, be it through equities or debt.
We are starting to see an improvement in productivity. We are seeing a new breed of entrepreneurs in Portugal which are much more outward-looking and less reliant on the domestic market.
Euromoney In which sectors are you seeing a recovery in productivity levels?
Companies that have been able to withstand the competitive threat arising from the opening up of global trade are now much more efficient. They have created joint ventures with local partners in order to have better control of distribution chains and logistics, for example. They are much better at identifying niche opportunities in their core markets, and they have also been diversifying and adding more countries to their lists of trading partners.
The new generation of entrepreneurs is more highly-skilled, more open-minded and more willing to adopt new technology, all of which has proven to be highly beneficial.
There are a number of other areas that are extremely important for the economy, including sectors like agriculture or forestry, which harness our natural resources. These have been major contributors to the economy in terms of value added, and I think there is clear potential for continued growth there.
Traditional sectors have been able to defy the laws of sustainability and have coped well with adversity, reinventing themselves and regaining market share in sectors like textiles and shoes.
The logistics sector will also be interesting for Portugal, given the new Panama Canal and the changes this will bring in global trade. Some investments are already being made with an eye to benefiting from Portugal’s location.
Another sector where Portugal has made huge progress is in education. We have been very successful in attracting students from all over the world to our universities, some of which are already numbered among the top 25 globally. Some of these are already having to turn away applications of thousands of students because demand for places is so high.
LL, Euronext The revenue and value-added that is generated by the educational sector is extremely important to Portugal. It also has very important implications for the future of the Portuguese economy because many of today’s students will be tomorrow’s successful entrepreneurs.
Euromoney This all sounds very encouraging for the very long term. But coming back to some more prosaic short-term issues, how damaging to Portugal’s image and to its banking sector was the collapse of Banco Espírito Santo?
We still don’t know what the total losses to the system arising from BES will be; nor do we know who has suffered the biggest losses, and how these will be dealt with. But I think the BES crisis could have been tackled more quickly, because it was well-known that the group was in trouble.
CC, IGCP But at least it put to the test the new rule book for the public support of the banking sector, and so far the procedure has worked very well.
More broadly, I think the most damaging impact of the Espírito Santo Group collapse was on related parties that somehow relied heavily on the support of BES.
On the positive side, the BES collapse did not lead to an increase in unemployment. Instead, the economy continued to grow steadily and proved to be stronger than expected in 2014 and the first few months of 2015.
On a more positive note, we were very pleased by how quickly the market absorbed the BES news. Exactly a month after the announcement of the resolution plan, we printed our first 15-year benchmark for six years, which we were able to issue at a yield below 4%. That showed how quickly the market came to understand that the BES situation was something that would not taint the whole economy, nor the creditworthiness of the sovereign.
So in spite of all the apparent implications for the economy and the treasury, worries about contamination did not gather any traction.
Euromoney The IMF says the banking system still faces high operating costs, overcapacity and weakening asset quality. Are these valid concerns?
Euromoney Would branch closures and other cutbacks be politically acceptable?
Euromoney Cristina, you mentioned the 15-year deal you did last year. This year, how has your funding strategy been impacted by quantitative easing and how serious are the distortions that have been created in the secondary market as a result of the ECB programme?
So I don’t think we should blame QE entirely for the drying-up of liquidity, which is something that has been going on for a while. It is true that it has been intensified since QE, but it was lingering well before that. This is something we’ll all have to get used to, and try to adopt mechanisms or issuance strategies to mitigate it as far as possible, because QE will be with us until September next year.
I think the recent repricing that we’ve seen in government bonds could be beneficial for the functioning of the market. What we’ve seen since the start of QE has been a divide between pricing in the primary and secondary markets. It may be positive if secondary market pricing comes closer to the primary market, because yields had dropped so far that institutional investors had started to disengage.
Euromoney How is Portugal affected by the Grexit discussion? Surely things are very different today to how they were in 2012? I have the impression now that whatever happens in Greece, the other so-called peripheral economies have ring-fenced themselves against any fall-out. Is this an accurate interpretation of how things have changed in the last three years?
Euromoney More broadly, is Portugal relaxed about Greece in a way that it wouldn’t have been two years ago?
Euromoney But the socialists are already talking about backtracking on austerity if they win the election scheduled for this autumn, aren’t they?
JS, CaixaBI But there is no such thing as extreme as Syriza in Portugal, which is good for our image in the investor community.
CC, IGCP The socialists have said that they are committed to the fiscal compact, which is also reassuring for investors.
Euromoney So however well Podemos does in Spain, or the Portuguese Socialist Party does in the polls, political risk in Portugal is negligible, as far as financial markets are concerned?
Euromoney So the outlook for Portugal remains bright?