Fitch Assesses Portugal’s Progress

Portugal’s recent decision to make a clean exit from its International Monetary Fund-European Union (IMF-EU) programme and its successful return to capital markets at favourable yields reflects investor confidence in the country’s progress since 2011, says Fitch Ratings.

The credit ratings agency (CRA) adds that the recovery also reflects strong market liquidity and a search for yield while global interest rates are low. Without a precautionary programme, the risk of Portugal getting caught up in a future bout of market volatility cannot be fully discounted. However, the sovereign’s large deposit buffer mitigates this risk.

Portugal will remain in the excessive deficit procedure (EDP) until 2015 under Fitch’s forecast, which should anchor fiscal policy and implies a substantial fiscal adjustment over the medium term. The government’s fiscal strategy document 2015-2018 published last week highlights its continued fiscal discipline, which is a key factor in the CRA’s rating assessment.

For example, its decision to reverse 20% of the cuts to public sector wages applied since 2011 largely depends on the rate of personnel and efficiency savings and is largely offset by other measures. Fitch expects this to have a neutral impact on the debt dynamics and does not see it as a weakening of the commitment to deficit reduction.

The absence of a precautionary programme also prevents Portugal from accessing the European Central Bank’s (ECB) outright monetary transactions (OMT) programme if needed.

Portugal’s deposit buffer (9% of gross domestic product [GDP] in March 2014) and falling deficits significantly reduce the chances of the country needing to call on the OMT. However, the sovereign has high funding needs in coming years and possible shocks such as a political crisis or adverse constitutional court rulings could still upset Portugal’s financing conditions.

The government’s fiscal strategy projects a balanced budget in 2018 and a decline in public debt to 114% of GDP by 2018, both of which are more optimistic than Fitch’s forecasts, which see a deficit of 1.8% and debt declining to 121% of GDP by 2018. The difference is driven by the pace of fiscal consolidation, the growth forecast after 2015 and the estimated cost of funding. The government’s more optimistic targets relative to our baseline mean there is some room for slippage without it impacting our rating assessment.

Fitch placed Portugal’s BB+ rating on positive outlook on 11 April, reflecting the progress the country has made in reducing its budget deficit as well as the improving economy, growth projections and financing conditions. The CRA repeated its comment at the time that securing a track record of market access on terms consistent with long-term public debt sustainability could trigger an upgrade.

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