London, 05 May 2010 -- Moody's Investors Service has today placed Portugal's Aa2 government bond ratings on review for possible downgrade, while the government's Prime-1 short-term rating was affirmed. Moody's expects that, in the event of a downgrade, Portugal's Aa2 ratings would fall by one, or at most two, notches. The review of Portugal's ratings -- which had been on negative outlook since October 2009 -- is expected to conclude within a three-month time horizon.
Today's rating action reflects the recent deterioration of Portugal's public finances as well as the economy's long-term growth challenges. "The review for possible downgrade will consider a repositioning of Portugal's ratings to reflect the potentially lasting deterioration in the government's debt metrics," says Anthony Thomas, Vice President-Senior Analyst in Moody's Sovereign Risk Group. "In the context of a small and slow-growing economy, such debt metrics may no longer be consistent with a Aa2 rating."
The weakening of Portugal's public finance position reflects the failure of successive administrations to consistently limit government budget deficits since Portugal joined the eurozone at its inception. "More recently, however, the government's has reiterated its objective to achieve or even surpass the deficit reduction targets published in its latest Stability and Growth Programme," says Mr. Thomas. "The well-structured debt profile means that refinancing risks are modest."
Moody's believes that increased risk discrimination in the financial markets may raise Portugal's financing costs for some time to come. Nonetheless, Moody's expects that debt service will remain very affordable in the near to medium term. Although its debt metrics may, on balance, turn out to be more consistent with a low Aa or a high A rating, the government's debt is neither unsustainable nor unbearable.
Portugal's growth challenges plus large fiscal deficits have led market participants to compare Portugal (and several other European countries) to Greece. Although Moody's believes that Greece faces far more serious fiscal difficulties than Portugal, the rating agency nevertheless sees an extended period of retrenchment for Portugal as inevitable until the country's domestic financial imbalances are corrected.
In addition to factors related to public debt sustainability, Moody's rating review will examine other aspects of the structural adjustment agenda -- in particular, the steps being taken by Portugal's policymakers to address the poor economic competitiveness and low domestic savings, which are at the root of the country's low trend growth rate. Moody's forecasts assume positive, albeit relatively slow, real economic growth.
"Portugal's growth problem is related more to its low productivity than its high costs per se," says Mr. Thomas. "The lack of a devaluation option creates stronger -- but not impossible -- headwinds for the country's economic recovery."
Portugal's country ceilings for bonds and bank deposits fall under the eurozone's regional ceilings and are therefore unaffected by this rating action.
The previous rating action on Portugal was implemented on 29 October 2009, when Moody's assigned a negative outlook to the government's Aa2 bond ratings.
The principal methodology used in rating the government of Portugal is Moody's Sovereign Bond Methodology, published in 2008, which can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.
London
Pierre Cailleteau
Managing Director
Sovereign Risk Group
Moody's Investors Service Ltd. - England
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
London
Arnaud Mares
Senior Vice President
Sovereign Risk Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
London
Anthony Thomas
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Euro plunges on the news:
Full text from S&P:
Overview
- Fiscal and economic structural weaknesses in our view leave the Republic of Portugal in a comparably weak position to address the significant deterioration in its public finances and expected lackluster economic growth prospects over the medium term.
- We are lowering our long-term ratings on Portugal to 'A-' from 'A+' and the short-term ratings to 'A-2' from 'A-1'.
- The negative outlook reflects our assessment of the risk of a further downgrade should fiscal consolidation fall short of expectations or should concerns over government liquidity mount.
Rating Action
On April 27, 2010, Standard & Poor's Ratings Services lowered its long-term local and foreign currency sovereign issuer credit ratings on the Republic of Portugal to 'A-' from 'A+'. At the same time the local and foreign currency
short-term ratings were lowered to 'A-2' from 'A-1'. The outlook is negative. The 'AAA' transfer and convertibility assessment is unchanged.
Rationale
The two-notch downgrade reflects our view of the amplified fiscal risks Portugal faces. Under our revised base case economic growth scenario, we expect the Portuguese government could struggle to stabilize its relatively high debt ratio over the outlook horizon until 2013. Portugal's public finances in our view remain structurally weak, notwithstanding the government's substantial public sector reforms of recent years.
We believe past dependence on now more scarce external financing as a source of economic growth, and weak external competitiveness add to the likely adverse growth dynamics in Portugal. As a result, to reach its current targets we expect that the Portuguese government would need to implement fiscal consolidation over and above its current plans. Portugal's fiscal indicators, as well as its growth outlook, in our view compare unfavorably with the 'A'
median for sovereigns.
We have revised downward our growth scenario for Portugal and now expect economic activity to stagnate in 2010, after a contraction of 2.7% in 2009. In our opinion, the economy's growth potential will likely remain subdued, constrained by weak international competitiveness, low productivity gains, stagnating investment growth, and falling domestic credit as the highly leveraged private sector reduces debt. Domestic credit, at 172% of GDP in 2009, is comparatively high in Portugal compared with that of most other Eurozone members.
We also consider it likely that relatively rigid product and labor markets could impede growth prospects in Portugal, prolonging the adjustment in prices and wages we view as necessary to regain external competitiveness. As a result, we expect real GDP growth to return to 1% only by 2012. Moreover, in our opinion the increase in nominal GDP is likely to be restricted by our expectation of low average GDP deflator growth of 0.6% over 2010-2013. This,
in turn, is likely to lead in our opinion to higher deficits and debt ratios.
An increase in the structural general government deficit alongside a cyclical decline in economic output has in our view caused Portugal's public finances to worsen significantly, reversing previous progress in fiscal consolidation
since 2005. The government deficit rose to 9.4% of GDP in 2009 from 2.7% in 2008. The government initially chose to implement only limited consolidation measures in 2010, which is why we expect the deficit to remain high, at 8.5% of GDP in 2010. However, we understand that the government is now considering accelerating some consolidation efforts to 2010 that were initially intended for 2011. Nevertheless, the overall consolidation effort remains unchanged. The government has announced that it aims to cut the deficit to less than 3% of GDP by 2013.
We expect fiscal consolidation to progress at a slower pace than the government foresees, achieving a deficit of 4.1% of GDP by 2013. This is because we believe that there is implementation risk with regard to the government's announced program, particularly given that the minority government will need opposition support to pass necessary legislation. Still, our base-case assumption remains that the government should be able to form ad hoc alliances to secure direct or indirect support for key legislation, as it did during the parliamentary vote on the convergence program on March 25, 2010. We also regard the government's growth assumptions as optimistic, in our view overstating the fiscal impact of cyclical recovery. The government could, however, raise taxes, which are currently not part of the consolidation plan, should the decrease in deficits not be as swift as envisaged. This option, which is not currently part of our base-case scenario for public finances, provides upside potential to our forecast numbers
In line with our expectation of high deficits and weak economic growth, we expect government debt to continue to rise rapidly, to 95% of GDP by 2013 from 66% in 2008. Portugal has one of the highest debt-rollover ratios in the Eurozone, at almost 18% of GDP in 2010. Fiscal imbalances and high debt rollover in our opinion leave Portugal vulnerable to changes in investor sentiment. The resulting interest rate shock or further shocks to economic growth could in our view lead to a significantly more pronounced increase in the government's debt ratio. We believe this could eventually increase the pressure for faster and more pronounced fiscal adjustment.
Outlook
The negative outlook on Portugal reflects our assessment of the potential for a further downgrade if deficits and debt levels exceed our current expectations and if consolidation measures are not fully implemented. Meanwhile, sustained weak growth in nominal GDP could in our view also undermine the government's efforts to improve the general government deficit and debt ratios. Downward pressure on the ratings could also result from adverse interest rate shocks to government finances.
We could revise the outlook to stable should the government manage to achieve at least its baseline consolidation agenda and put the budget deficit on a credible and sustainable downward path, thereby establishing a clear perspective for stabilizing and eventually reversing the debt ratio.
