December 15, 2017 / 9:07 PM / 6 months ago

Fitch Upgrades Portugal to 'BBB'; Outlook Stable

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: Portugal - Rating Action Report here LONDON, December 15 (Fitch) Fitch Ratings has upgraded Portugal's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'BBB' from 'BB+'. The Outlook is Stable. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS The upgrade of Portugal's IDRs reflects the following key rating drivers and their relative weights: High Gross general government debt (GGGD) is expected to decline by more than 3pp of GDP this year, to below 127% of GDP. This will be the first decline in the GGGD ratio since the sovereign debt crisis. Fitch's assessment is that the debt trajectory is on a firm downward trend and the decline in the GGGD ratio will continue through the medium-term. The favourable debt dynamics are driven by a combination of previous structural fiscal measures, the recent cyclical recovery and a substantial improvement in financing conditions. The current account will post its fifth consecutive surplus this year despite buoyant domestic demand growth, underpinned by structural improvement in external competitiveness. While net external debt (NXD) close to 90% of GDP remains high relative to 'BBB' rated peers, external deleveraging continues to progress at a gradual pace. Medium Portugal has achieved a significant improvement in the budget balance since 2014. The overall budget deficit will likely shrink to 1.4% of GDP in 2017 from 2% in 2016 and 7.2% in 2014, underpinned by buoyant tax revenue, which rose 5.1% in January-October 2017. The Portuguese economy has experienced a strong cyclical recovery since mid-2016 and the short term outlook has also improved. Fitch has revised up its GDP forecast to 2.6% and 1.9% in 2017 and 2018, respectively, a cumulative 0.9 pps higher than in the last rating review in June 2017. Strong labour market performance confirms the strength of the recovery. Employment grew 3% in 3Q17 and unemployment fell to 8.5% in September, compared with a peak of 17.5% in January 2013. Notwithstanding the strong performance in recent quarters Fitch maintains its assumption of medium-term growth potential at around 1.5%. The recapitalisations of two largest banks (CGD and BCP) and the majority sale of Novo Banco to a foreign investor help to mitigate contingent liabilities and financial stability risks. However, the high non-performing loan (NPL) ratio remains a risk and a potential constraint on medium-term growth. The banking sector was able to shrink the stock of NPLs to EUR42 billion by mid-2017 from EUR50 billion in mid-2016. Furthermore, the recovery, underpinned by stronger economic sentiment and increasing employment, creates a favourable environment for further normalisation of the banking sector. Financing conditions have turned favourable for the sovereign in recent months and debt management is actively taking advantage to lock in the benign conditions for a longer horizon. The average issuing yield in 2017 was 2.6% and the average issuing maturity was 7.8 years. Interest expenditure in the budget is expected to decline to 3.6% of GDP in 2018 from 3.9% in 2017. Portugal's 'BBB' IDRs also reflect the following key rating drivers: Portuguese sovereign remains heavily indebted with a GGGD ratio of 127% versus the 'BBB' median of 41% and it is the third highest in the eurozone. Fitch forecasts the budget deficit to remain unchanged in 2018 at 1.4% of GDP before shrinking marginally to 1.2% in 2019. While this deficit projection does not fully meet the medium-term objective of the Stability and Growth Pact, it paves the way for a firm decline in the GGGD path over the medium term as the primary surplus is expected to stabilise at around 2.5% of GDP. Portugal has gained market share in recent years, not least due to a surge in tourism, although its trade openness remains low compared with the 'BBB' median and especially versus similar sized EU economies. Human development, governance and income per capita indicators are above 'BBB' rated peers, highlighting Portugal's institutional strengths. The Ease of Doing Business indicator is also well above the rating median. 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 Foreign-Currency (LT FC) IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: - Public Finances: -1 notch, to reflect the persistently high GGGD level and non-linear risks. The SRM is estimated on the basis of a linear approach to government debt/GDP and does not fully capture the risk at high debt levels. - Macro: -1 notch, to reflect a relatively weak medium-term outlook, constrained by high private sector indebtedness, adverse demographic trends and prevailing financial sector weakness. - External finances: -1 notch to reflect the high net external debt, which is not captured in the SRM and our view that the SRM enhancement across the eurozone for "reserve currency status" overstates the degree of flexibility provided to eurozone members that effectively lost market access during the crises. Steady declines in external vulnerability over time warrant a revision of this QO factor to -1 from -2. 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 The main factors that could, individually or collectively, lead to a positive rating action: - Track record of further substantial decline in the GGGD-to-GDP ratio; - Evidence of significantly stronger potential growth over the medium term, exceeding 2% without jeopardising the necessary external adjustment; and - Continued strong export growth that leads to widening current account surpluses and rapid decline in NXD. The main factors that could, individually or collectively, lead to a negative rating action: - Reversal of the decline in the GGGD-to-GDP ratio; and - Renewed stress in the financial sector that requires significant additional public sector support and/or affects financial stability and growth outlook. KEY ASSUMPTIONS Fitch's long-run debt sustainability calculations are based on an average primary surplus of 2.5% of GDP and average annual GDP growth of 1.5% during 2019-2026, consistent with the European Commission's latest medium-term growth potential estimates. GDP deflator is rising gradually to 2% and marginal interest rate is stable at 3% from 2018 onwards. The full list of rating actions is as follows: Long-Term Foreign- and Local-Currency IDRs upgraded to 'BBB' from BB+; Outlook Stable Short-Term Foreign- and Local-Currency IDRs upgraded to 'F2' from 'B' Country Ceiling upgraded to 'AA' from 'A+' Issue ratings on long-term senior unsecured foreign and local-currency bonds upgraded to 'BBB' from 'BB+' Issue ratings on short-term senior unsecured local-currency bonds upgraded to 'F2' from 'B' Contact: Primary Analyst Gergely Kiss Director +44 20 3530 1425 Fitch ratings limited 30 North Colonnade London E14 5GN Secondary Analyst Douglas Winslow Director +44 20 3530 1721 Committee Chairperson James McCormack Managing Director +44 20 3530 1286 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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