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Rating Action:

Moody's changes Portugal's rating outlook to positive from stable; affirms Portugal's Baa3 ratings

09 Aug 2019

Paris, August 09, 2019 -- Moody's Investors Service ("Moody's") has today changed the outlook on the Government of Portugal's ratings to positive from stable, and affirmed the country's domestic and foreign long-term issuer, domestic and foreign senior unsecured and domestic senior unsecured MTN programme ratings at Baa3/(P)Baa3, and the foreign commercial paper and domestic other short-term ratings at P-3/(P)P-3.

The decision to assign a positive outlook was driven by two main factors:

1. The continued decline in the government's debt burden at a faster pace than previously anticipated, with further material declines likely over the coming 3-4 years. Moody's now expects general government debt-to-GDP to fall to below 110% in 2022.

2. The prospect of further, sustained improvements in the health of Portugal's banking sector. While some institutions continue to have an impact on the government finances, the system as a whole is becoming more robust. It has increased its loss-absorption capacity, non-performing loans, though high, continue to fall and ongoing declines in system-wide leverage enhance the future creditworthiness of borrowers.

The affirmation of Portugal's Baa3 rating reflects, first and foremost, Portugal's debt burden, which is one of the highest in Moody's rating universe and will continue to act as a constraint on the rating for some years to come in spite of its progressive decline. The affirmation also balances the relative wealth and diversification of the country's economy against modest growth prospects and structural economic constraints. Furthermore, it reflects the country's strong institutions and low external vulnerabilities, set against the remaining challenges that the banking system faces despite ongoing improvements.

In a related rating action, Moody's has changed the outlook on Parpublica-Participacoes Publicas (SGPS), SA to positive from stable and affirmed the Baa3/(P)Baa3 ratings on its domestic senior unsecured and domestic senior unsecured MTN programme ratings. Moody's rates Parpublica at the same level as the Portuguese government to reflect (1) the company's 100% government ownership; (2) the very close links between the company and the government; and (3) strong evidence of government financial support for the company, even though Parpublica lacks an explicit guarantee from the government.

Portugal's long-term local currency bond and deposit ceilings and the long-term foreign currency bond and deposit ceilings are unchanged at Aa3. The short-term foreign currency bond and deposit ceilings are also unaffected by this rating action and remain at P-1.

RATINGS RATIONALE

RATIONALE FOR THE POSITIVE OUTLOOK

FIRST DRIVER: IMPROVED FISCAL PERFORMANCE LEADING TO FASTER THAN EXPECTED REDUCTIONS IN INDEBTEDNESS

The first driver of the positive outlook is the continued improvement in Portugal's fiscal performance, which is now expected to improve the country's key debt metrics at a faster pace than anticipated a year ago. In 2018, the fiscal deficit fell to 0.5% of GDP, outperforming its 0.7% budget deficit target. The government has, to some extent, successfully resisted ongoing spending pressures despite the forthcoming elections. In Moody's view, this, in combination with a strong tax take, job-rich growth, falling interest costs, and expenditure containment will result in the 2019 fiscal deficit falling to the government's target of 0.2% of GDP. Going forward, Moody's thinks that political pressures to increase public-sector wages and health expenditure will continue. However, Moody's anticipates that the government will be able to resist enough of these pressures to maintain a very small fiscal deficit that is below 1% of GDP in the years to come; albeit at a slower pace, interest costs will maintain their downward trajectory as more expensive debt will continue to be replaced with lower cost issuance.

These changes in Moody's projections mean that debt reduction will continue at a faster pace than initially anticipated. Whereas Moody's projections are still more conservative than those of the government, the rating agency now expects debt-to-GDP to be at 108% in 2022, as compared to 114% at the time of the last rating action. Similarly, Moody's had debt affordability falling to 8.1% as measured by general government interest payments to general government revenues in 2022 back then, whereas the forecast is now at 6.3%; however, these improvements in debt affordability will be, in part, a function of a weaker inflation and growth environment across the monetary union.

SECOND DRIVER: ONGOING IMPROVEMENTS IN THE BANKING SECTOR

The second driver of the positive outlook is the Portuguese banking sector's continued recovery. Indeed, the stand-alone credit strength of the Portuguese banks, as expressed in the weighted-average baseline credit assessment (BCA), has improved faster than anticipated when Moody's upgraded the sovereign rating last year. This is important for the Portuguese government's credit strength because a healthier banking system reduces contingent liability risk for the government's balance sheet and it is also supportive of the country's future growth prospects.

Portuguese banks have increased their total loss absorption capacity due to balance sheet deleveraging, stricter provisioning requirements, equity raising, and recapitalization. Asset quality has continued to improve. The Portuguese banking system's NPL ratio has fallen steadily since its peak in mid-2016 and now stands at 9.6% according to the European Banking Authority (EBA), which is still high though compared to the EU average. The NPL reductions to-date have been achieved through a combination of cures, writeoffs, asset sales, and foreclosures.

The decline in Portugal's NPL ratio is expected to continue in the coming years, in part through the sale of portfolios of distressed assets. According to EBA data, the impairment coverage ratio has improved to 51.4% at the end of the first quarter of 2019 from 38.9% at the end of 2015. The system returned to profitability in 2018 due to lower provisioning costs and cost-cutting initiatives.

The significant reduction in the debt burden of the domestic private sector over the past few years also contributed to the improvement in asset quality. Private debt (households and non-financial corporations) outstanding fell to 169% of GDP at the end of 2018, according to the ECB, with continued declines in both households' and non-financial corporates' leverage. This 29-percentage point decline over the past three years has brought leverage levels to just above the euro area average of 166% of GDP. Having said this, given the low savings rate and prevalence of floating-rate debt, private-sector leverage is still a risk in Portugal, albeit at a lower level.

RATIONALE FOR THE AFFIRMATION AT Baa3

Portugal's Baa3 rating is strongly influenced by the very high debt burden, which remains a rating constraint because of the limitations that it places on the country's ability to absorb shocks. The government will face significant political pressures to increase spending, particularly on health and public-sector wages in the coming years, and so the degree of decline in the debt burden that can be achieved despite these pressures will remain an important rating consideration.

The affirmation of Portugal's Baa3 rating is also driven by macroeconomic fundamentals that balance the relative wealth and diversification of the country's economy against its modest growth prospects and structural economic constraints. Portugal is currently experiencing its longest economic expansion since it joined the single currency and has averaged growth of 1.9% over the past 22 quarters, which exceeds its potential growth rate of roughly 1.5%. Portugal used the period of the euro area sovereign debt crisis to push forward a structural change in the domestic economy that has increased the importance of exports (across a range of sectors) to the country's economic model. Private consumption and, to a lesser extent, investment spending have also made an important contribution to growth.

Portugal's institutional strength remains a key credit support, and the country's institutional framework has been key in facilitating credit-positive changes such as those to the country's growth model, the public finances and the banking system. While the institutions can be slower than those of some higher-rated peers to react, the effectiveness of their chosen policy direction has helped Portugal to move decisively past the challenges it faced pre-crisis.

WHAT COULD CHANGE THE RATING UP

Portugal's rating could be upgraded if Moody's concludes that the government's policy stance will continue to drive the fiscal consolidation and growth performance needed to achieve a decline in the debt burden over the course of the next government, and that the domestic and external economic environment will continue to support that outcome. Measures that contain public expenditure will likely be a key element of such a policy framework, and macroeconomic reforms that support near-term growth and boost growth potential by addressing structural bottlenecks in the economy would also support future upward pressure on the rating.

WHAT COULD CHANGE THE RATING DOWN

The outlook, and ultimately the rating, could come under downward pressure if there were indications that the commitment of the government to fiscal consolidation and debt reduction were to wane or that the needed political support for prudent fiscal policies was not forthcoming following this year's elections. This would put at risk the sustainability of the public debt trend. Weaker than expected economic growth, a sharp rise in interest costs, including from a negative confidence shock, or the need for unforeseen material capital support to the banking sector, would require further fiscal measures to achieve a consistent reduction in the debt burden, which, if not forthcoming, would be negative for the rating. Finally, a reversal of previous reforms -- including pension or labour market reforms -- would also place downward pressure on Portugal's rating.

GDP per capita (PPP basis, US$): 32,006 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.1% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.6% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -0.5% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -0.6% (2018 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 06 August 2019, a rating committee was called to discuss the rating of the Portugal, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has materially increased. The issuer has become less susceptible to event risks.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Sarah Carlson, CFA
Senior Vice President
Sovereign Risk Group
Moody's France SAS
96 Boulevard Haussmann
Paris 75008
France
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's France SAS
96 Boulevard Haussmann
Paris 75008
France
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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