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Rating Action:

Moody's changes outlook on Portugal's Ba1 rating to positive from stable

01 Sep 2017

London, 01 September 2017 -- Moody's Investors Service, ("Moody's") has today changed the outlook to positive from stable on Portugal's Ba1 domestic and foreign long-term issuer and senior unsecured ratings, as well as on the (P)Ba1 senior unsecured MTN programme rating. Concurrently, these long-term ratings as well as Portugal's (P)NP other short-term and NP commercial paper ratings have been affirmed.

The drivers of the change in outlook to positive from stable are:

1. The improving resilience of Portugal's economic growth given the recovery in investment;

2. Portugal's ongoing fiscal improvements which support Moody's expectation that fiscal consolidation will be maintained; and

3. Portugal's improving government debt structure and its sizeable cash buffers which mitigate risks to government financing.

In a related rating action, Moody's has changed the outlook to positive from stable on Parpublica-Participacoes Publicas (SGPS), SA's Ba1 senior unsecured rating and (P)Ba1 senior unsecured MTN programme rating, and has affirmed these ratings. Moody's rates SGPS 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 SGPS lacks an explicit guarantee from the government.

Portugal's local and foreign currency long-term bond and deposit ceilings remain unchanged at A1. The short-term foreign currency bond and deposit ceilings are also unaffected and remain at P-1.

RATINGS RATIONALE

RATIONALE FOR THE POSITIVE OUTLOOK

FIRST DRIVER: IMPROVING RESILIENCE OF GROWTH IN LIGHT OF THE RECOVERY IN INVESTMENT

Moody's expects that the broad-based economic recovery underway will increase the resilience of Portugal's growth to shocks, supporting its credit profile. Furthermore, improving investment dynamics, in so far as they are directed to productive opportunities, could also bolster potential growth in Portugal, which Moody's estimates to be currently at around 1.5%.

Strong economic activity in the first half of 2017 (2.8% year-on-year), the highest since 2000, supports Moody's assessment of a marked pick-up in GDP growth to 2.5% in 2017, above expectations for euro area average growth. Importantly for Moody's assessment, the contributors to growth have broadened in recent quarters to include investment, alongside private consumption. Notably, strong growth in gross fixed capital formation (GFCF) since the second half of 2016 has widened from spending on machinery and equipment to a recovery in the construction sector, which accounts for around half of total GFCF in Portugal. At the same time, an acceleration in exports, including from the tourism sector, has helped improve the contribution of external demand.

Moody's expects investment activity to remain buoyant and continue to contribute to growth over the forecast horizon, benefitting from improving economy-wide sentiment as companies respond to expected increased demand. This compares to the first half of 2016, when uncertainty likely weighed on firms' spending decisions. Private investment will also benefit from the positive spill-overs related to EU fund inflows, averaging around 2% of GDP per year, helping to drive public sector investment.

The strength of the economic recovery is further supported by positive labour market developments, with the unemployment rate reaching around 9% in June 2017 according to Eurostat (seasonally adjusted), sharply lower since Moody's last rating action in July 2014 (when it stood at around 14%) and the lowest monthly reading since November 2008. At the same time, the economy will benefit from higher employment, which grew 2.9% in Q1 2017 from 1.4% in 2016 (Eurostat, seasonally adjusted), with most of the new jobs in permanent positions. Nevertheless, elevated long-term and youth unemployment remain persistent credit concerns.

SECOND DRIVER: SIGNIFICANT FISCAL CONSOLIDATION EFFORTS SUPPORT PRUDENT BUDGET OUTLOOK

Portugal's fiscal consolidation efforts exceeded expectations in 2016, resulting in a decline in the budget deficit to 2% of GDP, from 4.4% in 2015, largely due to a significant cut in capital expenditures and tight control over spending on goods and services, supporting Moody's assessment of a prudent budget outlook. In particular, the headline deficit in 2016 was below both the budget target of 2.4% and the European Commission's (EC) Maastricht threshold of 3% for the first time since Portugal joined the euro area, allowing Portugal to exit the EC's Excessive Deficit Procedure in June 2017.

Despite the role of one-off revenues, the structural deficit improved by 0.3% in 2016, above the requirement of an unchanged structural balance, according to the EC's assessment. Notably, the underlying budget deficit, excluding one-off impacts from the banking sector, has been on a downward trend since 2010 and Portugal's structural fiscal adjustment of around 6.4 percentage points between 2010 and 2016 was the third largest in the EU.

Moody's believes that the significant cut in expenditures achieved in 2016 provides a strong base for a continued prudent fiscal position and support's Moody's expectation that the budget deficit will remain below 3% of GDP in the coming years. In particular, budget execution data shows expenditure growth to July 2017 running well below the full year budget (0.5% versus 4.4%), which supports Moody's forecast of a further small reduction in the deficit to 1.8% this year.

Importantly, the improvement in the budget deficit helped Portugal's primary balance move to a surplus of 2.2% of GDP in 2016, from 0.2% in 2015, one of the highest in the EU. Moody's expects the primary balance to average around 2.3% over the next two years, more conservative than the authorities' estimate of 2.9% as set out in the April 2017 Stability Programme, which should support a gradual reduction in the government debt burden starting in 2017.

THIRD DRIVER: IMPROVING DEBT STRUCTURE MITIGATES RISKS TO GOVERNMENT FINANCING

Active debt management policies have helped increase the resilience of Portuguese state debt to market developments, including from a gradual increase in interest rates.

Moody's notes that the average residual maturity of the state's direct debt has improved from around six years in early 2012 to around eight years as at mid-2017, in part reflecting buy-backs in the government bond market, which has helped to smooth the government's debt redemption profile. Furthermore, the refinancing at lower interest rates has led to an incremental decline in the average cost of debt outstanding from 4.1% in 2011 to 3.2% in 2016. Notably, Portugal's debt structure has benefitted from the refinancing of programme-era debt, including the recent waiver to repay early around an additional €9.3bn of International Monetary Fund (IMF) obligations.

Furthermore, Moody's considers efforts to widen the investor base have increased the resilience of government financing to shocks. In addition, Portugal's government liquidity also benefits from a sizeable year-end cash buffer which averages around 40-50% of the following year's state borrowing requirements, providing around a six-month window before needing to access the market. Nevertheless, Moody's expects Portuguese government bond yields to remain more sensitive to changes in investor sentiment than most peripheral European sovereigns, such that the risk of a material confidence shock will continue to weigh on Moody's assessment of government liquidity risk.

RATIONALE FOR AFFIRMING THE Ba1 RATING

Portugal's Ba1 issuer rating is supported by its relatively wealthy economy, with GDP per-capita on a purchasing-power parity (PPP) basis at $28,933 in 2016, above the median for Ba1 rated peers ($17,304). In addition, the large size of Portugal's economy is able to support a diverse and competitive economy, reflected in its higher ranking compared to similarly rated peers on international competitiveness surveys.

Portugal's very strong institutional strength is also an important factor supporting its Ba1 rating, evidenced by the country's significantly higher score than Ba1 peers on indicators such as the Worldwide Governance Indicators. Portugal's strong track record in implementing structural reforms allowed the economy to rebalance to an important extent towards its tradable sectors, supporting a marked improvement in its current account balance to an expected surplus of 0.6% on average over the next two years compared to a deficit of around 6% in 2011.

At the same time, Portugal's Ba1 issuer rating incorporates the weaknesses within its credit profile. The main credit challenge remains Portugal's very high public sector debt burden, one of the highest in the EU, which Moody's expects to decline only gradually from around 130% of GDP at end 2016 to reach around 120% by 2021, limiting the available fiscal space to withstand future shocks. Relatedly, Portugal's debt affordability, measured by interest payments to revenues, remains weaker than the median of Ba1 peers.

A further vulnerability of Portugal's credit profile is the continuing high levels of debt in the private sector, notably among non-financial corporates, compounded by the weaknesses in the banking sector, which constrains Portugal's longer-term growth prospects. Notably, despite recent progress on the recapitalisation strategies for some of the largest banks in the system, the sector remains burdened by a very large stock of non-performing assets and low levels of profitability, which weighs on the ability for the sector to support productive investment opportunities. Portugal's large negative net international investment position represents a further vulnerability.

WHAT COULD MOVE THE RATING UP

Portugal's government bond rating would be upgraded to investment grade should Moody's conclude that positive economic and fiscal trends are likely to be sustained and that the very high debt burden will move to a steady, downward trend. That conclusion would be supported by sustained fiscal improvements pointing to a more consistent record of primary surpluses, by evidence that economic growth remains broad-based, supporting the economy's resilience to shocks, and by further progress in the recapitalisation of the weakest banks. The positive outlook signals that Moody's would expect to draw such a conclusion, or not, over the next 12-18 months, and quite possibly within 12 months.

WHAT COULD MOVE THE RATING DOWN

The positive outlook signals that the rating is unlikely to move down over the next 12-18 months. However, the outlook could be stabilised were Moody's to conclude that the commitment of the government to fiscal consolidation and debt reduction, or its capacity to achieve that objective, were to wane. Weaker than expected economic growth or a sharp rise in interest costs, including from a negative confidence shock, would require further fiscal measures to achieve a consistent reduction in the debt burden, which, if not forthcoming, would undermine the basis for a positive outlook. Material delays in the recapitalisation of the weakest banks, increasing the risks of contingent liabilities for the government finances, would be similarly negative for the rating.

GDP per capita (PPP basis, US$): 28,933 (2016 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 1.4% (2016 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.9% (2016 Actual)

Gen. Gov. Financial Balance/GDP: -2.0% (2016 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.7% (2016 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 29 August 2017, a rating committee was called to discuss the rating of the Government of Portugal. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have increased. The issuer's fiscal or financial strength, including its debt profile, has increased. Other views raised included: The issuer's institutional strength/ framework, have not materially changed. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. 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 or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt 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.

Evan Wohlmann
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
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 Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
© 2018 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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