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Rating Action:

Moody's upgrades Portugal's rating to Baa2, changes outlook to stable from positive

17 Sep 2021

Paris, September 17, 2021 -- Moody's Investors Service ("Moody's") has today upgraded the Government of Portugal's long-term foreign- and local-currency issuer and senior unsecured ratings to Baa2 from Baa3. Concurrently, Moody's has also upgraded the country's senior unsecured medium-term local-currency note (MTN) programme ratings to (P)Baa2 from (P)Baa3 and has upgraded the foreign-currency commercial paper rating to P-2 from P-3 and the local-currency other short-term rating to (P)P-2 from (P)P-3.

The outlook has been changed to stable from positive.

The key drivers for today's rating action to upgrade Portugal's ratings to Baa2 are:

1. Moody's expectation that Portugal will see improvements in its longer-term growth prospects due to utilization of NextGen EU funds and implementation of structural reforms.

2. Moody's confidence that Portugal's debt burden will decline in the coming years due to stronger economic growth and improved effectiveness of fiscal policymaking. This rating driver is considered to be a governance factor under Moody's ESG framework.

The stable outlook balances Portugal's strong institutions and governance, a relatively diversified economy and elevated wealth levels compared to Baa2 peers, against persistent macroeconomic imbalances which include high private and public sector indebtedness and a negative international investment position as well as persistent weaknesses in the banking sector.

In a related rating action, Moody's has also upgraded Parpublica-Participacoes Publicas (SGPS), SA's local currency senior unsecured and senior unsecured MTN programme ratings to Baa2 and (P)Baa2 respectively (from Baa3 and (P)Baa3), and has changed the outlook to stable from positive. 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. De facto, Moody's considers SGPS to be integrated into the government's credit profile.

Concurrently, Moody's also raised Portugal's local- and foreign-currency country ceilings to Aa2 from Aa3, keeping the six-notch gap to the sovereign rating and reflecting Portugal's de minimis exit risk from the euro area.

Please click on this link https://www.moodys.com/viewresearchdoc.aspx?docid=PBC_ARFTL454621 for the List of Affected Credit Ratings. This list is an integral part of this Press Release and identifies each affected issuer.

RATINGS RATIONALE

RATIONALE FOR THE UPGRADE OF THE RATINGS TO Baa2

FIRST DRIVER: IMPROVING LONGER-TERM GROWTH PROSPECTS DUE TO UTILISATION OF NEXT GENERATION EU FUNDS AND IMPLEMENTATION OF STRUCTURAL REFORMS

The Portuguese economy is experiencing a robust rebound from the pandemic recession in spite of ongoing challenges in the tourism sector. Employment levels have normalized, which is supporting private consumption, and stronger rebounds in key export markets are supporting a recovery in goods exports.

Looking beyond 2021, the Next Generation EU (NGEU) funds will provide important support to medium-term growth, and Moody's expects growth rates will exceed euro area and Portugal's pre-pandemic averages. Measured as a percentage of GDP, Portugal is the sixth-largest recipient of NGEU funds; it has requested grants and loans under the Recovery and Resilience Facility that amount to 8.2% of 2020 GDP. To put this in context, this is roughly equivalent to five years of public investment and would help to address the growth challenge of years of persistent under-investment post-euro area sovereign debt crisis. Estimates of the funds' growth impact vary, but Moody's estimates that real GDP growth will be 0.7 percentage points higher, on average, over 2021 to 2025, lifting GDP 3.5% higher than it would have been without the funds by the end of 2025.

It will be challenging for Portugal to absorb effectively the NGEU funds on top of the EU structural funds that will also be forthcoming. However, Portugal has a relatively good track record of absorbing EU funds, which makes us confident that the government will be able to deliver on its investment plan.

Portugal's National Recovery and Resilience Plan (NRRP) also addresses some of the country's key structural challenges, which also has the potential to lift growth potential. It does this through a programme consisting of 37 reforms and 83 investment projects. It capitalises the newly established national development bank (Banco Português de Fomento) that will be used to address the structural undercapitalization of Portuguese SMEs. It also focuses on upskilling and reskilling the population, enabling digitalization of the public and private sector, increasing the stock of affordable housing, and reducing the environmental footprint of the building stock and transportation networks. The largest growth impact will likely come from improving the skills base of the labour force, digitalization, and housing access.

SECOND DRIVER: DECLINING DEBT BURDEN DUE TO STRONGER ECONOMIC GROWTH AND MORE EFFECTIVE FISCAL POLICYMAKING

Portugal entered the pandemic recession with a healthy budgetary position, where the authorities ran substantial primary surpluses from 2015 onwards. Moreover, the fiscal impact of the coronavirus-induced crisis has been much smaller than what Moody's has observed for other Southern European countries. For example, Greece, Spain and Italy will have seen around a increase in their debt burdens between 21 and 26 percentage points, in comparison to the 17 percentage point increase in Portugal.

In 2021, Moody's already expects that Portugal's debt burden will have started a steady decline, and Moody's expects this trend to continue for the foreseeable future. In 2021, we forecast that the debt burden will reach 127% of GDP, down from the 133.6% of GDP that was registered in 2020. By 2024, we expect the pandemic-related debt increase to have been completely unwound. This debt reduction will be driven by strong economic growth rates, a falling deficit, and favourable funding costs.

Strong debt affordability metrics are also strengthening Portugal's credit profile. The ECB's accommodative monetary policy continues to support the funding environment for all countries in the euro area. In Portugal's case, the long average maturity of the debt, which stood at 7.7 years in July 2021, reduces its sensitivity to higher future interest rates. We expect the ratio of interest payments to revenue to decline to 5.7% in 2022 from 6.7% in 2020.

This improvement in debt metrics is robust, even in stress scenarios such as a growth shock, higher interest rates, or a crystallization of a fiscal shock. Contingent liabilities incurred through the pandemic would also delay debt's return to pre-pandemic levels, though debt would continue to decline.

The Portuguese authorities relied on off-balance sheet measures to support the economy during the crisis, which has given rise to a material increase in contingent liabilities. According to the most recent data, government guarantees issued since March 2020 amounted to 5.2% of GDP . However, these additional contingent liabilities pose limited risk to our expectations that the debt burden will resume its downward trajectory in 2021; even with half of these pandemic-related guarantees being called, debt would still decline (though its return to pre-pandemic levels would be delayed by a year).

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook reflects balanced risks at the Baa2 rating level. On the one hand, the diversification of the economy, elevated wealth and strong institutions provide significant shock absorption capacity compared to Baa2-rated sovereigns. The institutions have been instrumental in implementing credit-positive reforms such as those to the country's growth model, the public finances and the banking system. Portugal is also noteworthy for the speed with which it will unwind the increase in debt due to the pandemic.

On the other hand, ongoing macroeconomic imbalances, including a highly leveraged economy and a negative international investment position, are key weaknesses. High levels of corporate indebtedness limit the investment capacity of a sizeable share of domestic firms which focus on deleveraging.

Portugal still has high levels of government debt, which limits the government's fiscal space to withstand shocks. The government will continue to face political pressures to increase spending, particularly on health and public-sector wages in the coming years, though Moody's does not expect that this will derail deficit and debt reduction plans. Lastly, despite lower contingent liability risk for the sovereign stemming from the restructuring of the largest banks, profitability in the banking sector remains weak and the elevated non-performing loans, which are likely to start rising again in 2021, will continue to weigh on its ability to contribute to the economy's growth potential.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Portugal's overall E issuer profile score is moderately negative (E-3). Portugal has low exposure to environmental risks across most categories, though water scarcity is a growing problem in many parts of the country and it regularly suffers from wildfires in the summer, with 2017 being a particularly intense year.

Moody's assesses Portugal's S issuer profile score as moderately negative (S-3), reflecting low exposure to social risks over most categories. This score is mainly driven by demographic risk: demographic change in the form of relatively fast aging of the population poses long-term fiscal sustainability challenges to Portugal. However, labour market issues also pose some challenges; for example, youth unemployment is relatively high. It is also noteworthy that half of adults have not completed secondary education. Portugal also has a significant digital skills deficit, where nearly half of the population lacks basic digital skills (and the share of the population that has never used the internet is more than double the EU average).

Portugal's very strong institutions and governance profile are captured by a positive G issuer profile score (G-1). Portugal scores very highly on institutional factors, as captured in the Worldwide Governance Indicators, reflecting strong policy effectiveness and rule of law.

Portugal's ESG Credit Impact Score is moderately negative (CIS-3), reflecting moderately negative exposure to environmental and social risks and, like many other advanced economies, very strong governance profile and in general capacity to respond to shocks.

GDP per capita (PPP basis, US$): 34,043 (2020 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -7.6% (2020 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0% (2020 Actual)

Gen. Gov. Financial Balance/GDP: -5.7% (2020 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -1.1% (2020 Actual) (also known as External Balance)

External debt/GDP: [not available]

Economic resiliency: a2

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

On 14 September 2021, 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 institutions and governance strength, have materially increased. The issuer's fiscal or financial strength, including its debt profile, has materially increased. The issuer's susceptibility to event risks has not materially changed.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

WHAT COULD CHANGE THE RATINGS UP

Portugal's ratings could be upgraded if the authorities demonstrated a track record of implementing further macroeconomic reforms, including in the context of NGEU, that resulted in sustained economic and fiscal improvements. For example, a durable increase in productivity, which would raise growth potential, could put upward pressure on the rating. A sustained deleveraging of the public sector that would bring debt levels closer to Baa-rated peers would also support a higher rating level. Furthermore, upward pressure on the ratings could develop if remaining vulnerabilities in the banking sector were addressed, particularly the legacy non-performing exposures (NPEs) and weak capitalisation levels.

WHAT COULD CHANGE THE RATINGS DOWN

The outlook, and ultimately the ratings, could come under downward pressure if our expectation that the debt burden will decline failed to materialise, perhaps due to a larger-than-expected increase in contingent liabilities. This could also manifest either through waning political support for prudent fiscal policies including an increased demand for higher spending or lower growth than Moody's current forecasts. Downward pressure could materialise if Moody's were to conclude that EU funds failed to deliver a boost to growth, particularly if the authorities did not follow through with structural reforms to increase Portugal's growth potential.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, 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

The List of Affected Credit Ratings announced here are a mix of solicited and unsolicited credit ratings. Additionally, the List of Affected Credit Ratings includes additional disclosures that vary with regard to some of the ratings. Please click on this link https://www.moodys.com/viewresearchdoc.aspx?docid=PBC_ARFTL454621 for the List of Affected Credit Ratings. This list is an integral part of this Press Release and provides, for each of the credit ratings covered, Moody's disclosures on the following items:

• Endorsement

• Rating Solicitation

• Issuer Participation

• Participation: Access to Management

• Participation: Access to Internal Documents

• Disclosure to Rated Entity

• Lead Analyst

• Releasing Office

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

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.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288435.

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

Alejandro Olivo
MD-Sovereign/Sub Sovereign
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.
© 2021 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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