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Portugal rating constrained by high debt burden despite return to growth

29 March, 2014

Moody's Investor Service said that Portugal's Ba3 rating with stable outlook is supported by the economy's return to growth, the government's track record on fiscal consolidation and its return to capital markets. Portugal's key credit challenge is the high public debt burden.
The rating agency's report is an update to the markets and does not constitute a rating action.
Moody's notes that Portugal's economy has started to grow again, and the broad structural reforms the Portuguese authorities have implemented under the EU/IMF economic adjustment program should support the rebalancing of the economy towards exports and a stronger growth path than in the past. Portugal's track record on fiscal consolidation has also been strong and the public debt ratio is expected to start declining from 2014 onwards.
Other credit strengths include the fact that Portugal has regained access to private capital markets, and that the sovereign's vulnerability to adverse funding conditions has been reduced by the smoothing of its debt redemption profile. The country is likely to exit its external support programme in mid-year, possibly with the support of a precautionary credit line from the European Stability Mechanism (ESM). Compared to its Ba3 peers, further credit strengths include the economy's size and its diversification, as well as the country's high average level of wealth.
However, Portugal faces a number of credit challenges, particularly those related to the very high government debt levels. The country would need to post significantly stronger growth rates than Moody's currently forecasts to meaningfully reduce the debt burden by the end of the decade. In addition, debt reduction requires the continuation of fiscal consolidation for several more years, with a focus on permanent expenditure cuts to reduce the size of the public sector. This process has been rendered more uncertain by the country's Constitutional Court, which rejected key spending measures of the government as unconstitutional.
Upward pressure on Portugal's Ba3 government bond rating will develop if the authorities successfully bring the current external support programme to an end while continuing to reduce the budget deficit; and if the economic recovery gathers speed so that government debt metrics are placed on a clear downward path.
Downward pressure will develop on Portugal's government bond rating should the country's fiscal-consolidation process falter or reverse. An additional driver of downward credit pressure could be as a result of a significant weakening of the banking sector or the crystallisation of material contingent liabilities.