Moody's Investors Service has today downgraded
Portugal's long-term government bond ratings to Ba2 from Baa1 and
assigned a negative outlook. Concurrently, Moody's has also downgraded
the government's short-term debt rating to (P) Not-Prime from (P)
Prime-2. Today's rating action concludes the review of Portugal's ratings
initiated on 5 April 2011.
The following drivers prompted Moody's decision to downgrade and assign a
negative outlook:
1. The growing risk that Portugal will require a second round of official
financing before it can return to the private market, and the increasing
possibility that private sector creditor participation will be required
as a pre-condition.
2. Heightened concerns that Portugal will not be able to fully achieve
the deficit reduction and debt stabilisation targets set out in its loan
agreement with the European Union (EU) and International Monetary Fund
(IMF) due to the formidable challenges the country is facing in reducing
spending, increasing tax compliance, achieving economic growth and
supporting the banking system.
RATINGS RATIONALE
The first driver informing today's downgrade of Portugal's sovereign
rating is the increasing probability that Portugal will not be able to
borrow at sustainable rates in the capital markets in the second half of
2013 and for some time thereafter. Such a scenario would necessitate
further rounds of official financing, and this may require the
participation of existing investors in proportion to the size of their
holdings of debt that will become due.
Moody's notes that European policymakers have grown increasingly
concerned about the shifting of Greek debt held by private investors onto
the balance sheets of the official sector. Should a Greek restructuring
become necessary at some future date, a shift from private to public
financing would imply that an increasingly large share of the cost would
need to be borne by public sector creditors. To offset this risk, some
policymakers have proposed that private sector participation should be a
precondition for additional rounds of official lending to Greece.
Although Portugal's Ba2 rating indicates a much lower risk of
restructuring than Greece's Caa1 rating, the EU's evolving approach to
providing official support is an important factor for Portugal because it
implies a rising risk that private sector participation could become a
precondition for additional rounds of official lending to Portugal in the
future as well. This development is significant not only because it
increases the economic risks facing current investors, but also because
it may discourage new private sector lending going forward and reduce the
likelihood that Portugal will soon be able to regain market access on
sustainable terms.
The second driver of today's rating action is Moody's concern that
Portugal will not achieve the deficit reduction target -- to 3% by 2013
from 9.1% last year as projected in the EU-IMF programme -- due to the
formidable challenges the country is facing in reducing spending,
increasing tax compliance, achieving economic growth and supporting the
banking system. As a result, the country may be unable to stabilise its
debt/GDP ratio by 2013. Specifically, Moody's is concerned about the
following sources of risk to the budget deficit projections:
1) The government's plans to restrain its spending may prove difficult to
implement in full in sectors such as healthcare, state-owned enterprises
and regional and local governments.
2) The government's plans to improve tax compliance (and, hence, generate
the projected additional revenues) within the timeframe of the loan
programme and, in combination with the factor above, may hinder the
authorities' ability to reduce the budget deficit as targeted.
3) Economic growth may turn out to be weaker than expected, which would
compromise the government's deficit reduction targets. Moreover, the
anticipated fiscal consolidation and bank deleveraging would further
exacerbate this. Consensus growth forecasts for the country have been
revised downwards following the EU/IMF loan agreement. Even after these
downward revisions, Moody's believes the risks to economic growth remain
skewed to the downside.
4) There is a non-negligible possibility that Portugal's banking sector
will require support beyond what is currently envisaged in the EU/IMF
loan agreement. Any capital infusion into the banking system from the
government would add additional debt to its balance sheet.
Moody's acknowledges that its earlier concerns about political uncertainty
within Portugal itself have been largely resolved. Portugal's national
elections on 5 June led to the formation of a viable government, both
components of which had campaigned on the basis of supporting the EU-IMF
loan agreement negotiated by the previous government. Moody's also
acknowledges the policy initiatives announced at the end of June
demonstrate the new Portuguese government's commitment to the programme.
However, the downside risks (as detailed above) are such that Moody's now
considers the government long-term bond rating to be more appropriately
positioned at Ba2. The negative outlook reflects the implementation risks
associated with the government's ambitious plans.
WHAT COULD CHANGE THE RATING UP/DOWN
Developments that could stabilise the outlook or lead to an upgrade would
be a reduction in the likelihood that private sector participation might
be required as precondition for future rounds of official support or
evidence that Portugal is likely to achieve or exceed its deficit
reduction targets.
A further downgrade could be triggered by a significant slippage in the
execution of the government's fiscal consolidation programme, a further
downward revision of the country's economic growth prospects or an
increased risk that further support requires private sector participation.
PREVIOUS RATING ACTION AND THE METHODOLOGY
Moody's previous rating action on Portugal was implemented on 5 April
2011, when the rating agency downgraded the government's long-term debt
rating by one notch to Baa1 and placed it on review for further possible
downgrade. It also downgraded the government's short-term debt rating to
(P) Prime-2 from (P) Prime-1.
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