Fitch Affirms Portugal at 'BB+'; Outlook Positive

(The following statement was released by the rating agency) LONDON, March 27 (Fitch) Fitch Ratings has affirmed Portugal's Long-term foreign and local currency Issuer Default Rating (IDRs) at 'BB+'. The Outlook is Positive. The agency has also affirmed Portugal's Short-term foreign-currency IDR at 'B' and the Country Ceiling at 'A+'. The issue ratings on Portugal's senior unsecured foreign and local currency bonds have also been affirmed 'BB+'. KEY RATING DRIVERS The affirmation and the Positive Outlook reflect the following key rating drivers: The economy has returned to growth. Real GDP grew by 0.5% in 4Q14, taking 2014 total to 0.9%, in line with the eurozone average. Fitch expects growth to increase to 1.5% in 2015, driven by rising employment, higher gross disposable income, low interest rates and strengthening confidence indicators, while recovery in the eurozone and euro depreciation should support export performance. The current account registered a surplus of 0.9% of GDP in 2013 and an estimated 0.5% in 2014, the first surpluses in at least two decades and a material improvement from an over 12% deficit in 2008. Excluding one-off factors the general government deficit at 3.4% of GDP fell below the the target of 4% in 2014. This follows a deficit of 5.2% in 2013 (4.9% with one-offs), below the official target of 5.5%. The primary surplus increased last year after moving into positive territory for the first time in 16 years in 2013. Portugal enjoys broad market access at favourable yields in several currencies and at different maturities allowing the early repayment of the IMF loan. The government has prefunded a significant portion of its financing needs for 2015 and built a sizeable deposit buffer (10% of GDP). The two main political parties (the Social Democratic Party, the leading member of the current coalition, and the main opposition the Socialist Party) are pro-European. Fitch expects no major deviation of policy after this year's elections. Currently, no anti-euro or populist party has attracted significant support in opinion polls in Portugal. Although the resolution of Banco Espirito Santo (BES) was handled in a smooth manner with the creation of the bridge bank Novo Banco in August 2014, the episode raised some doubts about the underlying strength of the banking sector and the effectiveness of monitoring by national authorities. Fitch's view is that this was a one-off event and spillover from BES to the real economy and the rest of the banking sector will remain limited. The three largest Portuguese banks passed the ECB comprehensive assessment conducted in October 2014 and no additional capital or asset sale was required. The authorities plan to sell Novo Banco before the elections. However, Fitch expects that the high level of corporate sector debt, weakening asset quality and the modest pace of write-downs will continue to act as a constraint on growth-supportive new lending. Portugal's long-term fiscal cost of an ageing population is one of the most stable in the EU, according to estimates by the European Commission, due to past pension reforms. Balancing these positive developments are the following fiscal and economic risks: Government targets for fiscal deficit reduction are at risk. In Fitch's view Portugal is unlikely to correct its excessive deficit in line with EU commitments to bring it below 3% of GDP in 2015 from 4.5% in 2014. Fitch forecasts a headline deficit of 3.1% this year. The official target of 2.7% is based on more optimistic assumptions of revenue growth and the positive impact of macroeconomic developments on the budget. Past constitutional Court rulings on fiscal measures have also constrained fiscal consolidation options. The official target also reflects a pause in the consolidation of the structural deficit (after excluding one-offs and cyclical impact from the headline budget deficit) ahead of parliamentary elections in 2H15. There are similar risks to government fiscal targets into the medium term and Fitch expects the overall pace of consolidation to slow. Progress towards rebalancing the economy has been slower than Fitch expected when the Outlook was revised to Positive in April 2014, notwithstanding structural reforms in areas such as the labour and product markets, which have been central to the government's adjustment programme. Private investment and GDP growth will likely be constrained by still-high corporate indebtedness and low competitiveness. Fitch has therefore revised down its potential growth estimate to around 1.25% from 1.5% in the April and October 2014 reviews. Investment has started to grow but it remains too low to maintain the capital stock. Investment share of GDP dropped to 15% in 2014, from 22% in 2007. Underlying public debt dynamics have weakened into the medium term with the forecast pace of debt reduction slowing. Wider deficits and weaker growth prospects mean we now expect debt to have peaked at 128.7% in 2014, before sliding to 117.5% in 2020. It would peak in 2015 if cash balances were not reduced. This compares with previous projections of a peak in 2013 and a gradual reduction to 115.8% by 2020. Such an elevated debt level (BB and BBB medians were close to 40% of GDP in 2014) leaves public finances with limited flexibility if faced with future shocks and exposed to the risk of deflation. From 2017 to 2020 we expect debt to fall by an average 1.7% of GDP per year compared with 2.5% in April 2014. Portugal's net foreign liabilities remain among the highest of Fitch-rated countries and are unlikely to fall to more comfortable levels in the medium term notwithstanding the improvement in the current account and recent FDI flows. RATING SENSITIVITIES Future developments that could individually or collectively result in an upgrade to investment grade include: --An underlying improvement in the debt dynamics and a clear downward trend in the gross government debt (GGGD/GDP) ratio; --An improvement in medium term economic prospects, leading to lower unemployment and progress in private sector deleveraging; --Further sustained progress in the unwinding of external imbalances. The following risk factors may, individually or collectively, result in the stabilisation of the Outlook: --A weakening in the pace of fiscal consolidation, resulting in a less favourable trajectory in debt to GDP; --Continued weak economic growth or deflation that could forestall corporate sector deleveraging or have a negative impact on the banking sector or public finances; --Failure to make further progress in unwinding external imbalances. KEY ASSUMPTIONS In its debt sensitivity analysis, Fitch assumes a primary surplus averaging 2.1% of GDP, trend real GDP growth averaging 1.3%, an average effective interest rate of 3.3% and deflator inflation of 1.3%. On the basis of these assumptions, the debt-to-GDP ratio would have peaked at 128.7% in 2014, and edge down slowly to 111.9% by 2024. The national statistics office published new nominal GDP numbers on 26 March which would push the debt ratio up to 130.2% in 2014. Fitch will incorporate the revised numbers once they are published by Eurostat. The European Central Bank's asset purchase programme should help underpin inflation expectations, and supports our base case that, in the context of a modest economic recovery, the eurozone will avoid prolonged deflation. Fitch also assumes gradual progress in deepening financial integration at the eurozone level and that eurozone governments will tighten fiscal policy over the medium term. Fitch's base case is that Greece will remain a member of the eurozone, though it recognises that 'Grexit' is a material risk. Although a Greek exit would represent a significant shock to the eurozone that could spark a bout of financial market volatility and dent confidence, Fitch does not believe it would precipitate a systemic crisis like that seen in 2012, or another country's rapid exit (see 'Grexit Still Possible; Systemic Crisis Unlikely'). In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action which is different than the original rating committee outcome. Contact: Primary Analyst Enam Ahmed Director +44 20 3530 1624 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Ed Parker Managing Director +44 20 3530 1176 Committee Chairperson James McCormack Managing Director +44 20 3530 1286 Media Relations: Athos Larkou, London, Tel: +44 203 530 1549, Email: athos.larkou@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria, 'Sovereign Rating Criteria' dated 12 August 2014 and 'Country Ceilings' dated 28 August 2014, are available at www.fitchratings.com. 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