Sovereign Rating Republic of Portugal

02th July of 2021

The European rating agency expects the Portuguese economy to grow by 3.7% in 2021 and 4.9% in 2022, figures above those recorded before the outbreak of the pandemic. The Portuguese country maintains the strength of its labour market with an estimated unemployment rate at the end of 2021 of 7.4%, three tenths of a percentage point lower than forecast in the previous report. On the negative side, the high volume of public debt stands out, which will reach 127.2% at the end of the year.

In its July review Axesor Rating confirms Portugal's unsolicited rating at BBB with a stable outlook, due to the potential for recovery of the Portuguese economy both in 2021 and 2022.

The recovery of domestic demand - supported by the materialisation of a historic savings rate of 12.8% - and of tourism activity, together with the effect of the 16,644 million euros from the European Funds - which will boost productive investment and stimulate the labour market - will raise Portugal's growth to 3.7% this year. The figure is 1.5 points lower than the 5.4% forecast in January's report, a revision due to the wave of infections in the first quarter of the year, which forced a further two week lockdown and postponed the resumption of activity.

Despite the aforementioned blip, the European rating agency expects the growth path to be extended through 2022, when Portuguese GDP will reach 4.9%.

The credit rating again values the strength of the Portuguese labour market, where the effects have had a "reduced impact" in terms of job destruction. In fact, the containment measures implemented by the Portuguese government have led to an improvement in productivity in most sectors. Moreover, the unemployment rate at the end of 2020 was 6.8%, lower than initially expected (8%) and only 0.3 percentage points higher than at the end of 2019. For 2021, the forecast is for a slight deterioration to 7.4% (three tenths of a percentage point lower than in the previous revision), which will improve in 2022 when the unemployment rate is estimated at 6.9%. Both figures are in line with the structural unemployment rate of 7% estimated by the European Commission.

However, the European rating agency continues to warn of the duality of the Portuguese labour market as the main weakness, "as it is detrimental to future growth potential while encouraging an exodus of workers". Moreover, the grade awarded is limited by a demographic evolution with forecasts of a negative vegetative growth of -0.17% in 2021 and a dependency rate of 64.6% of the population between 20 and 64 years of age, with a tendency to get worse in the coming decades due to a falling birth rate and an increase in life expectancy to 81 years of age. “A challenge for the growth potential of the economy, both because of the lower propensity of older people to consume and because of the pressure that care spending will put on public finances".

Axesor Rating also values positively the improvement in salaries, higher than in previous years, which is contributing, on the one hand, to boost consumption and, on the other hand, in the process of convergence in terms of per capita income with the rest of the European Union partners.

On the other hand, the rating is constrained by the high dependence on the external energy sector, which has had an impact on the evolution of the current account balance, which is usually in deficit. It has also increased external financing needs, with external debt rising to 105% of GDP (five percentage points higher than in the previous year) and is expected to deteriorate further in the coming years due to the current account imbalances projected to 2022 (-0.8% and -0.4% in 2021 and 2022, respectively). This increase the sensitivity of the Portuguese economy to possible financial shocks from abroad.

Recovery and Resilience Plan

The report positively assesses the effects of the Portugal Recovery Plan , Building the Future, financed with 16,644 million euros from the European Funds.

The Plan is made up of a total of 20 components organised in three areas: Resilience, Climate Transition and Digital Transition. It is expected to have an additional impact on the 2022 GDP growth rate of 1.4% and 3.5% on the 2025 GDP growth rate.

With regard to the labour market, the impact will be "very beneficial". Employment is projected to grow by 0.7% in 2022 and 1.4% in 2025, and the unemployment rate is expected to fall by 0.4% and 1.6% respectively in these years.

According to the Portuguese Government's forecasts, each euro invested through the Plan in the period 2021 - 2026 will have a multiplying effect of 5.3 times, being higher (6.2 times) in actions related to education and employment.

Tax deficit and public debt at record highs

While the economic shock caused by the health crisis has had a full impact on Portugal's public finances, which left behind a surplus for 2019, it was smaller than expected. The Portuguese economy closed 2020 with a tax deficit of -5.7%, 1.6 points better than forecast in the previous report.

In this regard, Axesor Rating points out that "we expect this situation to be progressively corrected in the coming years, both due to the expected higher economic growth and to the effects of the positive performance we had been observing prior to the outbreak of this health crisis".

Specifically, the European rating agency estimates that the public deficit will be corrected in 2021 to 4.5% and in 2022 to -3.2%, on the path to convergence with the limits established by the Maastricht Treaty.

It should be noted that the Budget Plan prepared by the Portuguese government for 2021 includes new spending measures aimed at the recovery of employment and the reactivation of the economy, which will reach 0.9% of GDP. Thus, current spending is expected to reach 91.2 billion euros, some 600 million euros more than in 2020 91.2 billion euros, aprox. 600 million euros more than in 2020. On the revenue side, the recovery in activity is estimated to raise current revenues to €88.5 billion (€5 billion higher than in 2020).

Axesor Rating believes that thenew fiscal deficit situation will put upward pressure on Portugal' s already high level of public debt, which closed 2020 with a public debt of 133.6% of GDP (net debt of 123% of GDP), levels not seen since 2014. However, this situation is expected to begin to stabilise from 2021 onwards, which is expected to close at 127.2% of GDP. However, the rating also takes into account "the improvement in the debt profile", with an increase in the average maturity to 7.6 years, a reduction in the average cost of debt to 2.2% and mainly concentrated in debt emissions.

On the other hand, Axesor Rating's rating for Portugal has taken into account the "intense exercise in accounting sanitation" of the banks' balance sheets since the 2008 crisis.

At Axesor Rating, they emphasise that "we find a more capitalised banking sector, which is capitalised with higher asset quality and notable liquidity, although the problem of profitability continues to worsen". In fact, the Portuguese financial system closed the year with an ROA of 0.4%. It also warns of the impact of the likely increase in non-performing loans in 2021.

Adequate institutional framework

Portugal registers the best governance rankings in the European Union and shows an adequate institutional framework which is recognised by its top position in the World Bank' s transparency and monitoring and control rankings.

In addition, and despite the current minority government, the rating also positively assesses the mood for understanding and coordination between the different parties in the face of the new recovery understanding and coordination, which is reflected in the recent approval of the Additional Budgets for 2020 and the budget plan for 2021. However, the latest disagreements between the government and its informal partners in the Bloco de Izquierdas (left block), specially on financial and tax policy, could put pressure on the legislature that began in 2019 and delay the path of adopting structural measures that Portugal has been adopting since the start of the post-crisis recovery.

All in all, Axesor Rating considers membership of the European Union -which has presided over the first half of the year-, as the economy is favourable due to the use of a single currency, economic cooperation among the different member powers and access to aid in situations of imbalance such as the current economic crisis by the COVID-19.