Finance & economics | Portugal’s economy

Adventure tourism

Weak growth makes Portugal vulnerable again

VISITORS to Lisbon, Portugal’s hilly capital, usually seek its nightlife, its sweet custard tarts (pasteis de nata) or its gothic architecture. But no guidebook could help two visitors on October 10th. The pair of analysts, from Dominion Bond Rating Service (DBRS), a Canadian credit-ratings agency, went to assess the creditworthiness of the Portuguese government.

Markets are waiting anxiously for October 21st, when DBRS will update its rating of Portuguese sovereign debt. Hints from DBRS have been playing havoc with the ten-year bond yield: in August a gloomy comment from Fergus McCormick, DBRS’s chief economist, saw it climb 14 basis points (hundredths of a percentage point). This week, word that DBRS was “totally comfortable” with the government’s fiscal position saw it dip by ten basis points.

This unusual attention to a little-known ratings agency is due to the eligibility rules for the European Central Bank’s (ECB) quantitative-easing scheme. The ECB will buy only sovereign debt that is rated as investment grade by at least one of four approved ratings agencies: Fitch, Moody’s, Standard and Poor’s and DBRS. At the moment, only DBRS grades Portuguese sovereign debt above the threshold. A downgrade would also prevent the ECB accepting Portuguese debt as collateral for banks within its liquidity scheme.

A negative decision would hit confidence and demand for Portuguese government bonds. In September alone the ECB bought €1 billion ($1.1 billion) of them, a big amount in a market worth just €112 billion overall. A rise in borrowing costs would hurt, though a lurch back into full-fledged crisis is unlikely. The government’s debt-management agency has a lot of cash on hand, and it has been actively refinancing its borrowing on longer maturities. According to Kathrin Muehlbronner, of Moody’s, it “can certainly stay out of markets for quite a while.”

Higher debt yields would, however, dampen the economic outlook. A downgrade would also put pressure on the Portuguese banks, by depressing the value of the government bonds they hold and obstructing their access to ECB liquidity. Andre Rodrigues of Caixa-Banco de Investimento, an investment bank, does not think access to liquidity is a problem in the short term, because bank balance sheets are “awash” with liquidity. But a downgrade would make it pricier.

All this puts DBRS in a tricky position. It has become part of the risk it is trying to assess. But Mr McCormick insists its decision will be based on longer-term fundamentals. Even the details of the budget for 2017, due to be presented to the European Commission by October 15th, are unlikely to influence its decision too much, as shaving the deficit by a few percentage points will not alter the basic fiscal position.

Deep problems lurk in the Portuguese economy, particularly in its banking sector. Portuguese banks suffer from a squeeze on profit margins from low interest rates, high costs and murky asset quality. On October 11th the Bank of Portugal, the central bank, revealed that 16.5% by value of corporate loans were non-performing, and as much as 36% in the construction sector. And although in August the European Commission agreed that the Portuguese government would be allowed to inject up to €2.7 billion of capital into Caixa Geral de Depositos (CGD), the state’s exposure to CGD (the country’s largest bank) could still amount to 1.5% of GDP.

An even bigger concern is the pace of Portuguese economic growth. In January the government expected GDP to grow at 2.1% in 2016, but so far this year it has staggered ahead at less than half that rate. The outlook is grim: structural reforms have disappointed; euro-zone demand is weak; and the hawkish glare of the commission limits room for a fiscal kick.

Weakness is self-reinforcing. Investment is being stifled by the weight of the corporate sector’s debt, which is close to 140% of GDP. And unhealthy banks cannot afford to force borrowers to the wall. In theory, the previous government made it easier to restructure debt, but in practice this is not being seen, says Ms Muehlbronner.

Commenting on the most important factors influencing DBRS’s decision, Mr McCormick says, “it’s not debt, it’s growth.” The days up to October 21st will be spent trying to work out whether recent weakness is enough to destabilise the Portuguese government’s debt-to-GDP ratio. A decision of no change would be a vote of confidence, at least for now.

This article appeared in the Finance & economics section of the print edition under the headline "Adventure tourism"

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