Fitch downgraded Portugal's rating by one notch, citing concerns about the economy and the current financial environment.
IHS Global Insight Perspective
Significance: Fitch downgraded Portugal's long-term
rating one notch from AA- to A+, with a Negative outlook.
Implications: The downgrade was triggered by concerns
about the government's ability to bring the fiscal deficit down and introduce
structural reforms to make the economy more competitive, amid a very
challenging financing environment.
Outlook: The Negative outlook suggests that a further
downgrade is likely over the coming months.
Risk Ratings
Fitch's rating now matches the assessment given by
Moody's (A1). However, it is still two notches above the rating given by IHS
Global Insight and Standard and Poor's.
Fitch Ratings, the credit agency, downgraded Portugal's
long-term rating one notch from AA to A+. The outlook has been kept as
negative, suggesting that the rating is likely to be downgraded again over the
coming months. Following this move, Fitch's rating is in line with the
assessment given by Moody's (A1). However, it is still two notches above the
rating given by Standard and Poor's. IHS Global Insight currently places
Portugal's medium-term sovereign rating as 25 in our 0 to 100 scale, with a
Negative outlook. This is equivalent to A- in the generic scale. This matches
Standard and Poor's rating, but it is two notches below Fitch's and Moody's
ratings.
Summary of Fitch's Statement
Fitch mentions that the downgrade reflects a "lower
reduction in the current-account deficit and a much more difficult financing
environment for the Portuguese government". More positively, their press
statement also mentions that, if the government is successful in reducing the
fiscal deficit to below 3% of GDP by 2012 as planned, the public-debt-to-GDP
ratio would stabilise at 86% of GDP. Therefore, the adjustment necessary to
bring it down to 60% would be relatively modest compared with the ones needed
by other advanced economies. In Fitch's view, the 2011 state budget shows the
determination of the government in achieving these targets. However, the margin
for error is low, and the government should be prepared to introduce further
austerity measures if needed. Fitch mentions that a "failure to meet its
2011 budget headline and structural deficit targets would erode confidence in
the medium-term sustainability of public finances that underpins Portugal's
current sovereign ratings".
The downgrade also reflects a sharp deterioration of the
financial environment being faced by the government. The government has shown
that it can still have access to market funding despite the crisis. However,
access has come at a very high cost, as reflected by the sharp increases in
bond yields in recent months. Fitch's rating assumes that the government will
continue to have access to markets, but it does not seek external liquidity
help. Nevertheless, Fitch acknowledges that the backstop facility put in place
by the European Union (EU) and the International Monetary Fund (IMF) greatly
reduces Portugal's liquidity risk.
Finally, Fitch also mentions that the rating is currently
underpinned by the structural imbalances present in the economy. These will
have to be overcome if the country is to raise potential growth. Although Fitch
currently believes the economy will enter a sustainable recovery after 2012,
the risk is that the fiscal adjustment put in place in 2011 could have a
worse-than-expected impact on the economy, which would place an even greater
pressure on public finances and bank asset quality.
Outlook and Implications
Despite Fitch's downgrade being highly expected, its
effects are certainly being felt in markets. For example, yields on 10-year
Portuguese government bonds increased sharply this morning to 6.840%, which is
their highest level in almost a month. Moreover, five-year credit default swaps
(CDS), which give an indication of how much it would cost to insure against a
potential default, also rose sharply.
We certainly agree with many of the reasons given by
Fitch in justifying its downgrade. These concerns are already incorporated in
our current rating which is, as previously mentioned, two notches below Fitch's
assessment. Over the medium term, future movements of our rating will mainly
depend on the performance of the economy and the achievement of the fiscal
target set by the government in its 2011 budget. Growth in 2010 was
significantly higher than originally expected, but next year will be extremely
challenging. Domestic demand is likely to be hit by significantly tighter
fiscal policy, while a combination of weaker external demand and the low
competitiveness of Portugal's export sector will limit export growth. On a more
positive note, in addition to many structural reforms implemented since 2005,
the government has continued with its efforts to improve the competitiveness of
the economy. Their success will be key in ensuring Portugal's economic
performance over the long term. Moreover, we believe that the fiscal plans put
in place by the government are sound. However, their implementation will be
key. Given the current negative sentiment towards peripheral Eurozone bonds in
the markets, any slippage in this respect is likely to be severely punished.
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