EthiFinance maintains the rating of the Republic of Portugal at BBB with a Stable outlook


In its June review EthiFinance Ratings maintained the Republic of Portugal's unsolicited rating at BBB with a Stable outlook, due to the recovery observed in 2021 and continued during the first quarter of 2022, which saw quarter-on-quarter growth of 2.6%, surpassing pre-pandemic GDP levels.

The European credit rating agency confirms the growth forecasts for the Portuguese economy for this year, set by the European Commission at 5.8%, being the economy of the Eurozone with the highest expected growth for 2022. This figure has already been advanced by the European credit rating agency in its January review.

The rating also considers its more controlled electricity market, the less direct dependence on Russia and Ukraine, as well as the recovery of the tourism sector, which last April recorded a new peak with 2.4 million guests and six million overnight stays, as some of the main differentiating factors with respect to its European partners.

Another of Portugal's strengths is its labor market, which in the first three months showed a four-tenths improvement in the unemployment rate compared to the last quarter of 2021, placing it at 5.9%. However, "we continue to warn of the persistence of the problem of duality in the labor market -mainly between skilled and low-skilled employees-, and of the higher incidence of temporary employment. Both reduce the potential for future growth while encouraging the exodus of workers to other European markets, thus aggravating the demographic problem," the report notes. In this regard, the vegetative growth closed the past year 2021 in negative. In addition, there is a high dependency rate (64.6% among the population between 20 and 64 years of age), which represents "one of the most important risks of the Portuguese economy. Not only because of the lower propensity of older people to consume, but also because of the pressure that healthcare spending will put on public finances."

In the latter area (public finances), the rating reflects the improvement of recent years with a correction of the deficit in 2021 to -2.8% of GDP, compared to -4.5% in the last report. This reduction is due to the significant fiscal consolidation effort that will continue throughout the year and will reduce the deficit by almost one point (- 1.9%).

Likewise, the approval of the General State Budget for 2022, which will come into effect on July 1, and which foresees an impact of 0.5% of GDP despite the additional spending measures approved to deal with the increase in inflation, was also positively assessed.

However, EthiFinance warns that despite the reduction in debt last year, it will not fall below 120.7% of GDP in 2022, which "becomes the main conditioning factor for our rating".

Inflation and the external sector

Despite the good outlook, EthiFinance Ratings warns of the risk that, as for the rest of the economies, inflation poses to Portuguese GDP growth. CPI in Portugal rose to 7.2% (underlying to 5.0%), levels that "could jeopardize private consumption". On the other hand, "the increase in energy prices in recent months has already begun to affect the industrial sector, which shows a certain trend of contraction since the first quarter of 2022". This has fed through to the producer price index and could increase inflationary pressures in the coming months.

To mitigate the effects of price increases on consumers, the Portuguese government has implemented a package of measures, such as tax reductions and direct aid for fuel consumption and food purchases (in this latter case aimed at households that are most vulnerable to price increases). Both fiscal and direct aid has also been approved to alleviate the increase in costs in the transport sector.

With respect to the external sector, the report points to a worsening of the current account balance due to the impact of the Russia-Ukraine conflict on energy prices and imports. Counteracting the positive effect of the recovery in the tourism sector ,"this situation is not expected to improve in the medium term, posing a risk to the Portuguese external sector, increasing its external debt and financial vulnerabilities".

The report further points to the "considerable" decline in net international investment position from -104% of GDP in 2020 to -95.9% in 2021. A figure that is expected to further improve over the next biennium due to tourism recovery, GDP growth and Recovery and Resilience Mechanism grants.

Financial sector and monetary policy

The actions announced by the ECB to curb the impact of inflationary pressures, which EthiFinance considers "appropriate”, and which include a gradual rise in interest rates, "will not significantly jeopardize economic growth in the Eurozone".

In this regard, the report highlights the improvement of the Portuguese financial system in recent years, whose NPL ratio in 2021 was 4.3% compared to 6.2% in 2019. However, the report emphasizes the "low profitability" of Portuguese banks, with an average ROA in 2021 of 0.3%, "a situation that could be reversed if the rise in interest rates materializes".

Institutional framework, Governance and ESG

Portugal is among the best governance rankings in the European Union and shows an adequate institutional framework that is recognized by its top position in the transparency and supervision and control rankings prepared by the World Bank.

Likewise, the absolute majority obtained by António Costa, who is facing his third term in office, is favorably valued and will allow him to implement his policies without depending on his former partners the Bloco de Esquerda (BE) and the Portuguese Communist Party (PCP).

Finally, EthiFinance Ratings considers the membership of the European Union -which it presided over during the first half of 2021- to be favorable, as the economy is favored by the use of a single currency, economic cooperation between the different member powers and access to aid before situations of imbalance such as those currently being experienced by the economies.

With respect to ESG (Environmental, Social and Governance) principles, despite the improvement in recent years, Portugal continues to be below the European average. In fact, it has not yet issued any sovereign green bonds. However, the Recovery and Resilience Plan is expected to be an incentive for the country to continue improving in this area. Despite poor recycling rates, high energy dependence or exposure to the physical risks of climate change, the report highlights the progress made by Portugal in significantly reducing the number of people at risk of poverty and school dropout rates, as well as the production of renewable energy (34.0% compared to the European average of 22.1%).