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Rating action

Scope Ratings GmbH (Scope) has today affirmed the Portuguese Republic’s long-term issuer and senior unsecured debt ratings in local- and in foreign-currency at A-. Scope has furthermore affirmed the short-term issuer ratings at S-1 in local- and in foreign-currency. All Outlooks remain Stable.

Summary and Outlook

The affirmation of Portugal’s A- ratings reflects the following credit strengths of the sovereign:

1. The sustained reduction of macro-economic and financial imbalances, supported by membership in the EU and the euro area, which enhances Portugal's economic resilience and stability.
    
2. The strong record of prudent fiscal policy and sustained debt reduction, including since the Covid-19 crisis, which supports Portugal's resilience against economic shocks.
    
3. A robust sovereign-debt profile, characterized by high affordability, a diversified and steady investor base, along with prudent debt management, which strengthens the country's overall fiscal health.

The Stable Outlook reflects Scope’s opinion that risks to the ratings are balanced over the coming 12 to 18 months.

The ratings/Outlooks could be upgraded if, individually or collectively: i) substantial improvements in fiscal fundamentals lead to a notable further reduction in public debt levels, and/or ii) medium-term growth prospects improved materially, accompanied by further improvement in the external position.

Conversely, the ratings/Outlooks could be downgraded, if individually or collectively: i) protracted fiscal deterioration resulted in a weaker fiscal outlook; and/or ii) GDP growth prospects worsened materially, for instance, due to a fading commitment to structural reforms.

Rating rationale

First driver of the affirmation: sustained reduction of macro-economic and financial imbalances

Portugal’s macro-economic stability has been driven by sustained long-term deleveraging, reducing financial imbalances, and significant improvements in the labour market. Portugal's private sector has leveraged the low interest rate environment over the last decade for reprofiling, as seen in declining household credit provision over time. Similarly, while the country’s negative net international investment position remains high, it improved from -104.6% of GDP in 2020 to -85.7% in 2023. Lower energy prices and sustained tourism exports have strengthened the country’s external balance, with current account surpluses reaching 1.3% GDP in 2023 and net external debt decreasing to 57.3% of GDP, the lowest level since 2007. Moreover, structural reforms have attracted FDI, doubling since 2008 to 70% of GDP by 2022. Still, Portugal's productivity lags other low-wage EU economies and its highly open economy remains vulnerable to weakening foreign demand, especially in Europe, with EU countries absorbing 65% of Portuguese exports.

Macro-economic resilience has also strengthened due to an improve labour market, which has supported steady GDP growth over time, with unemployment declining to 6.6% in 2023 from a peak of 18.2% in 2012. This has also increased social security contributions providing budgetary flexibility.

Second driver of the affirmation: strong record of prudent fiscal policy and debt reduction

Portugal demonstrates a robust track record of prudent fiscal policy. Pre-pandemic, the nation maintained primary surpluses averaging 2.1% of GDP from 2016-2019. Throughout the pandemic period, Portugal sustained relatively limited budget deficits compared to its rating peers, averaging 1.8% of GDP in 2020 and 2021. In 2022, Portugal achieved a low budget deficit of -0.3% of GDP, followed by an estimated budget surplus of 1.0% of GDP in 2023, signalling strong budgetary performance. Driven by post-pandemic increases in tourism and investment, Portugal's economy experienced substantial growth, with real GDP growth at 6.8% in 2022 and an estimated 2.3% in 2023. This, together with minimal interest expenses amounting to 1.9% of GDP in 2023 drove the reduction of Portugal's public debt-to-GDP ratio from 124.5% at the end of 2021 to an estimated 99.0% in 2023.

Going forward, lower GDP growth prospects coupled with higher interest expenses present challenges to further sustained reduction of the debt-to-GDP ratio, especially given Portugal’s still elevated public debt. Scope expects a slowdown in economic growth, with projected rates of 1.2% in 2024 and 1.8% in 2025, constrained by weak external demand. Additionally, Portugal’s budgetary flexibility is expected to gradually narrow due to higher interest expenses, forecasted to increase to 2.3% of GDP in 2024. Despite some budgetary easing, Scope forecasts a budget surplus of 0.1% of GDP in 2024, partly driven by better-than-expected fiscal outcomes in 2023. Overall, Scope expects public debt to decline to 94.2% of GDP in 2024.

However, over the medium to long term, Scope expects that higher structural expenses will curtail further declines of Portugal's government debt-to-GDP trajectory. Scope expects sustained, albeit declining, primary surpluses averaging 1.5% from 2024-2028 and forecasts Portugal’s debt-to-GDP ratio to decline to around 90.0% by 2026. However, Portugal’s limited growth potential, together with aging demographics, a low birth rate and growing societal pressures, may necessitate sustained spending to support social conditions, weighing on budgetary performance and flexibility. Portugal’s 2024 Budget emphasizes social support measures, including reductions in income taxes, increases in civil servants’ salaries, pensions, and the national minimum wage. While early elections in March 2024 are unlikely to disrupt debt reduction in the short term, the election outcome and the subsequent formation of the government and its policies will impact the future fiscal stance.

Third driver of the affirmation: favourable sovereign-debt profile

Portugal's debt profile is very favourable, characterized by affordability, stability, and prudent fiscal management. Debt affordability remains robust, bolstered by a sustainable cost of debt. Despite an uptick in the cost of debt issuance to 3.5% in 2023 and a projected 3.6% in 2024 (up from 1.7% in 2022), the cost of outstanding debt is forecasted to rise modestly from 2.0% in 2023 to 2.4% in 2024. Furthermore, Portugal has frontloaded its debt issuance, with around 50% of the annual financing requirements via Portuguese Government Bonds set to be completed by the end of February this year.

Portugal benefits from a diversified and steady investor base, including a significant portion held by the ECB and a robust domestic retail investor base, with the retail sector featuring two tenors, 7 years and 15 years, further enhancing resilience against market fluctuations. A stable long-term average debt maturity of 7.5 years helps mitigate short-term refinancing risks. In addition, the country maintains a substantial cash buffer, equivalent to 7.3% of GDP in 2023. This reserve acts as a safeguard against unforeseen financial shocks, thereby enhancing Portugal's fiscal flexibility.

Rating challenges: high public debt, limited growth potential, and external-sector risk

Portugal’s credit ratings face constraints due to: i) an elevated stock of public debt; ii) a limited growth potential with aging demographics, impacting the labour force and placing long-term pressure on public spending; and iii) vulnerability to external shocks, given the limited export range and open economic structure.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘a-’ for the Portuguese Republic. Under Scope’s methodology, the indicative rating receives i) a one-notch positive adjustment for the euro as reflecting a global reserve currency, and ii) no negative adjustment for political risks. On this basis, a final SQM quantitative rating of ‘a’ is reviewed by the Qualitative Scorecard (QS) and can be changed by up to three notches depending on the size of Portugal’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states.

Scope identified the following QS relative credit strength for the Portuguese sovereign: i) fiscal policy framework. Conversely, the following credit weaknesses have been identified in the QS: i) growth potential and outlook; ii) current account resilience; and iii) social factors. On aggregate, the QS generates a one-notch negative adjustment for Portugal’s credit ratings. This results in final A- long-term ratings on the Portuguese Republic. A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

Portugal exhibits commendable environmental performance, notably in reducing CO2 emissions per GDP, showcasing adaptability and commitment to sustainability. Greenhouse gas emissions decreased by one-third from 2005 to 2020, largely due to a shift away from coal-fired power generation. However, challenges persist in managing resource risks, especially regarding the ecological footprint of consumption relative to biocapacity. EU funds, primarily from the Recovery and Resilience Plan, are set to bolster the economy through Next Generation EU funds from 2021 to 2026, with 38% allocated to climate objectives, reflecting proactive environmental efforts.

Portugal faces significant demographic challenges, impacting its growth, public finances, and political stability in the medium term. Scope's quantitative metrics reveal unfavorable comparisons to peers in social risks, driven by high old-age dependency ratios and income inequality. The challenges arise from an aging population, low birth rates, weak job contract quality, and comparatively low wages. Income inequality is pronounced, with a majority of younger workers earning less than EUR 1,000 monthly, and many under precarious contracts. Addressing these issues may require sustained spending, potentially constraining budgetary flexibility in the medium to long term, as reflected by a negative qualitative adjustment in Portugal's social factors category.

In terms of governance factors, which Scope assesses through quantitative indicators for governance risks, Portugal compares favourably relative to its rating peers. This comparison is based on five of the six governance indices compiled by the World Bank, including control of corruption, the rule of law, voice and accountability, governance effectiveness, and regulatory quality. Portugal's relatively strong governance metrics are reflected by the country's robust track record of prudent fiscal policy.

Rating committee
The main points discussed by the rating committee were: i) fiscal fundamentals and debt trajectory; ii) macroeconomic sustainability and growth performance; iii) financial stability risks; iv) NGEU funds and past absorption of EU resources; v) external sector dynamics; and vi) governance factors.

Methodology
The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks is (Sovereign Quantitative Model Version 3.0), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party participation   YES
With access to internal documents                                NO
With access to management                                          YES
The following substantially material sources of information were used to prepare the Credit Ratings: public domain and the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings and Outlooks were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Jakob Suwalski, Senior Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 30 June 2017. The Credit Ratings/Outlooks were last updated on 24 March 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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