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-, and revised the Outlooks to Positive, from Stable. Scope has furthermore affirmed the short-term issuer ratings at S-1 in local- and in foreign-currency, with Stable Outlooks.

The revision of Portugal’s long-term credit ratings to Positive reflects the country's sustained debt reduction, a strong track record of prudent fiscal policy with anticipated fiscal surpluses for 2024 and 2025, a robust sovereign debt profile, and comparatively solid medium-term growth prospects along with continued improvements in the external position.

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Key rating drivers

Sustained debt reduction, strong record of prudent fiscal policy with expected fiscal surpluses for 2024 and 2025, and a robust sovereign-debt profile. Portugal has maintained strong fiscal results, recording primary surpluses of 2.3% of GDP from 2016 to 2019 and managing modest budget deficits of 1.7% during the pandemic and under recent inflationary pressures. By 2022, the deficit had been reduced to -0.3% of GDP, turning into a surplus of 1.2% in 2023. Boosted by post-pandemic growth in tourism and investment, Portugal’s real GDP grew by 6.8% in 2022 and 2.3% in 2023. Coupled with low interest expenses (1.9% of GDP in 2022), the high nominal GDP growth contributed to a rapid reduction in public debt, from 124.5% at the end of 2021 to 99.1% in 2023.

Going forward, amid more moderate growth prospects, the sustained debt reduction will be predominantly driven by sustained high primary surpluses. For 2024, Scope projects the primary surplus to moderate to 2.5% of GDP from 3.4% of GDP in 2023, and that Portugal records a budget surplus of 0.4% of GDP. Longer-term, Portugal’s budgetary flexibility is expected to gradually narrow due to structurally higher social benefits, reflecting increased demands from an aging population and measures to mitigate social pressures related to high housing costs, as well as higher interest expenses, which are forecasted to increase from 1.9% of GDP in 2022 to 2.4% of GDP in 2025.

Scope considers risks to policy continuity in Portugal to be low. This stability is underpinned by a consensus on fiscal prudence between the major political parties, though a fragmented parliament may necessitate negotiations with smaller parties, potentially affecting reform implementation. Scope forecasts that broad policy continuity will result in continued, albeit more modest primary surpluses, which coupled with economic resilience and favourable debt issuance costs, will further reduce the debt-to-GDP ratio from 99.1% of GDP in 2023 to 89.2% in 2026. This marked debt decline is in line with Portugal's target according to the Stability Programme 2024-2028 and is projected to decrease further to 78.1% in 2029.

Moreover, Portugal's debt profile is highly favourable, marked by affordable and stable costs and prudent management. The country has strategically frontloaded its annual financing needs early in the year, benefitting from a diverse and stable investor base, including significant holdings by the ECB and domestic retail investors. Additionally, a cash reserve equivalent to 4.3% of GDP by the end of 2023, a long-term average debt maturity of 7.7 years as of March 2024, and limited refinancing – 37% of debt within a five-year horizon – bolster financial resilience against unexpected shocks.

Comparatively solid medium-term growth prospects, accompanied by further improvement in the external position, enhance Portugal's economic resilience. Amid economic growth moderation and receding inflation, Portugal's GDP growth slowed from 6.8% in 2022 to 2.3% in 2023, still outperforming the euro area average. A significant rebound in tourism following the easing of pandemic restrictions, coupled with a lesser impact from the manufacturing downturn and reduced reliance on Russian gas, has differentiated Portugal from other European economies. The labour market has shown considerable improvement, with unemployment dropping to 6.5% in 2023 from a high of 16.5% in 2012. The turnaround in the labour market has been supported by reforms improving job quality and has also bolstered social security contributions, enhancing budgetary flexibility.

Scope projects that Portugal's economy will grow at a rate of 1.9% in 2024, and will pick up to 2.2% in 2025. Growth is projected to be primarily driven by exports and investments, with substantial EU funds providing additional support. Next Generation EU funds are expected to substantially enhance economic growth in Portugal through accelerated investments. Portugal has advanced significantly in fund disbursement, having received 35% of its EUR 22.2bn allocation from the NGEU funds (thereof EUR 16.3bn grants). Still, a total of only EUR 4.6bn, representing 21% of the total amount, has been disbursed to final beneficiaries to date. Scope expects that Portugal will accelerate its fund execution, focusing investments on critical areas such as energy efficiency and sustainable transport.

The macro-economic stability of Portugal is further supported by sustained long-term deleveraging, reducing financial imbalances. The private sector has capitalised on the low interest rate environment over the past decade for debt reprofiling, leading to a decline in household credit provision over time. Net external debt has continued its downward trend, reaching 52% of GDP in the first quarter of 2024, the lowest level since 2005. Similarly, the country’s negative net international investment position improved significantly, from around -83.6% of GDP in 2022 to -72.5% in 2023. In 2023, Portugal's current account transitioned from a 1.2% GDP deficit in 2022 to a 1.4% surplus, largely due to a robust increase in foreign tourism. Looking ahead, structural enhancements in the energy sector, particularly the increase in renewable energy usage, are expected to sustain small current account surpluses and bolster Portugal’s external position, thereby enhancing the country's resilience to external debt risks.

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 and iii) vulnerability to external shocks.

First, Portugal's high level of public debt, though decreasing, remains substantial. This elevated debt level poses a significant fiscal burden and limits the government's fiscal flexibility.

Second, the aging population in Portugal is leading to a decline in the workforce, which can constrain economic growth and productivity over time. This demographic trend also places increasing pressure on public resources as healthcare and pension expenditures rise.

Finally, Portugal's relatively small economy, characterized by a growing range of exports but still dominated by tourism and an open economic structure, is more susceptible to external risks compared to peers. This dependency on a growing but still narrow set of industries for export earnings makes the economy more vulnerable to external economic shocks, such as global recessions or disruptions in international trade.

Outlook and rating sensitivities

The Positive Outlook reflects Scope’s view that risks for the ratings are tilted to the upside over the forthcoming 12 to 18 months.

Upside scenarios for the long-term ratings are if (individually or collectively):

1. General government debt continues its downward trend supported by consistently strong budgetary performance; and/or
    
2. Portugal maintains current account surpluses and further improves its external balance sheet.

Downside scenarios for the rating and/or Outlooks are if (individually or collectively):

1. Protracted fiscal deterioration, weakening the fiscal outlook; and/or
    
2. GDP growth prospects worsened materially, for instance, due to a fading commitment to structural reforms.

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

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating, which was approved by the rating committee, 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 a commendable environmental performance, notably in reducing CO2 emissions per GDP, showcasing adaptability and commitment to sustainability. Portugal has made significant strides in enhancing its external balance through sustained policy efforts, particularly in the energy sector. Investments in renewable energy sources have reduced Portugal's reliance on energy imports, raising the share of energy from renewable sources in power generation to 61% in 2022. These efforts are supported by extensive funding from the Recovery and Resilience Plan aimed at decarbonisation and energy efficiency.

Portugal faces significant demographic challenges, impacting its growth, public finances, and political stability in the medium term. Scope's quantitative metrics reveal unfavourable 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, albeit improving job contract quality, and comparatively low wages. 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. Following the early parliamentary elections in March 2024, the minority government led by the Democratic Alliance faces a more fragmented political landscape, which could potentially impact the ability to implement timely policy responses over the medium-term.

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; v) external sector dynamics; vi) governance factors; and vii) peer comparison.

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 16 February 2024.

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, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
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