Fitch: Portugal EDP Exit Shows Fiscal Progress; Debt Still High
The recommendation by the European Commission (EC) to end the Excessive Deficit Procedure (EDP) for Portugal underscores the strengthening in the country’s public finances following policy adjustments and an economic recovery, Fitch Ratings says. We expect the underlying trend of deficit reduction to continue, but high government debt and weak asset quality in the banking sector still weigh on Portugal’s sovereign credit profile.
The EC’s recommendation reflects the fall in the general government deficit to 2% in 2016 – the lowest figure in decades – from 4.4% in 2015. The main driver was lower capital spending and contained current expenditure (including lower social transfers and interest payments). One-off tax payments and the acceleration in GDP growth in the second half of 2016 also supported government revenue.
The recapitalisation of state-owned bank Caixa Geral de Depositos (CGD), worth 1.1% of GDP, means that we expect the deficit to increase to 2.8% of GDP in 2017. Excluding this transfer, the deficit would be 1.7% and we forecast it to fall to 1.4% in 2018, thanks to the impact of further macroeconomic improvements and continued efforts to contain current expenditure.
Narrower deficits and a recovery in nominal GDP growth in line with our forecasts would see general government debt decline over the medium term. However, potential sovereign exposure to legacy problems in the banking sector presents a risk to our deficit projections. Asset quality in the banking sector remains weak, with NPLs (measured as credit at risk) at 11.8% at end-2016 and the nature and outcome of initiatives to address this unclear. Portugal has made some progress recently with the recapitalisation of CGD and the planned sale of Novo Banco, but further costs to the sovereign cannot be ruled out.
The short-term growth outlook is positive. Fitch expects GDP growth to accelerate to 1.8% in 2017 from 1.4% in 2016. The unemployment rate fell below 10% in February for the first time in eight years. However, medium-term GDP growth potential remains subdued, reflecting weak demographics and high private-sector indebtedness that hinders investment. Low potential growth is a constraint on faster debt reduction.
Political stability since the formation of the current government in late-2015 has helped sustain efforts to exit the EDP. Nevertheless, some drivers of the lower deficit may be difficult to sustain. Capital expenditure could accelerate from a low level, due to public demand for more spending and a ramp-up in EU funds disbursements. Low interest costs on government debt have reflected the unprecedented relaxation in eurozone monetary policy in recent years, and further gains may be limited.
Source: Fitch Ratings – Fitch: Portugal EDP Exit Shows Fiscal Progress; Debt Still High
