Yet another European sovereign is facing a credit rating downgrade, with Portugal being dropped to junk status by Fitch Ratings.
Fitch said the country’s large fiscal imbalances, high indebtedness across all sectors, and adverse macroeconomic outlook mean the sovereign’s credit profile is no longer consistent with an investment-grade rating.
The rating agency has also lowered Portugal’s growth forecasts in light of the gloomier European outlook. It now expects GDP to contract by 3% in 2012. “Over the next two years, the recession makes the government’s deficit-reduction plan much more challenging and will negatively impact bank asset quality,” it says.
Nevertheless, Fitch also says that the government’s commitment to its deficit reduction program is strong. It expects the official deficit target of 5.9% to be met this year, albeit with significant recourse to one-off measures. It also says that the country’s budget for 2012 is well-designed and is based on reasonable GDP assumptions, so it also expects the 4.5% deficit target for 2012 to be met.
However, it cautions that the risk of missing those targets, either from worse macroeconomic performance or insufficient expenditure control, is large. The state-owned enterprise sector is another key source of fiscal risk and has been responsible for several upward revisions to the general government debt and deficit figures over the past year, it says. Given these downside risks, Fitch says it sees a significant likelihood that further consolidation measures will be needed in 2012.
The sovereign debt crisis also poses significant risks to the banking system, which lends to one of the most indebted private sectors in Europe and is highly reliant on wholesale financing (access to which is now closed off), Fitch says. It believes that bank recapitalisation, and increased emergency liquidity from the European Central Bank to Portugal’s banks will be needed and provided.
“A worse economic and/or fiscal performance than forecast could lead to a further downgrade,” it says. And, although Portugal is funded to the end of 2013, sovereign liquidity risk may increase materially towards the end of that period if adverse market conditions persist, it adds.
Successful economic and fiscal rebalancing would ease downward pressure on the country’s credit rating. Improvement in Portugal’s potential growth rate would improve the sovereign’s credit profile over the long-term, Fitch concludes.