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Moody's: Portugal's latest budget projections reveal challenges ahead

January 29, 2010 | Moody's Investors Service

London, 28 January 2010 -- Moody's Investors Service says that Portugal's new budget proposals reveal the scale of the challenges ahead for the country's economy. Moody's says that a credible plan for deficit reduction will be needed to ensure the government's ability to reverse its adverse debt dynamics, and in turn to avoid further downward pressure on its ratings.

Moody's described the Portuguese government's 2010 budget proposals, as announced on 26 January, as including an upward revision of last year's budget deficit to 9.3% of GDP and also as indicating a slightly higher deficit for 2010 than previously anticipated. The estimated 2009 outturn is a full percentage point of GDP higher than had been expected.

"This not only means that the extent of fiscal consolidation required to restore the government's debt metrics to health is much greater than before," says Anthony Thomas, a Vice President-Senior Analyst in Moody's Sovereign Risk Group, "but also represents a further erosion of Portugal's debt affordability advantage vis-à-vis its peers, especially those in the Eurozone. In particular, the government can no longer be described as having relatively low debt."

Looking ahead, Moody's believes that the government's fiscal reduction goal for this year is deliberately being kept modest so as not to undermine the expected weak recovery. The government is planning to reduce the deficit by 1% of GDP, and is targeting a somewhat higher reduction in the structural underlying deficit. The emphasis is on expenditure restraint, particularly public sector wage costs. Moody's observes that, based on international comparisons, expenditure-driven fiscal consolidations have a better record of being sustained than revenue-driven ones. Moreover, in recent years, the Portuguese have demonstrated a good track record in controlling wage costs.

However, the limited deficit reduction this year means that more ambitious cuts will be needed in 2011-2013 if the government is to reduce the deficit to 3% of GDP in line with its Stability and Growth Pact commitment to the European Commission. "As the structural deficit will still be around 7% even after this year's reduction, it is difficult to envisage the government achieving this target without deeper cuts in spending or tax increases than current plans suggest," adds Mr. Thomas.

Moody's also points out that execution risk after 2010 is high compared with past performance. Fiscal adjustments have been characterised by an over-reliance on one-off measures to reduce the deficit below 3% of GDP. Indeed, the deficit has not fallen below 2½% of GDP since the start of EMU and no such reduction has proved sustainable.

Portugal's task in improving its debt dynamics will be rendered more difficult by its weak growth dynamics as a result of its weak competitiveness. "A higher underlying growth rate would make the task of fiscal consolidation and debt reversibility (reduction in this case) much easier to execute," says Mr. Thomas. Although the government has introduced reforms to strengthen economic performance, including measures to boost the export capabilities of small- and medium-sized enterprises, Moody's notes that they are unlikely to raise the trend growth rate in the near term. "Moody's believes that concrete measures to address the competitiveness gap would be supportive of Portugal's rating," says Mr. Thomas.

As other Eurozone members are likely to register more robust recoveries, there also is a risk that interest rates in the single currency area may rise faster than would be appropriate for Portugal. Given that the Portuguese government is no longer in the low-debt category and the challenges it faces ensuring sustained deficit reduction, the rating agency adds that higher interest costs also pose concerns about Portugal's debt affordability going forward. Moody's rating decisions for all countries are driven by this factor along with the rating agency's assessment of debt reversibility and debt finance-ability.

"Finance-ability -- at a cost -- is not in question for the foreseeable future for a Eurozone country such as Portugal, or even for Greece, which is rated 3 notches lower at A2," says Mr. Thomas. However, how far debt affordability will deteriorate and how reversible are questions that underlie the negative outlook on Portugal's Aa2 rating. As a result, only a transparent and credible plan for deficit reduction will be sufficient to stabilise the rating where it currently stands.

Moody's last rating action on Portugal was implemented on 29 October 2009, when the rating agency placed a negative outlook on the government's Aa2 bond ratings.

The principal methodology used in rating the government of Portugal is Moody's Sovereign Bond Methodology, published in September 2008, which can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

Company: Portugal

Full company nameRepublic of Portugal
Country of riskPortugal
Country of registrationPortugal

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