Moody’s cut Portugal’s sovereign debt by two notches to A1 from AA2 on Tuesday — but European markets seemed rather relaxed about it.
The rating agency explained its downgrade thus:
Moody’s believes that the Portuguese government’s financial strength will continue to weaken over the medium term, as evidenced by the recent and ongoing deterioration in the country’s debt metrics. “The Portuguese government’s debt-to-GDP and debt-to-revenues ratios have risen rapidly over the past two years,” says Anthony Thomas, Vice President – Senior Analyst in Moody’s Sovereign Risk Group. “This deterioration came about due to the government’s anti-crisis measures and the operation of the budget’s automatic stabilizers, such as higher unemployment benefits, when the economy went into recession.”
Looking ahead, Moody’s expects the government’s debt metrics to continue to deteriorate for at least another two to three years, with the debt-to-GDP and debt-to-revenues ratios eventually approaching 90% and 210%, respectively, before stabilizing once the budget has moved back into a primary surplus position.
“Moody’s also remains concerned about the economy’s medium-term growth potential,” says Thomas. The analyst says it is not yet clear whether the reforms will boost growth sufficiently to allow the deterioration in the country’s debt metrics to eventually reverse, especially as the labour market reforms are relatively recent. This would imply that Portugal’s government would remain relatively highly indebted for the foreseeable future.
And as for the stable outlook slapped on Lisbon’s debt profile:
Whilst the government’s debt metrics have undoubtedly deteriorated, Moody’s believes that they will stabilise at levels that are commensurate with a strong A rating. In our view, upside and downside risks to that base case scenario are evenly balanced. If in addition to recent fiscal consolidation efforts, the structural adjustments undertaken by both government and private sector achieve a boost in productivity and growth potential, the government’s debt metrics and the country’s external position could strengthen beyond current expectations. At the same time, however, Moody’s notes that a more severe deterioration in the country’s debt metrics in the event in the event of higher interest rates or weaker economic growth cannot be completely ruled out.
Moody’s had initially placed Portugal on downgrade review back in May, which might explain the rather apathetic reaction to Tuesday’s action.
The euro was already falling against the dollar before the announcement, and has since rallied a bit:
Five-year credit default swaps on Portugal rose slightly to 286bps from 279.5bps, according to CMA, while the PSI was down 0.31 per cent at pixel time. The spread between Portuguese and German government debt widened 4bps to 290 bps from Monday’s close.
Bocejos all ‘round for sovereign debt reminders in this market rally, then — S&P’s previous two-notch downgrade of Portugal in April had a rather greater effect.
Do watch out for follow-up rating actions on Portuguese banks, though, given the current focus on their stress-test performance.
Update: Here’s one clue as to investors’ relaxed reaction. As Moody’s senior analyst in sovereign risk Anthony Thomas told FT Alphaville, A1 remains ‘a very good rating’ for the country even despite the European crisis.
Even so – Thomas added that the government’s revised targets for debt issuance ‘are just not consistent’ with an AA rating. Nor is there sufficient clarity on how the deficit reduction plan recently put together by the government will impact economic growth in the medium term — it’s not clear if the trend rate here will be any better after fiscal austerity is carried out, Thomas says, suggesting that Portugal would have problems growing its way out of its debt.
Hence the two-notch cut — and what looks like a long period of concern over whether Portugal can cut it, even with Moody’s’ stable outlook.
Related links:
Moody’s on Spain: It’s not Portugal, and it’s not Greece – FT Alphaville
Can Portugal cut it? – FT Alphaville
Portugal v Greece on sovereign risk – FT Alphaville