BARCLAYS | The results of the general election in Portugal came in broadly in line with recent polls: the PSD/CDS conservative coalition, currently in government, won again with 38,5% of the vote, but it fell short of an absolute majority of seats in parliament. Political instability could potentially also result in early elections after one year.
The socialist PS was second with 32,4% of the vote, followed by the radical left BE with 10,2%, and the communist party with 8,1%. The PSD/CDS conservative coalition is likely to be nominated again as the new government, but this time without an absolute majority of seats in parliament.
If the conservative PSD/CDS coalition fails to secure the necessary support in the national assembly to form a government, then the socialist party (PS) could have a chance to take power with the support of BE (though still without an absolute majority). Even in the less likely event of the socialist party taking power with the support of the radical left BE party, we would not expect a roll-back of the reforms enacted over the past four years. Because public and private leverage remain elevated (together amount to 380% of GDP), pro-growth policies and further fiscal consolidation remain critical to ensure solvency. However, the lack of a government with an absolute majority could mean that further reforms may be difficult to approve.
A slowed reform agenda is to be expected in part because key areas have already undergone major reforms (ie, public administration, judiciary, social security, banking sector, and regulation of labour markets), but also because a minority government may not be able to pass through a fragmented parliament any ambitious reforms. Even with a majority in parliament, the conservative government coalition has experienced a few policy bumps, such as the constitutional court decisions overturning important fiscal measures on public pensions and wages, and the fallout of BES (the sale of Novo Banco is not yet completed).
Markets likely to react mildly favourably to a PSD/CDS government
The election of PSD/CDS may lead to a mild compression in political risk premium for Portuguese assets post-election. Market conditions for the periphery, and for Portugal in particular, have improved considerably since the government exited the EU-IMF programme in June 2014. IGCP, the Portuguese Treasury, has tapped the PGB market for EUR23.8bn. Currently, the 10y government bond yields 2.3% at a spread of c.180bp over the 10-year Bund and 53bp over Bonos, helped by a very accommodative monetary policy. Further improvements to Portugal’s rating outlook will critically depend on growth prospects, further reforms, and the ability to deleverage. Despite the victory of the reformist PSD/CDS coalition, a minority government might not be able to achieve these objectives.
Nevertheless, the string of Greek shocks this year have had very limited effect on Portugal. S&P upgraded Portugal to BB in February this year while maintaining a positive outlook, while Fitch upgraded Portugal to BB+ (again keeping a positive outlook) in November 2014. Whether the next government carries on with pending reforms will be critical to the rating outlook. Nonetheless, it seems possible that either or both of the large rating agencies could bring Portugal back into investment grade within the next few months.
Gradually improving macroeconomic outlook
Economic activity has gradually improved since mid-2014 and has now been in expansionary territory for four consecutive quarters (+0.4% q/q in Q2 15). We project 2015 growth at 1.6%, fundamentally driven by private consumption and favourable external conditions (ie, cheap oil and a weak euro). However, we think the 2015 fiscal deficit target of -2.7% of GDP (from -4.5% last year) seems ambitious without further expenditure cuts.
Long-standing imbalances and risks will require further government efforts. These include reducing the excessive leverage in both the public and private sectors (by end-2014 private and public debt stood at c.239% and 130% of GDP, respectively); meeting substantial medium-term financing needs; dealing with high NPLs and weak bank profitability, which continues to pressure capital adequacy.
