Portugal’s political stability and its government’s renewed commitment to consolidate public finances will keep its public debt ratio on a firm downward path, in contrast with Spain and Italy.
Portugal’s economic and fiscal adjustment since the crisis has been impressive, says Scope Ratings.
Growth has run above the euro area average since 2016 at around 2.5% annually. The fiscal deficit fell to around 0% of GDP in 2019 from 11.4% of GDP in 2010. The unemployment rate has fallen to less than 7% from around 17%. Portugal’s current account is just below balance and the banking sector has been recapitalised and restructured.
Prime Minister António Costa, re-elected in October last year, has made clear that his government’s budgetary priorities include achieving balanced budgets to reduce the still-elevated public debt stock while financing slightly higher public wages and social payments.
“Portuguese authorities have taken advantage of the favourable economic environment to address the country’s remaining public finance vulnerabilities”, says Alvise Lennkh, lead analyst on Portugal at Scope
“The structural deficit stood at 8.5% of potential GDP in 2010 and is now close to balance, which underpins our expectation of broadly balanced fiscal budgets in the coming years despite a weaker growth outlook”, he adds.
The commitment to maintain a prudent fiscal stance is reflected in Portugal’s 2020 draft budget, which projects for this year a budgetary surplus of 0.2% of GDP and an elevated primary surplus above 3% of GDP.
“The increase in public wages and social benefits aims to address growing social pressures and may slightly reduce the pace of fiscal consolidation but should not weaken the commitment to maintaining primary surpluses of around 3% of GDP”, says Giulia Branz, associate analyst at Scope.
“These spending increases contrast with much larger cuts since the crisis and have to be seen in the context of a healthy labour market and rising private sector wages” she adds.
Portugal’s prudent fiscal policy has contributed to the reduction of the government debt level from the peak of 132.9% of GDP in 2014 to 118.9% in 2019. Scope expects the debt-to-GDP ratio to fall to below 105% by 2024.
“The expected further decline of Portugal’s debt ratio by around 15 to 20pp until 2024 significantly outperforms the debt trajectories of Italy and Spain”, says Lennkh.
While Spain (A-/Stable) has grown at around 2% in the past, the persistent political standstill has prevented the implementation of additional significant reforms since 2015. The structural deficit remains the highest in the euro area at around 3% of GDP and unemployment is now stabilising just below 14%.
“As a consequence, Spain’s public debt, which is lower than Portugal’s at around 97% of GDP, is on a slightly declining trend due to growth and lower interest payments. However, the reduction is significantly slower than Portugal’s, and, more concerning, entirely cyclical in nature and now also subject to uncertainty given the expansionary policy initiatives of the new government”, says Lennkh.
Italy (BBB+/Stable), on the other hand, has a lengthy track record of primary surpluses but the country’s annual growth rate has only averaged around 0.9% over the past five years, keeping the debt-to-GDP ratio at an all-time high of around 136%.
“In this context, recent Italian budgets have postponed fiscal consolidation, favouring instead initiatives designed to support growth, resulting in a fairly flat debt trajectory expected over the coming years”, says Branz.
Looking ahead, despite Portugal’s improving public finances, its credit outlook remains constrained by its modest growth potential, large external debtor position, loss-making state-owned enterprises as well as contingent risks from the financial sector, including planned capital injections to Novo Banco of up to EUR 2.0bn until 2025.