It is exactly two years since Portugal exited the European Union bailout program. But after a period of promising recovery, the country’s economy is again deteriorating. The government in Lisbon is struggling with a mixture of high taxes, low growth, and unstable banks.
That explosive mixture is making investors nervous. Last week, Fergus McCormick, sovereign bond expert at the ratings agency DBRS, set off panic selling of Portuguese debt when he said in an interview that low growth figures in the second quarter had “raised our concerns about growth prospects, which appear to be slowing into the third quarter.” In response, yields on 10-year bonds leaped up 13 basis points, their biggest jump since June’s Brexit vote. Pressure continued all week.
Of course, Mr. McCormick was only making explicit what everyone already knew. But the DBRS agency has particular significance for Portugal: it is the only rating agency which still rates the country’s debt as “investment grade.” And that rating is the precondition for the bonds to be eligible for the European Central Bank’s bond buying program. If the ECB were to stop buying Portuguese bonds, the country would face considerable problems in financing its debt.
“To use a boxing metaphor, Portugal is facing a standing count.”
“To use a boxing metaphor, Portugal is facing a standing count,” said David Schnautz, bond strategist at Commerzbank. “As long as DBRS does not say ‘It’s all no problem,’ then some damage has already been done,” he added.
But the agency clearly does not plan to downgrade the country: its outlook for Portugal is stable. Generally, any downgrade would be preceded by a change in the outlook. “We normally do not change our rating by several steps all at once, except if the financing situation deteriorates substantially,” said Adriana Alvarado, an analyst at DBRS and a member of the agency’s rating committee for Portugal. “We don’t see that right now with Portugal,” she added.
In the first quarter, the Portuguese economy grew 0.9 percent, dropping slightly in the second to 0.8 percent. “That means it is unlikely Portugal will reach this year’s growth target, 1.8 percent,” explained Ms. Alvarado. Many institutions have already cut forecasts for Portuguese growth. The IMF predicts 1 percent GDP growth, Barclays bank thinks it will be 0.7 percent.
“I am very concerned about the financial and economic situation,” said João César das Neves, an economist at the Catholic University in Lisbon. The reason for his worry is the country’s political leadership: since late 2015, the Socialist party has governed Portugal with the support of communists and radical leftists. The government has reversed many reforms passed by its conservative predecessor. “The support of the extreme left does not create a favorable climate for new projects, so investment is at a historic low,” said the economist: “The result is economic stagnation.”
A high level of corporate debt is another factor weighing on investment. It is currently running at 143 percent of economic output, among the highest in Europe. At the same time, the banks have a large number of bad loans on their books. According to the Portuguese Central Bank, they now represent 12 percent of all loans. Both factors act as a brake on economic growth.
All this will make it hard to cut the government deficit to 2.5 percent by the end of the year, as demanded by the European Union’s strict budget rules. In 2015, the figure was 4.4 percent. On October 15, the Portuguese government has to present its plans for scrutiny by the European Commission. “For Brussels, the measures proposed will be a litmus test for the government, which is in any case fragile,” said Mr. Schnautz, the Commerzbank strategist. Ms. Alvarado also sees that date as crucial. One week later, on October 21, she and her colleagues at DBRS will revisit their rating for Portuguese debt.
Even if the government does not collapse because of E.U. demands for cuts and Brussels accepts its budget plan, the Portuguese banks remain a major risk. Already in 2015, Lisbon’s bailout of Banif bank ripped a hole in the government’s budget.
“We are going to see a financial collapse in Portugal, either in the banking sector, or of public finances, or both.”
And Banif is unlikely to be the last bank to get into trouble.
In a recent report, ratings agency Moody’s said Portugal’s banks “are among the most weakly capitalized institutions in the euro zone.” The country’s largest bank, the state-owned Caixa Geral de Depósitos, is in urgent need of a capital injection. Analysts think it could need up to €5 billion, around $5.66 billion, — money which will burden public finances and push up government debt, already at 129 percent of GDP. Ratings agency Fitch, which on Friday left its outlook for Portugal unchanged, noted that Lisbon had almost three times the level of debt as other countries with the same rating.
“In the near future, we are going to see a financial collapse in Portugal, either in the banking sector, or of public finances, or both,” warned Mr. das Neves, the economist. “Soon, we are going to need European help again.” In 2011, Portugal received €78 billion in emergency bailout assistance from the European Union and the ECB. In 2014, it left the bailout program, thus regaining a large measure of financial autonomy.
The bleak scenario outlined by Mr. das Neves is not new. At the end of June, the German finance minister, Wolfgang Schäuble, said of Portugal: “It will apply for a new bailout program, and it will receive it.” Afterwards, Mr. Schäuble claimed his words had been misunderstood. But by then, the sentence was public knowledge. In the meantime, many other voices are saying very similar things.
Sandra Louven is Handelsblatt’s Madrid correspondent, covering Spain, Portugal and North Africa. To contact the author: email@example.com.