Portugal’s left-wing government has not only surprised observers with its stability and popularity, the coalition some called a geringonça, or contraption, has overseen the country’s move from bailout recipient to credit rating star. But, as Peter Wise reports, there is still work to be done.

Port Costa

Portugal’s Socialist leader António Costa 

Portugal is in fashion. Celebrities including Madonna and actor Michael Fassbinder, who recently bought houses in Lisbon, acclaim the country as 'cool'. Tourist numbers are at record highs and foreign buyers are fuelling a real estate boom. In the words of Pedro Santa Clara, a professor of finance at the Nova School of Business and Economics: “Portugal hasn’t been this cool since the Age of Discoveries 500 years ago.”

The country’s economic recovery is also attracting international admiration. Growth has outpaced the EU average for the first time this century, reaching 2.7% in 2017, while the Socialist government has succeeded in cutting the budget deficit to the lowest level since democracy was restored in 1974. At the same time, employment is growing at a faster rate than the economy and unemployment has fallen to pre-crisis levels.

In recognition of this recovery, Standard & Poor’s and Fitch Ratings have lifted Portugal’s debt rating from junk status to investment grade. Moody’s is expected to follow suit within a year. In May 2017, Portugal exited the EU’s 'excessive deficit procedure' for countries in persistent breach of the bloc’s budget rules. A month later, the International Monetary Fund (IMF) commended Portugal for “notable progress” in stabilising its banking system. In January, Mário Centeno, the finance minister, took over as president of the Eurogroup of eurozone finance ministers, his election being seen as a symbol of Portugal’s return to the fold of fiscally disciplined member states.

A pleasant surprise

Few foresaw this succession of successes when Socialist leader António Costa unexpectedly became prime minister in November 2015. After an inconclusive general election in which no party won an outright majority, he forged an anti-austerity alliance between his centre-left Socialists (PS) and three smaller parties from the anti-establishment and Communist left. Under the agreement, the smaller left-wing parties provide his minority PS government with a working majority in parliament. Critics dubbed the pact the 'geringonça’, meaning a strange contraption.

Many international analysts expected internal conflicts to break up the unforeseen pact between rival left-wing parties or forecast a damaging clash with Brussels over meeting fiscal targets. Portuguese bankers on roadshows faced sceptical questioning from international investors on the outlook for politics and the economy long after Mr Costa took office.

More than two-and-a-half years after the election, however, the alliance is in robust health. This makes Mr Costa unique among centre-left European leaders in being in power, in being popular (the PS has a 13-point opinion poll lead) and in pursuing an anti-austerity policy programme.

“Many of us underestimated the extent to which the parties on the left were invested in making the alliance work,” says Federico Santi, an analyst at Eurasia Group. The likelihood of political instability before the next scheduled general election in October 2019 is now considered to be remote.

Exports boost

At 2.7%, Portugal's gross domestic product (GDP) growth in 2017 was the strongest since 2000. However, expansion is projected to slow in 2018 and 2019 to about 2% as the economic cycle matures.

Higher demand has been driving yields and spreads lower. Yields are currently trading at record lows, while spreads stand below 2015 levels

Cristina Casalinho

“We expect investment and exports to remain the main drivers as structural change in the economy and competitive gains continue to bear fruit,” says Rui Constantino, chief economist at Banco Santander Totta. “Exports, both of goods and services, have evolved very positively, and should continue to do so, taking advantage of the benign external outlook. Exports have increased from 27% of GDP before the financial crisis to 43% and should rise above 45% over the next two years.”

The increased weight of exports reflects a significant shift in the economy from non-tradable to tradable sectors. Together with recent gains in export competiveness, this has lifted Portugal’s potential growth rate to about 1.5%, says Mr Constantino.

“This improvement of exports,” he adds, “is contributing to a resurgence in investment, in terms of both export companies expanding their installed capacity and investment in construction, especially urban renewal.” Having peaked at more than 17% in 2013 during Portugal’s economic adjustment programme overseen by the EU and the IMF, unemployment has fallen below 8%, the lowest level since 2004.

A stroke of luck?

The international context has helped. Mr Costa has been described as “the luckiest politician in the world” for having come to power as oil prices fell and the global economy began to recover, lifting Portuguese exports. “Turning the page on austerity,” as Mr Costa puts it, by restoring public sector wages and pensions to pre-bailout levels, has helped drive growth. But opponents accuse the government of imposing 'hidden austerity' by increasing tax revenues through indirect tax rises and drastically cutting back public investment.

Robust and job-rich growth has contributed to a sharp fall in the budget deficit, which fell to 0.9% of GDP in 2017, excluding extraordinary items, a record low and well below the government’s initial forecast of 1.6%. The official forecast for this year has been revised downwards from 1.1% of GDP to 0.7%. This would bring Portugal close to a balanced budget, an achievement few would have thought possible only a year ago.

Including one-offs, however, last year’s deficit came in at 3%, due to a €3.9bn injection of capital into Caixa Geral de Depósitos, the state-owned bank. Mr Centeno is trying to persuade EU statistics office Eurostat not to include the amount in the deficit, arguing that it should be classified as an investment rather than state aid. Since 2007, the sum of state funds used to rescue banks and stabilise the financial system is estimated at €17bn, the equivalent of 9% of GDP at current prices.

While yields and spreads fall…

The credit rating decisions by S&P in September 2017 and Fitch in December – the latter being the first time a leading rating agency has awarded Lisbon a two-notch upgrade – paved the wave for yields on government debt to drop to record lows.

Cristina Casalinho, chief executive of Portugal’s public debt management agency, the IGCP, says the upgrades returned Portugal to the investment grade category, enabling it to rejoin the Barclays European government bond index. “As a consequence, our investor base has broadened,” she says. “Higher demand has been driving yields and spreads lower. Yields are currently trading at record lows, while spreads stand below 2015 levels.”

Yields on Portugal’s benchmark 10-year debt have dropped by about 60 basis points (bps) since January and 250bps over the past 12 months. Bond issues by the IGCP have already raised two-thirds of 2018’s planned €15bn financing programme, the same amount as in the previous two years.

“By maintaining a stable programme, we aim to build a track record for predictability and transparency, which helps broaden and diversify our investor base,” says Ms Casalinho. The agency, she says, has sought to “reduce funding costs and make public debt more resilient to interest rate shocks by maintaining a comfortable cash buffer and a high weighted average maturity for the total debt”.

This helps lower refinancing risk and provides more flexibility in the timing of bond issues. To help smooth the redemption profile, the IGCP has been buying back and switching government bonds for debt with longer maturities. This has earned Portugal praise from the European Commission, the IMF and rating agencies for rendering its debt more resilient to shocks.

…debt levels remain high

The expanding economy saw the public debt-to-GDP ratio drop by 3.9 percentage points in 2017 to 126.2%, in line with Portugal’s commitments to Brussels and only the second time in a decade that the year-on-year ratio has fallen. Through the IGCP, the government has been paying down ahead of schedule the €26.3bn bailout loan it received from the IMF during the 2011 to 2014 adjustment programme.

About 85% of the loan has now been paid off, with €10bn in early repayments being made in 2017. Early repayment of the IMF portion of its €78bn bailout enables Portugal to lower the cost of servicing its debt by replacing the IMF debt with new bonds at lower interest rates.

The public debt burden nevertheless remains one of the economy’s principle vulnerabilities. It is the third highest in the euro area and even a forecast decrease to below 110% of GDP by 2023 would still leave Portugal vulnerable to unexpected interest rate increases or cyclical downturns among its main trading partners.

In terms of domestic risks to the economy, Mr Constantino highlights a potential deceleration in economic reform, noting that “a possible slower pace of structural reforms could affect the transformation of the economy and the gains in competitiveness made over the past few years”.


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