WASHINGTON (MNI) – The following are excerpts from a statment and
report by Standard & Poor’s Friday examining two scenarios for how the
ratings agency envisions the deleveraging of Portugal might unfold, and
the potential ratings impact:
Standard & Poor’s Ratings Services said today that it expects the
Republic of Portugal (BBB-/Negative/A-3) will negotiate a support
program from the IMF and EU over the next few months, and will likely
need to access funding from the European Stability Mechanism (ESM) by
2013. Accordingly, we have examined two scenarios for how we envision
the deleveraging of Portugal might unfold, and the potential ratings
impact, in an article published today titled, “The Deleveraging Of
Portugal: What Does It Mean For Debt Sustainability?” on the Global
Credit Portal.
“In our view, the successful implementation of fiscal and
structural reform measures is necessary if Portugal is to correct its
fiscal and external imbalances–its so-called ‘twin deficits’,” Standard
& Poor’s credit analyst Eileen Zhang said.
Despite the potential disruption and delay to the fiscal
consolidation program as a result of an early election, we still expect
Portugal’s fiscal deficit to narrow significantly during 2011. On the
other hand, the benefits of labor market and other critical reforms
intended to make the economy more flexible in our view are likely to
accrue only gradually. At the same time, we note that uncertainties
persist regarding the private sector’s continuing access to external
funding, and as a result how orderly the private sector deleveraging
process will be.
“Our baseline scenario still assumes that the Portuguese economy
will be able to gradually rebalance,” Ms. Zhang said. “Our expectation
is that the economy will contract 3.2% in cumulative terms during 2011
and 2012, before recovering in 2013. The contraction of GDP will likely
make the task of stabilizing the government debt-to-GDP ratio more
challenging. We have also included in the report projections of an
alternative, more negative scenario, involving a sharper contraction of
the Portuguese economy. In both cases, we examine the likely policy
response and the possible conditions we think Portugal may need to meet
in 2013 to access ESM lending.”
…
We expect borrowing from multilateral lenders will likely come with
stringent fiscal conditions attached. To maintain access, we believe the
government will likely be expected to implement revenue raising measures
and also to extensively cut public expenditure under the close
supervision of the lenders. The government is unlikely to have the
option to run a contra-cyclical fiscal policy even if the economy
shrinks more than expected, in our opinion. A continued procyclical
fiscal response to weaker economic growth is one of the key assumptions
we make in the two scenarios discussed below.
The Outlook For Portugal’s Financial Sector
The Portuguese financial system relies heavily on external funding,
which, given the difficult market conditions, increases banks’
vulnerability to capital flows, in our opinion. In 2010, we saw that
limited access to the capital markets was mainly offset by the extensive
use of the European Central Bank (ECB) liquidity facility, which may not
be made available for any additional inflow of funds during 2011 and
2012. Short-term funding from the ECB is currently at E39 billion,
equivalent to 24% of GDP. In our view, the wholesale markets will likely
remain closed to banks for medium- and long-term debt issuance for at
least the remainder of 2011 and potentially 2012, as has been the case
since April 2010.
Therefore, we anticipate that Portuguese banks could be unable to
fully roll over their upcoming maturities, which, system wide, we
estimate could exceed E16 billion in 2011 and E17 billion in 2012. As a
result, and in contrast to previous recessions when lending continued to
expand, we believe that the Portuguese financial system will likely
deleverage by selling assets and shrinking their loan books. In both our
baseline and alternative scenarios, we expect the reliance on ECB
funding to remain close to the current estimated level of E40 billion in
the next few years. We believe the banks and the regulator, Banco do
Portugal, do not currently intend to increase the financial system’s
recourse to the ECB. Nevertheless, we anticipate that in the event of
any temporary liquidity strains on the banks’ short-term funding sources
(for example, commercial paper, interbank loans, or repos) the banks
will likely be able to turn to the ECB by using eligible assets for
discount.
We expect Portugal’s outstanding credit to therefore contract in
the coming year and that the magnitude of the contraction could
significantly dampen domestic demand. The ongoing ECB monetary
tightening cycle–which we believe could result in an appreciating euro
and lower nominal growth on the back of lower inflation–is likely to
render Portugal’s rebalancing efforts even more difficult.
In our view, the key variables in our two scenarios are therefore
the extent of domestic customer deposit growth and the level of
refinancing (through private placements, repos, etc.) and as a result,
the magnitude of the domestic credit contraction.
** Market News International Washington Bureau: 202-371-2121 **
[TOPICS: MI$$$$,M$X$$$,MGX$$$,MFX$$$,MR$$$$,M$$CR$,MK$$$$]