From the Press Release:
Rating action concludes review for possible downgrade
London, 13 July 2010 -- Moody's Investors Service has today downgraded Portugal's government bond ratings to A1 from Aa2. The two-notch downgrade reflects the rating agency's following conclusions:
1.) The Portuguese government's financial strength will continue to weaken over the medium term, as evidenced by ongoing deterioration in the country's debt metrics, such as debt to GDP and debt to revenues; and
2.) The Portuguese economy's growth prospects are likely to remain relatively weak unless recent structural reforms bear fruit over the medium to longer term.
The rating outlook is now stable, with the upside and downside risks evenly balanced.
Today's rating action concludes the review for possible downgrade that Moody's initiated on 5 May 2010.
Separately, Moody's has also affirmed Portugal's short-term issuer rating of Prime-1 with a stable outlook. Portugal falls under the Eurozone's Aaa regional ceilings for bonds and bank deposits, which were unaffected by the Portuguese government's downgrade.
RATIONALE FOR DOWNGRADE
Moody's believes that the Portuguese government's financial strength will continue to weaken over the medium term, as evidenced by the recent and ongoing deterioration in the country's debt metrics. "The Portuguese government's debt-to-GDP and debt-to-revenues ratios have risen rapidly over the past two years," says Anthony Thomas, Vice President - Senior Analyst in Moody's Sovereign Risk Group. "This deterioration came about due to the government's anti-crisis measures and the operation of the budget's automatic stabilizers, such as higher unemployment benefits, when the economy went into recession."
Looking ahead, Moody's expects the government's debt metrics to continue to deteriorate for at least another two to three years, with the debt-to-GDP and debt-to-revenues ratios eventually approaching 90% and 210%, respectively, before stabilizing once the budget has moved back into a primary surplus position.
"Moody's also remains concerned about the economy's medium-term growth potential," says Thomas. The analyst says it is not yet clear whether the reforms will boost growth sufficiently to allow the deterioration in the country's debt metrics to eventually reverse, especially as the labour market reforms are relatively recent. This would imply that Portugal's government would remain relatively highly indebted for the foreseeable future.
RATIONALE FOR STABLE OUTLOOK
Whilst the government's debt metrics have undoubtedly deteriorated, Moody's believes that they will stabilise at levels that are commensurate with a strong A rating. In our view, upside and downside risks to that base case scenario are evenly balanced. If in addition to recent fiscal consolidation efforts, the structural adjustments undertaken by both government and private sector achieve a boost in productivity and growth potential, the government's debt metrics and the country's external position could strengthen beyond current expectations. At the same time, however, Moody's notes that a more severe deterioration in the country's debt metrics in the event in the event of higher interest rates or weaker economic growth cannot be completely ruled out.
For further information, please refer to Moody's Special Comment entitled "Key Drivers of Portugal's Downgrade to A1", which is available on www.moodys.com.
PREVIOUS RATING ACTION & METHODOLOGY
Moody's last rating action affecting Portugal was implemented on 5 May 2010, when the rating agency placed Portugal's Aa2 government bond ratings on review for possible downgrade, while the government's Prime-1 short-term rating was affirmed. Prior to that, Moody's last rating action on Portugal was taken on 29 October 2009 when the rating agency changed the outlook on the government's Aa2 ratings to negative from stable.
The principal methodology used in rating the government of Portugal is "Moody's Sovereign Bond Ratings", which was published in September 2008 and can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.