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Portugal set to keep investment-grade rating as growth flags
October 19, 2016 / 12:30 PM / a year ago

Portugal set to keep investment-grade rating as growth flags

* Only DBRS rates Portugal above “junk”

* Access to QE programme depends on DBRS

* Growth down to around 1 pct in 2016 from 1.6 pct

By Andrei Khalip

LISBON, Oct 19 (Reuters) - Portugal’s last investment-grade credit rating is likely to survive a review on Friday despite worries about economic growth, aided by the promise of budget deficit cuts in 2017 and renewed vows of left-wing support for the government.

Rating agency DBRS’s lowest investment-grade rating is what separates heavily indebted, slow-growing Portugal from losing eligibility for the European Central Bank’s bond-buying programme. Without access to the programme, many analysts fear Portugal would face a debt crisis and need a new bailout.

“From the political standpoint, the budget was an important test and now some risks have eased ... Our baseline scenario is that there will be no downgrade of the rating or outlook,” said Elia Lattuga, fixed income strategist at UniCredit in London.

Portuguese bonds have rallied to their highest in more than a month after the minority Socialist government, which under a year-old accord relies on two far-left parties in parliament to pass laws, presented the bill on Friday.

Analysts say the rally will gain strength if DBRS makes no move on Friday, but a downgrade would hit the bonds hard, and could make the benchmark yield spike by up to 200 basis points.

The three other rating agencies recognised by the ECB -- Moody‘s, Standard & Poor’s and Fitch -- all rate Portugal one notch below investment-grade after having cut its debt to “junk” status around the time of the country’s EU/IMF bailout in 2011.

Warnings by DBRS in August of risks to Portugal’s creditworthiness, mainly from slowing growth and weakness of the banking sector, two years after the economy emerged from a deep recession, have pushed up its bond premiums.

But UniCredit said DBRS’s published rating methodology, based on six variables from fiscal policy and economy to debt and politics, pointed to a largely steady assessment of Portugal since the last review in April.

The draft budget promises to cut the deficit to 1.6 percent of GDP from this year’s estimated 2.4 percent, which is below a 2.5 percent target agreed with Brussels. It sees growth edging up to 1.5 percent from 1.2 percent, which analysts say is achievable, if on the optimistic side and subject to risks.

The Communists and Left Bloc have signalled their support for the bill, saying that proposed pension rises and income tax cuts are true to their deal with the government, which aims to boost family incomes after years of austerity.

“The coalition turned out more solid than many had thought and there is commitment to meet the European targets, while also keeping the electoral base happy,” said Diego Iscaro, senior economist at IHS Global Insight consultants in London.

“The signals from the agencies, the signals that Portugal is sending with the budget, point to a very, very unlikely downgrade. The worst that could happen is an outlook cut,” he said, while adding he was concerned about longer-term growth.

If DBRS cuts the outlook it would mean a greater likelihood of a rating cut at the next review in six months.

The government is optimistic that DBRS will recognise its fiscal effort and keep the rating steady.

But analysts warn that while the administration solves the tactical issues of avoiding a downgrade and pleasing its political allies and Brussels, it misses the key strategic goal of promoting investment for future growth.

Some fear that could eventually hit Portugal’s creditworthiness.

“Further out, there is a clear risk of a downgrade and if that were to occur, or if quantitative easing were to end, yields on Portuguese bonds would rise quite sharply,” said John Taylor, European fixed income portfolio manager at AllianceBernstein.

“Portugal is not a strong fundamental story.” (Additional reporting By Abhinav Ramnarayan, Editing by Axel Bugge and Catherine Evans)

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