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Friday, April 29, 2016

Financial Independence in Portugal Hangs by a Thread

Portugal’s Financial Independence Hangs by a Thread



Country’s access to ECB bond-buying program depends on debt rating by Canadian firm DBRS


A woman holds Portuguese flags during a march marking the Carnation Revolution's 42nd anniversary in Lisbon, Portugal, this week. The country’s access to bond markets depends on an investment-grade debt rating from a little-known Canadian firm DBRS Ltd. PHOTO: REUTERS

By PATRICIA KOWSMANN
April 29, 2016 12:30 a.m. ET

LISBON—Nearly two years after Portugal left a €78 billion ($88 billion) international bailout program, its financial independence continues to hang by a thread.

That thread is a little-known Canadian firm, DBRS Ltd., the only rating company that maintains an investment-grade rating on Portuguese debt. That rating gives Portugal access to the European Central Bank’s bond-buying program, which has kept bond yields low and relatively stable despite recent global market turmoil, a December bank failure and friction between European Union officials and the country’s new government over its budget plans.

On Friday, DBRS will announce the result of its twice-yearly review of Portugal. A downgrade to junk status—the rating the country gets from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings—would force it out of the ECB program and raise borrowing costs for its government, banks and companies.

That, in turn, could reawaken fears over Portugal’s future in the eurozone and the sustainability of the bloc itself, which is struggling to manage Greece’s fiscal troubles. Portugal would be required to take a new bailout to get a chance to re-enter the ECB program.

A DBRS downgrade “of course is a concern; it will be a problem if it happens,” Finance Minister Mario Centeno said in an interview in Washington this month.

Mr. Centeno said he hoped the government’s pledges of fiscal restraint would help avoid a downgrade. In February, DBRS said it was “comfortable” with the BBB (low) rating and stable outlook it had given Portugal.

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Still, Portugal’s reliance on a single ratings firm is widely viewed as a problem.

“The fact that the country’s future in sovereign debt markets hinges upon a single decision shows that Portugal is still in a very delicate situation,” saidAntonio Barroso, an analyst at political-risk consultancy Teneo Intelligence. “It is also a reminder for politicians both in Lisbon and in Brussels that they should be doing more in order to prevent a return of the crisis to the eurozone.”

During its three-year bailout program, which ended in May 2014, Portugal was considered an exemplary follower of the Germany-led austerity model. The center-right government at the time, led by Prime Minister Pedro Passos Coelho, cut public employees’ wages, raised taxes and slashed spending to balance its accounts. The budget deficit fell sharply, from close to 10% of gross domestic product in 2010 to 3% of GDP last year, excluding a capital injection into a failed lender.

Mr. Passos Coelho privatized state companies and changed labor regulations to bring down labor costs and make exports more competitive.

Still, Portugal’s economy struggles. Exports are rising, but so are imports. Investments remain scarce. Unemployment exceeds 12%.

The International Monetary Fund predicted recently that Portugal’s economy would grow an average of 1.3% a year over the next six years, too slowly to reduce a debt burden that stands at 129% of GDP.

Portugal’s perception among investors has been hit by two bank failures since 2014 and the election of a Socialist-led government that has raised the minimum wage and promised to raise public-sector wages and lower taxes.

Socialist Prime Minister António Costa, who took office late last year with the backing of three far-left parties, has softened his rhetorical attack on his predecessor’s austerity measures. He has agreed to make deeper budget cuts this year to avoid a fight with the European Commission.

Mr. Centeno, who has traveled to Washington and other capitals to reassure creditors, last week outlined a plan to cut the deficit next year to 1.4% of GDP, from a target of 2.2% in 2016.

Even if it manages to avoid a downgrade now, pressure on Portugal is expected to grow.

DBRS has cited a global economic slowdown, debt sustainability and a rise in bond yields as factors to watch.

As he cuts the budget, Mr. Costa could be forced to choose between alienating his far-left allies in parliament or confronting the European Commission and its fiscal rules.

“The biggest concern that we would have would be [an] open conflict with the European Commission,” Fergus McCormick, head sovereign analyst at DBRS, said in February.

—Tom Fairless in Frankfurt and Viktoria Dendrinou in Brussels contributed to this article

Write to Patricia Kowsmann at patricia.kowsmann@wsj.com

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