GOVERNMENT DEBT AND CASH MANAGEMENT ANNUAL REPORT

Transcription

1 GOVERNMENT DEBT AND CASH MANAGEMENT ANNUAL REPORT

2 CONTENTS INTRODUCTION... 7 Box PRIMARY MARKET PARTICIPANTS FOR THE ECONOMY AND FINANCIAL MARKETS IN INTERNATIONAL ENVIRONMENT... 1 PORTUGUESE ECONOMY GOVERNMENT DEBT MARKET EURO AREA THE PORTUGUESE GOVERNMENT DEBT MANAGEMENT STRATEGY IN THE PRIMARY MARKET OF PORTUGUESE GOVERNMENT DEBT THE SECONDARY MARKET OF PORTUGUESE GOVERNMENT DEBT FINANCING, CASH AND ACTIVE DEBT MANAGEMENT OPERATIONS FINANCING PROGRAMME BORROWING REQUIREMENTS DEBT BUYBACK PROGRAMME FINANCING ACTIVITY... 5 OPERATIONS WITHIN THE FRAMEWORK OF THE REPO FACILITY ACTIVE DEBT MANAGEMENT OPERATIONS CASH MANAGEMENT OPERATIONS Box TRANSACTIONS CARRIED OUT UNDER THE EMTN PROGRAMME: Private placements.. 64 Box LAUNCH OF TREASURY CERTIFICATES CASH MANAGEMENT CENTRAL GOVERNMENT CASH ACCOUNTS DIRECT GOVERNMENT DEBT AND COSTS STATE S DIRECT DEBT OUTSTANDING CURRENT DEBT COSTS RISK MANAGEMENT CHARACTERIZATION OF THE DEBT PORTFOLIO AND COST INDICATORS RISK INDICATORS... 8 Box RISK MANAGEMENT: Bilateral CSA /88

3 LIST OF GRAPHS Graph 1 Real GDP growth...1 Graph 2 - Real GDP growth in the euro area...11 Graph 3 Unemployment rate...12 Graph 4 Price developments...13 Graph 5 General Government deficit and debt in Graph 6 Central bank intervention rates...15 Graph 7 - Spreads of euro area sovereigns versus the German Bund...16 Graph 8 Long-term interest rates...17 Graph 9 Term structure of interest rates...18 Graph 1 Relative performance of equity and bond markets...19 Graph 11 Euro exchange rates...2 Graph 12 Real GDP growth and demand components...21 Graph 13 Inflation rate...22 Graph 14 Budget deficit and Government debt in Portugal...23 Graph 15 Financial markets...24 Graph 16 The swap curve...26 Graph 17 The Bund curve...26 Graph 18 Government bond issuance in euros in Graph 19 Euro government bond issuance by maturity...28 Graph 2 Portuguese Government bond yield curve at end Graph 21 Debt stock structure by type of instrument...3 Graph 22 Financing structure by type of instrument...31 Graph 23 Syndicate structure...32 Graph 24 OT issuance size...33 Graph 25 OT placement (auctions and syndicates) by Primary Dealers *...34 Graph 26 BT curve at end Graph 27 Placement of Treasury bills by Specialists (*)...35 Graph 28 1-year asset swap spreads...39 Graph 29 5-year asset swap spreads...39 Graph 3 3-year asset swap spreads...4 Graph 31 Daily average turnover of OT in the designated platforms...42 Graph 32 Daily average turnover in 21 by Benchmark OT /88

4 Graph 33 Daily average turnover and outstanding of BT...43 Graph 34 Geographical distribution of OT turnover in the secondary market in Graph 35 Geographical distribution of BT turnover in the secondary market in Graph 36-5Y, 1Y and 3Y bid-offer spread in the designated platforms...45 Graph month BT bid-offer spread on MTS Portugal platforms...46 Graph 38 Repo window...46 Graph 39 Annual financing amounts (*)...5 Graph 4 OT issuance in Graph 41 OT auctions held in 21 (amounts placed and bid-to-cover)...53 Graph 42 BT auctions held in 21 Amounts placed and bid-to-cover...57 Graph 43 BT auctions held in 21 Weighted average rate of the competitive phase vs. market rates...57 Graph 44 Financing repos...58 Graph 45 - CEDIC...58 Graph 46 Saving Certificates...59 Graph 47 Treasury Certificates...59 Graph 48 - Stand-by facilities...6 Graph 49 Commercial Paper...6 Graph 5 Treasury Certificates by month of issue...66 Graph 51 Institutions using HB in Graph 52 Number of accounts with HB by type of institution...69 Graph 53 Compliance with the principle of centralised cash management...71 Graph 54 Direct Government debt by instrument...74 Graph 55 Saving Certificates A, B and C series holding period...75 Graph 56 Changes in direct Government debt...76 Graph 57 Relative CaR / expected cost...83 Graph 58 Refinancing profile of the debt portfolio...83 Graph 59 Modified duration of the total portfolio...84 Graph 6 Refixing profile of the debt portfolio...84 Graph 61 Credit risk components /88

5 LIST OF TABLES Table 1 CDS spreads...37 Table 2 Asset swap spreads...37 Table 3 Ratings...38 Table 4 - Participants in the OT segment on 31 December Table 5 - Participants in the BT segment on 31 December Table 6 Borrowing requirements...48 Table 7 Issuance of medium- and long-term debt and short-term net financing (*)...5 Table 8 Syndicated placement in Table 9 OT issuance in 21: Regular issuance...53 Table 1 EMTN Issuance in Table 11 Syndicated placement of USD issue 3.5% March Table 12 BT issuance auctions held in Table 13 Transactions with financial derivatives...62 Table 14 Financial derivatives portfolio as at Table 15 Interest profile of a Treasury Certificate...65 Table 16 Central Government Cash Balances...67 Table 17 Number of institutions and accounts with HB...68 Table 18 Investment of cash balances 29/ Table 19 Financial transfers between Portugal and the European Union...7 Table 2 Direct Government debt...72 Table 21 Stock of Saving Certificates...75 Table 22 Currents costs of the direct Government debt...76 Table 23 Changes in the interest of Saving Certificates...77 Table 24 Changes in the interest of the direct Government debt...78 Table 25 Debt portfolio at year-end (after swaps)...79 Table 26 Annual cost of the debt portfolio and of the benchmark...79 Table 27 Portfolio CaR for 211 and Table 28 Sensitivity analysis of the portfolio s CaR for Table 29 Exchange rate risk /88

6 Abbreviations BT CA CaR CCT CDS CEDIC CPI CSA EBT EC ECB ECP EFSF EMTN EMU EPE EU FRDP EuroMTS GDP GFCF HB HIPC IGCP ILB IMF IRS ISDA MEDIP MTA NLF OE OEVT OMP OT OTC PEC PLC POCP PPP Repos RTE SI S&P SFA TA Treasury Bills Saving Certificates Cost-at-Risk Certificati di Crediti del Tesoro Credit Default Swaps Special Certificates of Government Debt Consumer Price Index Credit Support Annex Treasury Bill Specialist European Commission European Central Bank Euro Commercial Paper European Financial Stability Fund Euro Medium Term Notes European Monetary Unit Public Corporations European Union Government Debt Normalisation Fund Pan-European Electronic Trading Platform for Government Benchmark Bonds Gross Domestic Product Gross Fixed Capital Formation Homebanking Harmonised Index of Consumer Prices Instituto de Gestão da Tesouraria e do Crédito Público Inflation-Linked Bond International Monetary Fund Interest Rate Swaps International Swaps and Derivatives Association Special Market for Public Debt Minimum transfer amounts Net Financing Needs State Budget Primary Dealers of the Portuguese Government Bond Market Other Auction Participant Portuguese Fixed-Rate Government Bonds Over-the-counter Stability and Growth Programme Public Limited Company Official Chart of Public Accounting Private Public Partnerships Repurchase Agreements Government Cash Management Regime Integrated Services Standard & Poor s Autonomous Funds and Services Threshold Amounts 6/88

7 INTRODUCTION In this report, IGCP describes the key areas of its intervention throughout 21 in the integrated financing of the Republic and Government cash management. The Financing Programme of the Republic was carried out under adverse conditions given the highly volatile market environment and more generally the worsening of the sovereign debt crisis, with particular impact on the group of countries in which Portugal is included. Risk aversion rose significantly throughout the year, leading to a significant widening of spreads in countries with greater budget difficulties and higher indebtedness, which translated into significantly higher financing costs. The sovereign debt crisis and the increasingly negative perception by the market of the most vulnerable countries inevitably affected the traditional base of investors in Portuguese Government debt, making it necessary to strengthen communication efforts and to extend the geographical scope of these investors. On the other hand, the need to carry out the Financing Programme and to meet the Republic s borrowing requirements made it necessary to adopt a flexible strategy in terms of market issuance and the wider use of financing instruments, including private placements. In spite of this challenging environment, it was possible to fully meet the Republic s financing needs, which amounted to EUR 26.4 billion in 21 (including redemptions and budgetary needs of the previous year which were met in 21) through the issuance of OT in the amount of EUR 21.7 billion, MTN in a total of EUR 2.3 billion, the net financing of BT which totalled EUR 2 billion and the issuance of Treasury Certificates amounting to EUR.685 billion. The contribution of other instruments (CA, CEDIC and Repos) was slightly negative. Still in terms of financing, Treasury Certificates were launched in July 21, making it possible for households to invest their medium- and long-term savings. This instrument s return is based on OT secondary market yields. At the end of 21, the outstanding of Treasury Certificates reached EUR 685 million. In cash management, efforts continued to be made to broaden and deepen the scope of services rendered. IGCP considers this a prerequisite to fully comply with the principle of Centralised Cash Management. In this context, the year was marked by a 27% increase in the automatic payment terminal network provided to public administrative services (from 678 in 29 to 86 in 21), as well as by the increase in the use of the Single Collection Document (11% in terms of number of documents processed and 6% in terms of amounts involved, reaching EUR 44 billion). These contributed to greater efficiency of the Government s payment network. The Board of Directors would like to express its gratitude and recognition to the members of the Advisory Board and the Supervisory Committee, as well as to all staff members for their dedication and commitment, which was paramount for the successful fulfilment of IGCP s mission. The Board of Directors June 211 7/88

8 Box PRIMARY MARKET PARTICIPANTS FOR 211 OT Government Bonds OEVT Primary Dealers OMP Other Auction Participants Banco Espírito Santo Banco Santander Barclays Bank BNP Paribas Caixa Banco de Investimento Citigroup Global Markets Crédit Agricole CIB Credit Suisse Deutsche Bank Goldman Sachs International HSBC France ING Bank Jefferies International Limited Morgan Stanley Nomura International Royal Bank of Scotland Société Générale Unicredit (HVB) BPI Caixa Central de Crédito Agrícola Mútuo Commerzbank Millennium BCP 8/88

9 BT Treasury Bills EBT Treasury Bill Specialists Banco Espírito Santo Banco Santander Barclays Bank BBVA BNP Paribas Caixa Geral de Depósitos Citigroup Global Markets Crédit Agricole CIB Credit Suisse International Deutsche Bank Goldman Sachs International HSBC France Jefferies International Limited Millennium BCP Royal Bank of Scotland Société Générale 9/88

10 THE ECONOMY AND FINANCIAL MARKETS IN 21 INTERNATIONAL ENVIRONMENT Following one of deepest recessions in recent history, the world economy recovered in 21. According to the European Commission s estimates global growth was 4.8 per cent, following a.6 per cent decline in 29. This positive performance was fuelled by a 7.1 per cent increase in emerging economies, following a significant deceleration in the previous year, as well as by a 2.7 per cent gain in advanced economies, after a negative performance in 29, when GDP dropped 3.2 per cent. GDP expanded 2.6 per cent in the US, 1.7 per cent in the euro area and 3.5 per cent in Japan. Nevertheless, the output gap remained negative in all economies at -3.4, -4.1 and -2.3 per cent, respectively. According to European Commission estimates, the economy is expected to remain relatively buoyant in 211, albeit at a more moderate pace than in 21. Growth is seen at 1.5 per cent in the euro area, 2.1 per cent in the US and 1.3 per cent in Japan. Graph 1 Real GDP growth 6 Annual growth rate 4 Output gap 4 2 % As % of potential GDP E E Euro area US Japan Euro area US Japan SOURCE: European Commission and OECD According to the expenditure approach, in the US only public consumption decelerated from the previous year, gaining 1.2 per cent from 1.9 per cent in 29. Domestic demand had a 1.8 percentage point contribution to growth as result of public and private consumption, as well as investment. The stock correction of the last 3 years was reversed and inventory rebuilding added 1.5 percentage points to GDP. In turn, net exports subtracted.7 percentage points from GDP, as the acceleration in imports (14.1 per cent) outweighed the increase in exports (11.8 per cent). 1/88

11 The breakdown of euro area GDP was very similar to that of the US. Public consumption was also the only component to decelerate from 29, albeit remaining positive at 1 per cent, down from 2.4 per cent in 29. Private consumption gained.6 per cent. Investment remained in negative territory (-.8 per cent) although the drop was less pronounced than in 29, when it contracted 11.4 per cent. In this context, domestic demand added.4 percentage points to GDP growth. Inventory rebuilding also contributed to GDP with.5 percentage points, following two years of negative contribution to growth. Contrary to the US, in the euro area net external demand added.8 percentage points to growth. Following a year of contraction, growth turned positive in most member states of the euro area in 21, with the exception of only three countries: Spain, Greece and Ireland. Graph 2 - Real GDP growth in the euro area E 4 2 % GRE SPA IRE CYP ITA SLV POR FRA NET EU-16 BEL AUS FIN MAL LUX GER SLQ SOURCE: European Commission Exceeding expectations of the main international institutions, growth was particularly robust in the first half of the year, primarily due to an acceleration of exports, which jumped 11.8 per cent year on year in the US and 1.7 per cent in the euro area. Economic activity subsequently slowed down in the second half. The low levels of consumer confidence, the high unemployment rates and the weak gains in household income had a negative impact on private consumption and economic activity in advanced economies. On the supply side, business confidence in the US industry was relatively random throughout the year, although on average it remained above 29 levels. In contrast, business confidence in the euro area showed signs of a gradual recovery, especially in the last quarter of the year, when it reached positive territory. Industrial production accelerated in both economies. 11/88

12 On the demand side, consumer confidence improved in the US while remaining volatile in the euro area. Although confidence improved from the previous year, it remained subdued, reflecting to a large extent the deterioration of the labour market. In both the US and the euro area, the unemployment rate continued to increase in 21, reaching 9.6 and 1.1 per cent of the active population, respectively. In Japan, the unemployment rate remained at 5.1 per cent. Graph 3 Unemployment rate 12 1 % of labour force Euro area US Japan SOURCE: Eurostat In December 21, oil prices reached their highest level since September 28 and were 23 per cent above 29 year-end levels. Energy and food prices contributed to an acceleration of the inflation rate, especially in the euro area, although inflation remained at a moderate pace. In the US, year-on-year inflation picked up at the beginning of 21, chiefly as a consequence of base effects, given the low readings in the same period of 29. Inflation decelerated significantly in June, from 2 to 1.1 per cent, subsequently increasing a modest.3 percentage points in the second half of the year. In the euro area, inflation accelerated gradually, from 1 per cent in January to 2.2 per cent in December. The annual average inflation rate in 21 was 1.7 per cent in the US and 1.6 per cent in the euro area (significantly above the -.3 per cent and.3 per cent recorded in 29). 12/88

13 Graph 4 Price developments 6 Inflation and oil prices 16 3, Core inflation YoY inflation rate (%) Price/ Crude per barrel YoY inflation rate (%) 2,5 2, 1,5 1,,5-4 1, Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Euro area (HICP) US (CPI) Brent (USD) Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Euro area (HICP) US (CPI) Jul-9 Jan-1 Jul-1 SOURCE: Reuters and Eurostat In contrast, core inflation (which excludes energy and food prices) decelerated in the US, dropping from 1.7 to 1 per cent in annual average terms, and in the euro area, falling from 1.4 to 1 per cent. The financial crisis had a significant impact on the public finances of major world economies. The stimulus packages and the measures to support the banking system in 29 led to a sharp increase in budget deficits and large imbalances. According to European Commission estimates, the budget deficit reached 6.3 per cent of GDP in the euro area, 11.5 per cent in the US and 6.5 per cent in Japan. In all three cases, the deficits were very similar to those seen in 29 (6.3, 11.2 and 6.3 per cent, respectively). The budget deterioration led, in turn, to an increase in government debt. In the euro area, government debt reached 84.2 per cent of GDP in 21, up from 79.2 per cent in the previous year. In the US, it rose from 84.7 to 92.2 per cent and in Japan from to per cent. 13/88

14 Graph 5 General Government deficit and debt in 21 (as percentage of GDP) 12 Budget deficit SLQ SLV FIN SPA FRA POR CYP EU-16 NET AUS MAL GER BEL ITA GRE LUX Government debt SOURCE: European Commission Note: for greater clarity in reading the graph, Ireland (with a budget deficit of 32.3 per cent of GDP and a government debt of 97.4 per cent) was excluded from the graph. The major central banks maintained a loose monetary policy, with official rates at record lows. The US Federal Reserve kept the Fed Funds rate in a target range of to.25 per cent, the European Central Bank (ECB) left its repo rate at 1 per cent and the Bank of England s base rate was also unchanged at.5 per cent. The Bank of Japan kept its official rate at.1 per cent throughout most of the year and even reduced its target to a range of to.1 per cent in October. In addition, central banks extended the extraordinary liquidity support measures so as to stabilize the interbank money market and, in the European case, in order to support the government debt markets of some euro area countries. Following the 3 November meeting, the Federal Reserve announced a new quantitative easing programme, saying it would buy up to USD 6 billion of long-term assets by the end of the first half of 211 and that it would continue to reinvest the coupons received, so the purchase of Treasury bonds and other long-term assets would total USD 85-9 billion, between November 21 and June 211. The ECB also extended its stimulus measures consecutively, at least until mid April /88

15 Graph 6 Central bank intervention rates Jan-7 Mai-7 Set-7 Jan-8 Mai-8 Set-8 Jan-9 Mai-9 Set-9 Jan-1 Mai-1 Set-1 Jan-11 % ECB FED Bank of England SOURCE: Reuters In the bond market, the year was marked by the government debt crisis involving some euro area countries, particularly Greece, Ireland and Portugal and, to a lesser extent, Spain and Italy. The deterioration of public finances resulting from the economic and financial crisis of raised investors concerns with the sustainability of some European sovereign debts, leading to a widening of spreads against the German curve in countries where large budget imbalances were accompanied by weak economic growth. Greater sovereign risk aversion was first evident in the Greek bond market, where 1-year spreads against Germany jumped more than 7 basis points between the end of 29 and 7 May 21, when they peaked at 95 basis points. During this period, the spread of Portuguese OT increased 3 basis points and that of Irish bonds approximately 15 basis points. This spread widening was interrupted by the agreement reached among the other EMU member states (on 2 May) to provide Greece with a financial support package (which, together with the IMF s contribution, amounted to EUR 11 billion over 3 years), as well as by ECB interventions, which initiated a debt buying programme at the time. The explicit goal of this programme was to increase the depth and liquidity of market segments not working properly. In the context of this sovereign debt crisis, in early May the EU Council and the Member States agreed on a group of measures aimed at preserving financial stability, notably setting up a European Financial Stability Fund (EFSF) and carrying out stress tests to assess the solvency of the euro area banking system in extreme adverse scenarios. 15/88

16 However, the widening of spreads was subsequently resumed, surpassing May levels, particularly in the case of Ireland. The year s new highs were reached on 11 November, when the 1-year spread against Germany peaked at 929 basis points in Greece, 682 basis points in Ireland and 493 basis points in Portugal. Graph 7 - Spreads of euro area sovereigns versus the German Bund (1-year Government bonds) Jan-8 Jan-9 Jan-1 Jan-11 b.p.. Greece Ireland Portugal Spain Italy SOURCE: Reuters Following this new deterioration iin market conditions, on 28 November Ireland requested the financial support of the other euro area countries and a rescue package of EUR 85 billion for a 3-year period was agreed on. Ireland was therefore the first country to resort to the support mechanism created by the EU in May. The worsening of conditions in bond markets of some peripheral euro area countries was not accompanied by a similar deterioration in countries with a lower credit risk, where government bonds had significant gains in the first half of the year. In longer maturities, US and German bond yields neared the record lows seen in 28. Between the end of 29 and August 21, 1-year Bund yields dropped from 3.38 to close to 2.1 per cent, while in the US the 1-year Treasury yields fell from 3.84 to a low of 2.4 per cent in early October. This trend was inverted towards the end of the year, following signs of a pick-up in economic activity, especially in Germany, where the unemployment rate dropped to a 3-year low and confidence levels reached record highs. In this context, long-term interest rates increased later in the year and by yearend 1-year yields were relatively close to the levels seen at the end of 29: approximately 3 per cent in Germany and 3.3 per cent in the US, only 4 and 55 basis points below end-29 levels, respectively. The 1-year spread between Treasuries and Bunds was relatively stable throughout the year in a range of 1 to 8 basis points. 16/88

17 Graph 8 Long-term interest rates (1-year Government bonds) b.p. 1-1 Jan-8 Jan-9 Jan-1 Jan-11 % Spread (US Treasury-Bund) Bund US Treasury SOURCE: Reuters The short-end of the yield curve remained anchored by official rates. In Germany, the 3-month Bubill remained within a narrow range of between.25 and.45 per cent, while in the US, 3-month Tbills were almost unchanged at around.15 per cent. As a result, the yield curve flattened slightly throughout the year. In Germany, the spread between 1- year Bunds and 3-month Bubills dropped from 33 to 272 basis points, while in the US, the spread between 1-year Treasuries and 3-month Tbills narrowed from 378 to 318 basis points. 17/88

18 Graph 9 Term structure of interest rates 4 Euro area 2 4 US % 5. ḅ p 1 % 5. ḅ p maturity (years) maturity (years) Difference 31 Dec 29 Difference 31 Dec Dec Dec 21 SOURCE: Reuters Despite the losses suffered in the last four months of the year, the bond market ended up having a globally positive year in 21, with the government bond index (FTSE GovTop) gaining 2.8 per cent in Germany and 3.2 per cent in the US. Equity markets continued to rally, especially in the second half of the year, fuelled by signs of a gradual pick-up in economic activity. Nevertheless, 21 gains were more modest than those seen in the previous year. Between end-29 and end-21, the German Xetra Dax gained 16.1 per cent (against 23.8 per cent in 29), while the S&P 5 and the Nasdaq, in the US, were up 12.8 and 19.2 per cent, respectively (versus 23.5 and 53.3 per cent in the previous year). 18/88

19 Graph 1 Relative performance of equity and bond markets Jan-8 Jan-9 Jan-1 Jan-11 Price index: bonds/equity (31 Dec 27 = 1) Germany (FTSE GovTop Price vs Xetra Dax) US (FTSE GovTop Price vs S&P 5) SOURCE: Reuters In the foreign exchange market, the euro depreciated significantly in the first half of the year particularly against the US dollar essentially reflecting concerns with the sovereign debt crisis involving some euro area countries. The EUR/USD dropped 2 per cent in the first semester, from a peak of 1.51 at the beginning of December 29 to a low of 1.19 in June 21. In the second half of the year, the euro took back most of these losses, boosted by the strong pick-up of economic activity in Germany. The single currency ended the year at 1.34 against the US dollar, down 7.2 per cent from the end of 29. The EUR/GBP followed a similar trend, with the euro depreciating overall 4.2 per cent against the pound sterling. The drop of the single currency versus the Japanese Yen was more pronounced (18.6 per cent for the year as a whole), leading the Bank of Japan to intervene in the foreign exchange market in order to prevent an even stronger appreciation of its currency. 19/88

20 Graph 11 Euro exchange rates 14 Index: 31 Dec 27 = Jan-8 Mai-8 Set-8 Jan-9 Mai-9 Set-9 Jan-1 Mai-1 Set-1 Jan-11 EUR / USD EUR / JPY EUR / GBP SOURCE: Reuters In this context, the euro effective exchange rate depreciated considerably in 21 (7 per cent in annual average terms), partially offsetting the losses in competitiveness observed in previous years, especially in 27 and 28. 2/88

21 PORTUGUESE ECONOMY Following a strong contraction in 29 (of 2.5 per cent), in the midst of the global economic and financial crisis, in 21 the Portuguese economy bounced back, with GDP gaining an estimated 1.4 per cent 1. Economic activity was particularly strong in the first three months, when the year-on-year quarterly rate reached 4.3 per cent, subsequently cooling down in the rest of the year. GDP growth was fuelled by private consumption, government spending and exports. Investment dropped once again, albeit at a slower pace than in 29. The acceleration of economic activity in the first months of the year was essentially a result of buoyant private consumption, in a context of a relatively low interest rate environment and the anticipation of spending, ahead of the increase in the VAT rate on 1 July 21. In the second half of the year, private consumption decelerated sharply, reflecting the negative impact of the measures announced in the 211 budget on consumer expectations, as well as the deterioration of labour market conditions. In contrast, both exports and imports remained buoyant throughout the year, reversing to a large extent the decline seen in 29. The acceleration of exports reflected the strengthening of external demand and gains in market share, while the increase in imports was a consequence of the bounce-back in private consumption, with a significant imported component. According to EC estimates, GDP gained 1.7 per cent in 21 in the euro area 2,.5 percentage points more than the growth estimated for the Portuguese economy. Graph 12 Real GDP growth and demand components 5 Annual growth rate Portugal 's GDP - breakdown % E Euro area Portugal % E Net exports Internal demand GDP SOURCE: European Commission, National Institute of Statistics and Ministry of Finance 1 Quarterly National Accounts Flash Estimates of the National Institute of Statistics. 2 European Commission, Autumn Forecasts, October /88

22 Labour market conditions continued to deteriorate, in line with the negative trend initiated in the second quarter of 28, when unemployment started to rise. In the third quarter of 21, the unemployment rate reached 1.9 per cent of the active population, up from 1.1 per cent at the end of 29. Inflation, as measured by the annual average change in the harmonised index of consumer prices (HICP), accelerated to 1.4 per cent in 21, following a.9 per cent drop in 29. This increase is.2 percentage points lower than the euro area average, so that Portugal s inflation remains below that of the euro area since April 28. Several factors contributed to 21 inflation, such as the bounce-back in domestic demand, the increase of VAT (in July) and of the price of energy and raw materials in international markets, which helped to reverse the drop in prices seen in 29. Graph 13 Inflation rate 4 HICP 12-month avreage rate of change (%) Jan-6 Abr-6 Jul-6 Out-6 Jan-7 Abr-7 Jul-7 Out-7 Jan-8 Abr-8 Jul-8 Out-8 Jan-9 Abr-9 Jul-9 Out-9 Jan-1 Abr-1 Jul-1 Out-1 Differential Euro area Portugal SOURCE: Eurostat The external borrowing needs of the Portuguese economy, measured by the joint deficit of the current and capital account balances, fell from 9.4 to per cent of GDP in 21. This reduction reflected the decline in investment, as well as a slight drop in the domestic savings rate. In December 29, the European Council decided that Portugal should correct its excessive deficit by 213. In this context, in March 21 the Government submitted the Stability and Growth Programme (SGP), setting the goal of reaching a budget deficit of 2.8 per cent of GDP (below the 3 per cent threshold) in 213. However, given the turmoil in sovereign debt markets, particularly in the euro area, fuelled by concerns with the sustainability of public finances, in May the Government announced several additional measures aimed at accelerating the budget consolidation process. The budget goals set in the SGP were revised, in order to bring forward the correction of the excessive deficit a year earlier than initially foreseen. 3 Winter 21 Economic Bulletin, Banco de Portugal. 22/88

23 The Public Administration (PA) deficit was 9.1 per cent of GDP in 21 and the PA perimeter was extended to include some public companies and public-private partnerships (PPP). It should be noted that budget figures were influenced by extraordinary measures on the revenue side, such as the transfer of Portugal Telecom s pension fund to the State (which was equivalent to 1.5 percentage points of GDP), and on the expenditure side, such as the purchase of two submarines. The primary deficit, in combination with the snowball effect, led to an increase in the government debt of 1 percentage points to 93 per cent of GDP. Graph 14 Budget deficit and Government debt in Portugal As % of GDP E As % of GDP... Government debt (right) Budget deficit (left) Cyclically-adjusted budget deficit (left) SOURCE: European Commission and Ministry of Finance Investors concerns with the sustainability of public finances, especially in the case of some euro area countries, fuelled a new wave of market turbulence during 21. Sovereign risk perception changed dramatically, with a significant differentiation of member States, particularly between countries known as peripheral, such as Portugal, and those considered core countries, such as Germany. The 1-year interpolated spread between Portuguese OT and German Bunds soared almost 3 basis points in 21 and the widening trend became especially pronounced as from the end of April. The OT swap spread followed a similar path, jumping from 51 basis points at the end of 29 to 336 basis points at the end of 21. In the first few months of 21, long-term yields followed a downward trend in several government bond markets 4. However, this trend was subsequently reversed. In the euro area, the upward trend in long-term yields throughout most of the second half of the year more than offset the drop in the first few months and yields ended the year higher. This was not the case in the US, UK and in Japan. 4 According to the FTSE GovTop1 bond index. 23/88

24 The Portuguese government bond market suffered heavy losses in 21, of 11.7 per cent, which was much higher than the 2.4 per cent loss suffered by the euro area as a whole and contrasts with the 3.2 per cent gain in the Treasury market. In equity markets, Portugal s PSI 2 index also suffered heavy losses, falling 1.3 per cent in 21, while the Euronext European index had a modest 1. per cent gain and in the US the S&P 5 was up 12.8 per cent. The major equity indexes dropped in January and subsequently initiated an upward trend which was interrupted in April. Equity markets recovered again in the second semester, but this was not enough, in the case of Portugal, to offset the heavy losses of the first half of the year. Graph 15 Financial markets Índices Government obrigacionistas bond indices 14 Índices Equity indices accionistas Índice: Index: Dez Dec 26 = Jan-7 Abr-7 Jul-7 Jan-8 Jul-7 Out-7 Jul-8 Jan-8 Jan-9 Abr-8 Jul-9 Jan-1 Jul-8 Out-8 Jul-1 Jan-9 Jan-11 Índice: Index: Dez Dec 26 = = Jan-7 Abr-7 Jul-7 Jan-8 Jul-7 Out-7 Jul-8 Jan-8 Jan-9 Abr-8 Jul-9 Jan-1 Jul-8 Out-8 Jul-1 Jan-9 Jan-11 1 Reino Euro Unido area Alemanha US Portugal Euronext S&P 5 PSI 2 SOURCE: Thomson Reuters 24/88

25 GOVERNMENT DEBT MARKET EURO AREA Yields overview The year 21 was marked by turmoil in financial markets, particularly in government debt markets, fuelled by a surge in the credit risk of euro area sovereign issuers, which was accompanied by downgrades by the main rating agencies, especially of Portugal, Ireland, Spain and Greece. Throughout Europe, primary markets of the main sovereign issuers were affected by an increase in debt placement premia and interest rates. During most of the year, particularly in the second half, there were concerns as to the capacity of sovereigns to obtain funding in the market. The liquidity and depth of the respective secondary markets were severely affected. Turnover fell significantly, while market makers faced serious difficulties to quote prices in the market. In Portugal, the secondary market started to operate in a multi-platform environment as from May, with two additional trading systems, BrokerTec and espeed, although MTS Portugal continued to have a leading role in terms of turnover and in the number of primary dealers acting as market makers. The European Central Bank played a crucial role in some sovereign markets, such as Portugal, Ireland and Greece, buying government bonds when yields soared as a consequence of the lack of demand in the secondary market. According to official data, in 21 the ECB bought EUR 74 billion of sovereign debt. Greeks fragile financial situation deteriorated further in the first few months of 21, culminating in a call for a rescue package in May, involving the IMF and the remaining euro area countries. The sharp increase in risk premia and the growing differentiation among euro area sovereigns raised new challenges for issuers during 21, as fears of being unable to obtain funding re-surfaced. This time however, fears were not triggered by generalized concerns with insufficient demand, but by difficult situations in some countries, notably Greece, Portugal and Ireland. During the year, the European Central Bank maintained its main refinancing rate steady at 1 per cent (unchanged since May 29). The Federal Reserve and the Bank of England were also on hold. The former kept the Fed funds rate within a target range of to.25 per cent, while the latter held its official rates steady at.5 per cent (unchanged since 5 March 29). The slope of the euro swap curve (2 versus 1 years) was nearly unchanged, dropping from 174 basis points on 2 January to 171 basis points on 3 December 21. The German curve steepened modestly, from 25 basis points at the start of 21 to 29 basis points at year-end. In the US, the spread between 1- and 2-year Treasuries was basis points at the beginning of the year and basis points at the end. 25/88

26 Graph 16 The swap curve 4,5 4, 3,5 3, 2,5 2, 1,5 1,,5, MO 6MO 1YR 2YR 3YR 4YR 5YR 6YR 7YR 8YR 9YR 1YR 15YR % 2YR b.p. 3YR Changes in 21 (right) (left) (left) SOURCE: Bloomberg Throughout the year, 1-year Bund yields dropped 42.8 basis points, from per cent in January to per cent on 3 December. Graph 17 The Bund curve % 4,5 4, 3,5 3, 2,5 2, 1,5 1,,5, MO b.p. 6MO 1YR 2YR 3YR 4YR 5YR 6YR 7YR 9YR 1YR 2YR 3YR Changes (right) (left) (left) SOURCE: Bloomberg 26/88

27 Euro area issuance Total gross issuance of euro area sovereigns in the government bond market amounted to approximately EUR billion in 21, against EUR billion in the previous year. Nominal bond issuance, i.e. excluding inflation linked bonds (ILB) and CCT 5 issued by the Republic of Italy, accounted for approximately 91.6 per cent of this total, while ILB issues represented almost 4.8 per cent. Three sovereign issuers Germany, Italy and France were responsible for approximately 67.5 per cent of the government bond market (nominal segment), slightly more than in the previous year (6.4 per cent). The Republic of Portugal accounted for approximately 2.5 per cent of the gross bond issuance of euro area sovereigns in 21, up from 1.8 per cent in 29. Graph 18 Government bond issuance in euros in 21 Italy - 23,7% Germany - 22,2% France - 21,6% Spain - 1,8% Greece - 2,3% Netherlands - 5,9% Belgium - 4,6% Austria - 2,4% Portugal - 2,5% Finland - 1,5% Ireland - 2,5% SOURCE: IGCP and Primary Dealers In a context of economic and financial crisis and large borrowing needs by most sovereigns, there were important changes in the issuers' strategies in relation to the previous year. Issuance in the 2- to 5-year and 5- to 1-year buckets (excluding 1-years) reduced in relative terms from 27.1 and 31.6 per cent to 23.5 and 3.7 per cent, respectively. In turn, longer-term maturities gained importance, with issues in the 1- to 15-year and above-15 year buckets increasing from 26.3 and 14.9 per cent to 29.6 and 16.1 per cent, respectively. 5 CCT, i.e., Certificati di Credito del Tesoro, 7-year floating rate notes. 27/88

28 Graph 19 Euro government bond issuance by maturity 35% 3% 25% 2% 15% 1% 5% % 2-5 years 5-1 years 1-15 years more than 15 years SOURCE: IGCP, Primary Dealers and websites of euro area sovereign issuers The issuance of inflation-linked bonds (EUR 46.2 billion) was higher than in 29 (EUR 34.2 billion) and similar to 28 levels (EUR 44 billion). Germany, France and Italy continued to tap this market segment. 28/88

29 THE PORTUGUESE GOVERNMENT DEBT MANAGEMENT STRATEGY IN 21 Strategic objectives In 21, Portuguese Government debt management and issuance continued to observe the principles of accuracy and efficiency set out in the Debt Framework Law (Law no. 7/98 of 3 February), ensuring the funding necessary for the execution of the budget and pursuing the goals of direct and indirect cost minimization in a long-term perspective, whilst smoothing their distribution over several annual budgets and preventing an excessive concentration of redemptions over time and the exposure to excessive risks. Nevertheless, the difficulties faced by peripheral countries, such as Portugal, particularly the persistent high volatility in the market, led IGCP to suspend the benchmark which has been used to assess compliance with these objectives. A new benchmark model, more suited to the new context of financial markets, is expected to be implemented in 211. In addition, the goal of minimizing cash balances, which was established after the integration of debt and cash management, was subordinated to the need to accumulate cash reserves, in view of the uncertainty as to the ability to access the market at all times. Financial strategy The management of the Portuguese Government debt is based on a financing strategy focused on the development of a liquid yield curve in the euro sovereign debt market, using the most advanced technical infrastructures in the primary and secondary markets. This strategy is based on the use of standard instruments and issuance methods; an international distribution network which includes a group of financial intermediaries with renowned capacity to place and trade Portuguese Government debt; a secondary market driven by a wholesale segment among specialists and supported by market making obligations; and the active marketing of Portuguese Government debt among final investors. In spite of the dramatic changes to market conditions in 21, efforts were made to carry out the year s funding according to the same guidelines of the previous years. In 21, financing was once again concentrated on OT issuance. This was accompanied by an increase in the net contribution of Treasury Bills (BT) to the funding of the Republic. IGCP launched a new OT series the new 1-year benchmark and the remaining borrowing needs were met in the OT market through the reopening of series issued in previous years. As far as financing through Treasury bills (BT) is concerned, at the end of 21 the outstanding of BT was approximately EUR 19.3 billion, corresponding to 8 lines outstanding. In the face of adverse market conditions, in 21 IGCP decided to maintain the Euro Medium Term Notes (EMTN) Programme. The goal of this Programme is to launch opportunistic issues in foreign currencies or with associated structures, at a cost lower than the OT secondary market. This programme makes it possible to widen the investor base and reduce financing costs. But in 21 its biggest 29/88

30 advantage was to reduce the supply pressure in the OT market. Four issues were placed under the EMTN programme during the year, with a total equivalent to EUR 2,27 million. Graph 2 Portuguese Government bond yield curve at end-21 yields 7,1% 6,6% 6,1% 5,6% 5,1% 4,6% 4,1% 3,6% 3,1% 2,6% 2,1% 1,6% 1,1%,6%,1% BT Jan 211 BT Fev 211 BT Mar 211 BT Jul 211 Outstanding (EUR million) BT Ago 211 BT Set 211 BT Out 211 BT Nov 211 OT Abr 211 OT Jun 211 OT Jun 212 OT Set 213 OT Jun 214 OT Out 214 OT Out 215 OT Out 216 OT Out 217 OT Jun 218 OT Jun 219 OT Jun 22 OT Abr 221 OT Out 223 OT Abr 237 Benchmarks issued before 29 Benchmarks issued in 21 Overall, non-marketable instruments Saving and Treasury Certificates, as well as CEDIC (Special Certificates of Government Debt) made a slightly positive net contribution to the Republic's annual borrowing needs. Graph 21 Debt stock structure by type of instrument Retail 14,5% 28 Others 5,3% Retail 12,7% 29 Others 5,1% Retail 1,6% 21 Others 6,9% BT 1,8% BT 13,% BT 12,7% OT 69,3% OT 69,2% OT 69,8% Temporary cash needs continued to be met via very short-term instruments, namely through the repo market, which is a cost-effective and flexible alternative. In addition, commercial paper was issued and credit lines held with Primary Dealers (OEVT) were used. 3/88

31 Graph 22 Financing structure by type of instrument 12% % 1% 8% 23% 4% 13% 21% 8% 6% 4% 83% 77% 8% 2% % -2% -6% -2% -1% OT BT (net issuance) Other short-term instruments (net issuance) Other medium- and long-term instruments (net issuance) 31/88

32 THE PRIMARY MARKET OF PORTUGUESE GOVERNMENT DEBT The main components of the annual financing programme were announced to the market at the start of 21. Following the guidelines of this programme, priority was given to setting up and maintaining conditions necessary to develop the Portuguese government yield curve and to increase the liquidity and efficiency of the OT market. In this context, the 21 issuing programme was focused on the issuance of a new OT series in the 1-year bucket and the strengthening of the liquidity of several maturities of the yield curve, by increasing the outstanding of series issued in previous years. Government bond market OT The issuance of OT is the main source of funding of the Republic of Portugal. The new OT series are launched via syndicate and their amount is subsequently increased through auctions, using an electronic multi-price auction system (the Bloomberg Auction System). The syndicated placement includes a pot system for the book-building, which enables IGCP to intervene in the allocation of investors and to select those of greater quality, so as to ensure a good performance of the new issue in the secondary market, thereby facilitating the placement of subsequent reopenings via auction. Graph 23 Syndicate structure 21 Full pot Retention + Co-lead pot Joint-Leads 5 Co-Leads 1 In order to meet the liquidity requirements of the euro debt market, an outstanding of at least EUR 6 billion was set as the target size for new OT series. In 21, the new 1-year OT series was launched with an initial size of EUR 3 billion, thereby ensuring that the new issue was traded in the secondary market with benchmark status under market-making obligations. In early 29, Primary Dealers were 32/88

33 informed that IGCP would consider an amount of between EUR 6 and 8 billion as the maximum outstanding per OT, depending on market demand for each series. The adverse conditions in the secondary market and the need to improve liquidity of OT series, led IGCP, in early 21, to consider it possible that some series may reach an outstanding of around EUR 1 billion in the next few years. Graph 24 OT issuance size 12 Competitive auctions (average amounts) 4 Syndicated issues EUR million EUR million Primary Dealers (OEVT) play a strategic role in the OT market as a distribution channel they have exclusive access to the primary market 6 and preference in the constitution of syndicates and as suppliers of reference prices and liquidity in the secondary market, as well as advisers of the Republic in the definition and implementation of the financing strategy. They are also vital in promoting and marketing the Portuguese government debt among final investors. At the end of 21, the group of Primary Dealers included 18 banks. Morgan Stanley Société Générale Barclays Bank HSBC France Citigroup Most distinguished Primary Dealers in 21 (*) (*) Evaluation based on an overall performance indicator, which includes a set of criteria covering the different intervention areas of the Primary Dealers in the OT market (participation in the primary and secondary market, participation in buyback operations, their advice to IGCP, the marketing and broadening of their investor base. 6 There is also a second-tier group of primary market participants the Other Auction Participants (OMP) which included 4 banks at the end of 21: BPI, Caixa de Crédito Agrícola Mútuo, Commerzbank and Millennium BCP. These institutions also contribute to the development of the Portuguese government debt market but they do not comply with all the criteria of the Primary Dealer status. Participation in the market as OMP is usually the first step towards becoming a Primary Dealer. 33/88

34 Non-resident investors and financial institutions continued to have a strong participation in the placement of Portuguese government debt in the primary market in 21. This was accompanied by a reduction in the participation of domestic investors, from 18.6 to 14. per cent. Graph 25 OT placement (auctions and syndicates) by Primary Dealers * 1 15,5% 14,4% 11,% 11,3% 11,4% 1,% 18,6% 14,% ,5% 85,6% 89,% 88,7% 88,6% 9,% 81,4% 86,% Non-residents Residents * The amounts subscribed by non-resident Primary Dealers in the auctions were used as proxy for the amounts bought by nonresident investors. The Treasury bills market BT BT lines are placed via multi-price auctions, using the electronic Bloomberg Auction System. They are held on the first and third Wednesday of each month, according to a quarterly-announced auction calendar. All BT lines have benchmark status in the secondary market and are thus under market-making obligations 7, thereby ensuring the existence of a liquid short-term segment in the Portuguese yield curve. In 21, eight new BT lines were launched with a 12-month maturity via two consecutive auctions each and were subsequently reopened with a residual maturity of six, three and, in some cases, nine months. At the end of year, the outstanding of BT was EUR 19.3 billion. 7 Until they reach a one-month residual maturity. 34/88