Issuer Debt Rated Rating Trend

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1 Rating Report November 21, 214 Previous Report: May 23, 213 Analysts Carla Clifton cclifton@dbrs.com Michael Heydt mheydt@dbrs.com Ratings Issuer Debt Rated Rating Trend, Long-Term Foreign Currency Issuer Rating BBB (low) Stable, Long-Term Local Currency Issuer Rating BBB (low) Stable, Short-Term Foreign Currency Issuer Rating R-2 (middle) Stable, Short-Term Local Currency Issuer Rating R-2 (middle) Stable Rating Rationale DBRS Ratings Limited (DBRS) has confirmed the s long-term foreign and local currency issuer ratings at BBB (low) and short-term foreign and local currency issuer ratings at R-2 (middle). The trends on all ratings remain Stable. The rating confirmation reflects: (1) s commitment to improve its public finances and implement structural reforms, (2) the benefits of euro area membership, and (3) the moderate impact of age-related expenditures on the public finances over the long-term. However, these supportive factors are balanced by significant challenges, including: (1) elevated levels of public sector debt; (2) high private sector indebtedness, (3) an uncertain medium-term outlook for potential GDP and (4) remaining fiscal challenges. The Stable trend principally reflects three factors, namely: (1) DBRS s assessment that has made substantial progress in narrowing the fiscal and the current account deficits, (2) the build-up of sizeable cash buffers, which reduce rollover risk over the short-term, and (3) the strengthening of the country s banking sector as a result of the restructuring and recapitalization measures taken by the sector. Downward pressure on the ratings could materialise if growth significantly underperforms relative to current expectations or the commitment to fiscal consolidation weakens, thereby adversely impacting public debt dynamics. Conversely, the ratings could be subject to upward pressure if growth underperforms and s fiscal consolidation plans deliver material reduction in the stock of debt. (Continued on Page 2) Rating Considerations Strengths (1) Rebalancing economy (2) Benefits of Euro zone membership (3) Moderate fiscal impact of age-related costs Summary Statistics Challenges (1) High public sector debt (2) Elevated private indebtedness (3) Uncertain growth outlook (4) Fiscal challenges 1 Sovereign Ratings Group For the year ended December E 215F Nominal GDP (euro billions) GDP per capita (euro thousands) 16,38 16,335 16,726 17,212 Real GDP (% change yoy) Unemployment rate (%) Inflation (%) Current account balance (% GDP) External debt (% GDP) n.a. n.a. General gov't balance (% GDP) Primary balance (% GDP) Gross public debt (% GDP) Human Development Index.816 n.a. n.a. n.a. Note: The figure for the general government balance reflects the balance excluding the effect of one-off measures : General Government Debt (% GDP)

2 21 November 214 Rating Rationale (Continued from page 1) has made considerable progress toward restoring the sustainability of its public finances. The fiscal deficit declined from 11.2% of GDP in 21 to 4.9% in 213 and is estimated at 4.8% in 214. Excluding the effect of one-offs, the deficit is expected to reach 3.7% of GDP in 214. The consolidation so far has involved a reduction in the structural primary balance of 9 percentage points of potential GDP. Additional measures totalling.7% of GDP in 215 aim to reduce the deficit further to 2.7% of GDP. The emerging economic recovery is expected to support fiscal consolidation. However, DBRS believes that the substantial reliance on cyclical factors to reduce the deficit next year suggests insufficient progress with respect to the structural deficit and carries material downside risks that if the economy underperforms, the target will not be reached. 2 Sovereign Ratings Group has also experienced some success in rebalancing the economy towards the tradable sector. The current account balance (according to the Banco de measure) improved from a deficit of 1.6% of GDP in 21 to a small surplus in 213 and has stayed in positive territory in 214H1. These represent the first current account surpluses in 3 years and reflect a marked improvement on the 2-8 period when the current account deficit averaged around 1% of GDP. The turnaround in the current account deficit reflects a significant decline in the goods deficit and an improvement in the services surplus. While this is partly explained by substantial import compression, exports have also performed well, supported by improvements in unit labour costs and greater market diversification. Moreover, DBRS believes that membership of the euro area confers material benefits on. It facilitates trade flows and lowers interest rates. In addition, the European Financial Stability Facility (EFSF) and European Financial Stabilisation Mechanism, in coordination with the International Monetary Fund (IMF), provided with a EUR 76.4 billion financing package in May 211, helping cover sovereign funding needs through mid-214. DBRS believes that so long as the country continues to adhere to fiscal consolidation and to implementing the structural reform agenda, it is therefore reasonable to assume that its euro area partners will agree to provide the country with additional official sector financial support were to be shut-off from the sovereign bond markets. DBRS further sees the maintenance of an adequate cash buffer also has supportive of the rating. Finally, s relatively modest refinancing needs for 215, estimated at EUR 7.8 billion, average maturity of its stock of debt of 8.2 years and a material share of 36% of total debt accounted for by official sector lending, also support the rating. The relatively benign outlook for the long-term sustainability of age-related spending also underpins the ratings. The European Commission estimates age-related expenditure in will increase from 26.% of GDP in 21 to 26.1% by 26. This compares favourably with the 3.7 percentage points projected increase for the EU27. However, there are emerging downside risks to these estimates as s population has recently declined more severely than previously anticipated, thus putting pressure on the dependency ratio. Finally, the health of the financial sector has improved as a result of the restructuring and recapitalization efforts carried out by the banks in the last few years. The improvements in the sector were reflected in the results of the ECB asset quality review for the sector as a whole. Moreover, the developments relating to the collapse of Banco Espirito Santo (BES) earlier in the year, which resulted in the government having to inject EUR3.9 billion into the newly created, Novo Banco did not generate widespread contagion. In addition, the links between the sovereign and the banking sector have abated somewhat as a result of progression towards the adoption of the Single Resolution Mechanism (SRM) and the creation of the Banking Sector Restructuring Fund (FRB). Notwithstanding these supporting factors, s rating continues to be constrained by several factors. Firstly, additional fiscal adjustment is needed. This could be difficult given the approaching parliamentary elections and the Constitutional Court s resistance to some of the expenditure cuts proposed to date which are believed to impinge on the acquired rights of public sector workers or to affect those on lower incomes in a disproportionate manner. Public debt dynamics continue to be exposed to several downside risks. Failure to adhere to the planned fiscal consolidation measures in the run-up to the 215 general election could result in a larger than expected deficit next year. Moreover, some uncertainty remains as to how the government will be able to reduce expenditure further in line with the consolidation plans set out in the April 214 Stability Programme. Finally, growth prospects could be constrained by the high levels of household and corporate

3 214 Deficit One Off Measures 214 Deficit Exc. One Off Measures 215 Pressures Macroeconomic Effect 215 Deficit Without Measures Consolidation Measures 215 Deficit 21 November 214 sector indebtedness and are vulnerable to external shocks. In particular, is exposed to potential losses in growth momentum in its main trading partners, notably Spain, France, Germany and Italy. Foreign versus Local Currency Ratings The Portuguese government issues predominantly in euros, with non-euro debt (after swaps) standing at below 5% at the end of 213. The share of government debt held by the non IMF-EU and ECB non-resident sector was 36% at end September 214. DBRS maintains its foreign and local currency ratings at the same level because the Portuguese government s ability to refinance the bonds in foreign currency is commensurate with its ability to refinance Euro-denominated bonds. Fiscal Management and Policy has made substantial progress in reducing its large fiscal deficits. The headline deficit narrowed from 9.8% of GDP in 29 to 4.9% in 213. In 214, the deficit (adjusted for the effect of one-off measures) is expected to come down further to 3.7% of GDP and to 2.7% in 215, thus potentially allowing the government to exit the European Commission s Excessive Deficit Procedure (EDP) on schedule. However, risks to the fiscal outlook persist in the short and medium-term. Bringing the headline deficit to below the 3.% Maastricht Treaty criteria next year is predicated on a contribution from the improvement in the macroeconomic conditions worth 1.2% of GDP as GDP growth accelerates to 1.5% from 1.% in 214. In addition, the implementation of.7% (EUR1.3 billion) in additional consolidation measures is also expected to help reduce the deficit to 2.7% of GDP by year end. These measures are evenly split between expenditure reducing (mostly related to reductions in intermediate consumption) and revenue raising initiatives. However, according to the Portuguese Public Finance Council s evaluation of Budget 215, EUR.4 billion - or nearly one-third of the consolidation measures to take effect next year - are poorly defined, thereby making it somewhat difficult for the council to evaluate their likely impact or to pass judgment on the difficulty of implementing them : From 214 to 215 Deficit (% of GDP) Source: Haver Analytics, IMF, Ministry of Finance, Unidade Tecnica de Apoio Orçamental (UTAO), and Banco de : Medium-Term Fiscal Plan (% of GDP and Share of Adjustment) 59% 59% 61% 63% 66% 67% 41% 41% 39% 38% 34% 33% According to the fiscal adjustment plan for , reductions to the outlays on public sector employees wages and pensions are expected to contribute the most of the required fiscal adjustment. They were projected to fall from 1.7% of GDP in 213 to 8.2% of GDP by 218. The containment of social security costs from 23.4% of GDP in 213 to 21.2% by 218 was also put forward as a key contributor to the reduction in primary expenditure. However, the negative rulings by the Constitutional Court in May 214 regarding public sector wages and sickness benefits has raised questions over the government s ability to deliver on the planned expenditure reductions Looking ahead, getting the primary balance to 4.2% of GDP by 218 will be essential to getting the country s debt on a sustained downward trajectory given estimates for nominal GDP growth of 4.3% of GDP and an interest bill of 4.2% of GDP under ESA95. However, greater clarity on how plans to deliver the remaining improvements in its primary balance is unlikely to materialise before the country s Parliamentary elections, which are due in autumn Share of Adjustment Accounted for by Change in Strcutral Primary Expenditure Share of Adjustment Accounted for by Change in Strcutral Revenue Structural Balance - rhs Structural Primayr Balance - rhs 3 Sovereign Ratings Group

4 Refinancing Needs of SOEs Loan to the Resolution Fund Participation in ESM Capital Other Repayment of CoCos Other Net Acquisitions of Financial Assets 21 November 214 s long-term fiscal sustainability compares favourably with that of its EU partners, according to the European Commission (EC). However, the most recent demographic projections point to a steeper decline in the population (by 22% over the 213 to 26 period compared to a previous estimate of a decline of onl y 4%). Such a decline, would result in an increase in the dependency ratio from 57% to 65% by 26. Thus, although the recently adopted measures to boost the sustainability of the social security system, including increasing the retirement age from 65 to 66, will go some way towards alleviating such pressures, more may have to be done if the markedly declining trend in the size of the country s population is not reversed. Debt and Liquidity s debt to GDP is very elevated. In the second quarter of 214, general government debt reached 129.4% of GDP. However, with an average maturity of 8.2 years, reflecting an average maturity of 12.6 years on the EU-IMF loans and of 5.8 years on the non-official sector debt, rollover risks are currently contained. Moreover, since it exited the Economic and Financial Adjustment Programme (EFAP) in May 214, has secured access to the sovereign bond markets at affordable yields. In addition, modest redemption needs in 215 and relatively robust level of cash reserves provide a buffer against unexpected market turmoil. Ultimately, however, progress on fiscal consolidation and structural reform are required to both support debt reduction and secure the support of the euro area s creditor countries in case of distress in accessing the sovereign bond markets. The government s return to the sovereign debt markets at progressively lower yields throughout 214 represents a positive development. issued five and ten-year Treasury bonds (PGBs) maturing in 219 and 224 in January and February with yields of 4.7% and 5.1%, respectively. In addition, the government also tapped the markets in April and June with 5-year bonds through auctions for the first time since 211. Moreover, in the second half of the year, the government issued EUR1 billion in 1-year PGBs in June, and EUR4.6 billion in five and ten year PGBs in September and in October and November, respectively. To note is the reduction in the yield paid for the five year obligations issued in January and October, from 4.7% to 1.9%. Finally, also tapped the markets with a US-dollars syndicated deal in July, which amounted to USD 4.5 billion (or EUR 3.3 billion) Cash Buffers 5.3 : Use of Deposits (EUR Bn) 2.7 Source: IGCP, Ministry of Finance E 215F 216F 217F 218F PGBs & MTN Other Net Acquisition of Financial Assets Use of Deposits - rhs IMF Privatizations Deficit : Other Net Acquisition of Financial Assets, 214 (EUR Bn) Sovereign Ratings Group In terms of liquidity, the buy-backs carried out to improve the maturity profile of the State s financing needs have helped improve s funding outlook. In addition, the material role which the country s Social Security Financial Stabilization Fund (FEFSS) has played as a buyer of Portuguese Government Bonds (PGBs), has also helped achieve a smooth exiting from the EFAP. Moreover, the accumulation of a significant cash buffer also provides a little breathing space for the government in case of short-live market distress. In fact, the debt management agency plans to end 215 with a cash buffer of EUR7.5, which would, on current assumptions about the deficit and the refinancing needs, cover two-thirds of the government s gross financing needs for 216. We therefore see has having sufficient financing flexibility to meet its obligations whilst negotiating access to official financing in a case of prolonged market turmoil. DBRS remains however concerned over s high levels of public debt. Looking ahead, the country s public debt trajectory is subject to substantial uncertainty. Under the government s medium term fiscal adjustment plan for , the reduction in the debt-to-gdp ratio is predicated on the achievement of sizeable primary balances (4.2% of GDP by 218) and robust growth in nominal GDP (3.% pa on average). In fact,

5 November 214 with the revenue-earning part of the asset sales programme now completed, debt reduction from 214 onwards is heavily dependent on growth in nominal GDP. However, assumptions on growth and fiscal outcomes are subject to substantial downside risks. DBRS therefore examined debt dynamics under various adverse scenarios, as shown in the chart below. On the plus side, the eventual sale of Novo Banco could contribute to a reduction in the stock of debt going forward : Change in Public Debt (% of GDP) Other GDP Change in Debt - rhs Interest PB Source: Haver Analytics, IMF, Ministry of Finance and Banco de : General Government Debt (% of GDP) Baseline scenario Growth shock Primary balance shock Contingent liability shock Combined shock In the baseline scenario, debt-to-gdp declines from 129% in 214 to just under 12% of GDP in 218. However, in the event that growth underperforms on average by.8 percentage points per year or there is substantial fiscal slippage relative to the ambitious consolidation plan set out in the medium-term plan, the debt-to-gdp ratio either declines slowly only from 214 onwards or it stabilises at close to current levels. Moreover, a sizeable contingent liabilities shock (4.9% of GDP) coupled with weaker than anticipated growth and fiscal slippage would result in the debt failing to stabilize and entering an upward trajectory, reaching nearly 145% of GDP by 218. A contingent liabilities shock could emanate from guarantees given by the government to various sectors of the economy. However, DBRS sees the risks of a crystallization of contingent liabilities as having become more contained. This is the result of the inclusion of a number of SOEs with sizeable debt stocks inside the government perimeter and with their total financing accounted for within the state s financing requirements). Therefore, given that the debt of Carris and the public transport company for Porto (STCP) are now included inside the general government perimeter, there is only EUR3.6 billion (2.1% of GDP) worth of debt by SOEs still outside the government perimeter. Additional factors which could weigh on debt sustainability include the uncertainty associated with the cost to the government of the public-private partnerships (PPPs). DBRS recognizes that the current fiscal projections already assume a cost profile for PPPs based on a worst case scenario. Moreover, with the introduction of new expenditure controls, the renegotiation of some PPP contracts, the ongoing privatization process and the adoption of concession schemes in the transport sector, DBRS sees PPPs as diminishing risk. Risks to the sovereign balance sheet emanating from failing banks are also diminishing due to recent improvements in the general health of the banking sector and the progression towards a single banking sector resolution mechanism and the creation of a banking sector resolution fund. Offsetting this positive development somewhat, however, is the reduction in the size of the funds available for the purposes of shoring up financial sector stability to EUR2.5 billion in 214, from EUR6.4 billion at end 213. The substantial reduction in the size of this buffer resulted from the government support provided to Novo Bank via a EUR3.9 billion loan to the banking sector restructuring fund (FRB). Economic Structure and Performance After contracting markedly between 29 and 212, the Portuguese economy showed the first signs of recovery in the second half of 213 and has grown at 1% YoY on average in the three quarters between 214Q1 and 214Q3. Domestic demand drove the recovery in 214H1 with net exports providing a negative contribution to GDP growth. Following steep declines in 211 and 212, private consumption, which accounts for 65% of s GDP, has been the main driver of GDP growth this year. Gross fixed capital formation also presented 5 Sovereign Ratings Group

6 21:Q1 21:Q2 21:Q3 21:Q4 211:Q1 211:Q2 211:Q3 211:Q4 212:Q1 212:Q2 212:Q3 212:Q4 213:Q1 213:Q2 213:Q3 213:Q4 214:Q1 214:Q2 214:Q November 214 a positive a contribution to GDP in 214H1, giving further support to the economic recovery. In addition, a modest recovery in public consumption also supported growth in GDP in 214H1. The labour market is improving in line with GDP and the decline in the unemployment rate has substantially outperformed the government s expectations. Unemployment declined from 15.7% in 213Q3 to 13.6% in 214Q3, close to the government s expected 13.4% for 215. Moreover, employment is growing at a stronger pace than anticipated suggesting that the improvement in the unemployment rate reflects an increase in the number of those employed rather than a marked decline in the size of the labour force : Growth in GDP (QoQ, % and Ppts) Exports Imports GFCF Public Consumption Household Consumption QoQ Growth in Real GDP (lhs) YoY Growth in Real GDP (lhs) : Labour Market (23-214Q3) Unemployment Rate (%) lhs Employed Population (Million) rhs Source: Haver Analytics, and Ministry of Finance. Looking ahead, the government assumes average annual growth in GDP of 1.7% over the period with net trade, investment and household consumption, all expected to contribute to the recovery. However, DBRS sees material downside risks to this assumption given the potential for net exports and investment to disappoint as a result of the high levels of leverage which still permeate the corporate sector and the uncertainty surrounding the prospects for world growth. In addition, the risks to the projections for nominal GDP are also substantial given the projected, but little substantiated, wedge between consumer price inflation and the differential between real and nominal GDP. The contribution of exports to growth represents one of the key elements of s ongoing economic rebalancing. Exports as a share of GDP increased from 32% in 28 to 4% in 214H1. By 216, the share of exports in the Portuguese economy is expected to increase further to 44%. The contribution from exports is expected to derive from s improving trade performance as reflected by recent gains in market share. The contribution from household consumption is also assumed to be material and should be supported by a mild recovery in disposable income as the prospects for further tax increases dissipate on the back of the high tax burden. Business investment is expected to recover reflecting the sharp and prolonged decline in the country s capital stock during the crisis, the abatement of the uncertainty generated by the sovereign debt crisis, and the progressive stabilization of financing conditions. DBRS cautions, however, that high levels of leverage in the public and private sectors will likely continue to add to dampen the contribution of domestically-generated investment to growth over the medium-term. Monetary Policy and Financial Stability With the support of the EU and IMF sponsored Economic and Financial Assistance Programme (EFAP) s funds devoted to financial stability, s financial system weathered the worst of the financial crisis relatively well. However, the banking sector continues to be challenged by weak profitability. In addition, the crisis at the country s second largest commercial bank which led to the institution having to be resolved through the bail-in of shareholders and junior bondholders and to the creation of a new institution, namely Novo Bank whose capital was boosted through an injection by the banking sector resolution fund (FRB) of EUR4.9bn, resulted in a very significant decline in the EFAP s buffer available for the purpose of shoring up financial stability. However, the funding structure of the sector appears to have improved through the move towards a more balanced split between wholesale and ECB funding. This rebalancing has been mostly achieved through 6 Sovereign Ratings Group

7 H Sep 21 November 214 an increased focus on promoting growth in retail funds although it was also assisted by strong loan and asset deleveraging. As a result, reliance on ECB funding has fallen materially with Eurosystem liquidity abating from 12.5% of total liabilities (EUR64.1 billion) in 212H2 to EUR41.5 billion or 9.2% of total liabilities in 214H2. Moreover, the results of the ECB s Asset Quality Review (AQR) and the EBA s stress tests did not identify any substantial shortcomings in relation to the capital position of the country s largest banks, once restructuring and capital-enhancing measures, have been taking into account. In fact, all of the banks examined passed comfortably the stress baseline scenario with only Banco Comercial Português (Millenium BCP) reporting a capital shortfall under the adverse scenario below the minimum 5.5% threshold by end 216. As a result, concerns over the stability of the financial sector in, which intensified earlier in the year as a result of the developments with Banco Espirito Santo (BES), have now abated. The capital adequacy of the Portuguese banking system has been gradually improving. At the end of 214H1, the Common Equity Tier 1 (CET1) ratio stood at 1.6%, against a minimum requirement established by the BdP of 7 %. Net of BES, the CET1 was of 12.3%. Capital boosting in some banks was helped by the injections of Convertible CoCos subscribed by the sovereign as part of the EFAP. However, banks have repaid a large share of these CoCos to the government throughout 214. In spite of the acceptable capital position of the major banks, and like the financial systems of many other advanced economies, the Portuguese banking system has experienced a material decline in profitability since the onset of the financial crisis in 28. This is partly driven by limited lending volumes and strong loan deleveraging, driven by the weak economic conditions and the low interest rate environment. Despite positive contributions from the banks international operations which accounted for over one-third of banks profits last year, net interest income earned by banks fell by nearly 3% in 213 driven by weak domestic performance.. Moreover, in the first half of 214, the results for the banking sector continued to deteriorate. Factors which continue to weigh on banks profitability, include high levels of household and corporate leverage, which dampen appetite for new borrowing and thus restrict the banks ability to reshape their portfolios in favour of more profitable lending. Continuing deterioration in asset quality, albeit at a moderating pace, continues to weigh very negatively on banks profitability through high levels of provisioning. 1% 8% 6% 4% 2% % : MFIs Funding Structure (% of Total Liabilities) H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H : Debt and Borrowing (% of GDP and YoY % Change) Other Capital Borrowing from Central Banks Borrowing other from Banks Debt Securities Deposits Source: Banco de (BdP), European Central Bank (ECB). NFC Debt - Bank Loans Household Debt Euro Area - Bank Loans 7 Sovereign Ratings Group Asset quality also remains a source of concern. Non-Performing Loans (NPLs) maintained their ascendant tendency in the first half of 214, increasing from 15.6% at end 213 to 17% in 214H2. Most of the deterioration in asset quality relates to corporate, real estate and consumer credit with the deterioration in mortgage-related asset quality being, so far, relatively contained. However, household debt, whilst declining (it fell from 95.4% of GDP in 29Q4 to 88.4% of GDP in 214Q2) remains high by international standards (it was lower only than in Ireland, the Netherlands and Cyprus, at the end of 213). Moreover, the predominance of flexible rate mortgage loans, poses non-negligible risks to banks asset quality if and when interest rates start to normalize from their current low levels as a considerable number of home-owners are likely to be currently shielded from the build-up of arrears by the very low rates they currently enjoy on their variable interest rate mortgages. However, DBRS expects the risks to mortgage-related asset quality from a normalization in interest rates to be somewhat offset by higher bank earnings due to the higher rates.

8 Q1/28 Q2/28 Q3/28 Q4/28 Q1/29 Q2/29 Q3/29 Q4/29 Q1/21 Q2/21 Q3/21 Q4/21 Q1/211 Q2/211 Q3/211 Q4/211 Q1/212 Q2/212 Q3/212 Q4/212 Q1/213 Q2/213 Q3/213 Q4/213 Q1/214 Q2/ November 214 Balance of Payments s current account continued to improve in 214 after posting the first surplus in decades in 213. The improvement in s current account reflects two factors. Firstly, a marked improvement in the goods balance has made a very material contribution to the closing of the current account deficit. Secondly, the improvement in the services surplus, from 2.7% of GDP on average over the ten years to 211Q1 to 4.9% of GDP in the three years to 214Q2 has also made a substantial contribution to the closing of the large deficits of the last 15 years. The improvement in the travel services balance played an important role in driving the improvement in the services surplus as it grew from 2.5% of GDP in the 11 years from 2Q1 to 211Q1 to 3.2% of GDP over 211Q2 to 214Q1. 1% 5% : Current Account (% of GDP) 1% 5% 6% 4% : Unit Labour Costs (% Change YoY) % % 2% -5% -5% % -2% -1% -1% -4% -15% Secondary Income Primary Income Services Balance Goods Balance -2% Current Account -15% -2% -6% -8% Productivity (YoY % Change) Unit Labour Costs (YoY % Change) Wages in Industry (YoY % Change) Source: Haver Analytics. s improved performance in the services sector is likely to reflect to some extent the improvement in cost competitiveness afforded by the reduction in unit labour costs which in turn has been spurred by reductions in wages (especially in 212) and improvements in productivity (213). However, exogenous demand factors such as political instability in other competitive tourist destinations may have also played a part in driving tourist arrivals up in recent years. The improvement in s current account balance has manifested itself in a reduced external borrowing requirement at end 213. However, large and persistent current accounts deficits for the last two decades resulted in a very large negative Net International Investment Position (NIIP) of over 1% of GDP. At 214Q2, s NIIP stood at 117.9% of GDP, reflecting only a very marginal improvement (of.4 percentage points) on the position in 213Q. A sharp increase in borrowing from abroad by the government sector as public debt increased at a substantial pace and by financial institutions from the mid-2s onwards accounts for the sharp deterioration in s external debt over the last decade. Looking ahead, DBRS expects the current account position to remain mildly positive or close to balance but expects s external high debt to persist given the high levels of government debt and the high maturity of a high share of the loans. Political Environnent Last general election: June 5, 211 Next general election: No later than 215 Parties in power: Social Democrat Party (PDS)-led coalition with the People s Party (CDS-PP) Government Structure: Parliamentary democracy Prime Minister: Pedro Passos Coelho s political environment has been marked by relative stability punctuated by only sporadic episodes of uncertainty. Support for the governing coalition has also been relatively stable in spite of the government s decisions to increase the tax burden. 8 Sovereign Ratings Group

9 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Cyprus Italy Spain Euro Area Greece Germany Finland Ireland 21 November 214 Support for the main opposition party, Partido Socialista (PS), has gained momentum. The election in September 214of Antonio Costa to the helm of PS has been accompanied by ae resurgence in support for the party, according to the latest polls. This suggests that the election could be tight. In fact, recent polls put support for the PS at 34.8%, slightly above the support for the combined PSD at 26.2% and CDS/PP at 8% coalition members : Opinion Polls (% of Respondents) Support for the Euro (% of Respondents) PPD/PSD PS CDS/PP CDU BE OP/B/N A Good Thing Can't Decide A Good Thing (October 213) rhs A Bad Thing Don't Know Source: European Commission, Eurobarometer Survey, October 214 and Eurosondagem Survey of support for the country s various political parties. In terms of the next elections, it is early to say whether the recent allegations of corruption faced by senior members of the Public Administration will dampen support for the incumbents. The allegations are related to the administration of the Golden Visas scheme, a program to attract foreign wealthy entrepreneurs to the country. The allegations have been followed by the the resignation of the Minister of Home Affairs Miguel Macedo. However, support for euro area membership and for the parties which are in favour of continued euro area membership (which tend to account for ¾ of the votes in general elections) seem well anchored. Recent polls suggest a slight improvement in the share of respondents who believe the euro is positive for their country. 9 Sovereign Ratings Group

10 21 November 214 : Selected Indicators For the year ended December 31 (EUR billions unless otherwise noted) Public Sector Debt General Government Gross Debt % GDP 73.7% 86.6% 96.2% 111.1% 124.8% 128.% General Government Net Debt % GDP 64.9% 76.5% 93.7% 12.6% 114.6% 117.5% Central Government Gross Debt % GDP 7.3% 82.2% 95.% 11.3% 125.1% 128.8% Domestic Debt General Government n.a % GDP n.a. 3.3% 46.3% 58.6% 5.4% 48.4% External Debt General Government n.a % GDP n.a. 56.3% 53.6% 56.% 77.7% 82.3% Private Sector n.a % GDP n.a..2%.2%.2%.1%.1% Gross External % GDP 195.7% 216.9% 22.4% 21.9% 227.1% 215.9% Private Sector Debt Household % GDP 97.1% 1.2% 12.4% 14.8% 12.3% 95.2% Non-Financial Firms % GDP 27.9% 219.1% 226.1% 229.3% 235.4% 241.1% Fiscal Balances (% GDP) Revenues 41.6% 4.4% 4.6% 42.6% 43.% 45.2% Expenditures 45.3% 5.2% 51.8% 5.% 48.5% 5.1% Interest Payments (% Revenues) 7.5% 7.4% 7.2% 1.1% 11.5% 11.% Primary Balance -.7% -6.8% -8.2% -3.% -.6%.1% General Government Balance -3.8% -9.8% -11.2% -7.4% -5.5% -4.9% Balance of Payments & Liquidity Current Account Balance % GDP -12.1% -1.4% -1.% -6.2% -2.2%.7% Trade Balance -9.3% -6.7% -7.1% -3.6%.1% 2.2% Net Foreign Direct Investment (% of GDP) -.9% -.8% -5.1% 3.7% -8.2% -.2% International Investment Position % GDP -92.4% -16.2% -12.9% -11.8% -113.% % External Assets External Liabilities Note: Household and non-financial corporations debt includes all financial liabilities. Source: Banco de, Instituto Nacional de Estatistica (INE), Finance Ministry, IGCP, Eurostat, and Haver Analytics. 1 Sovereign Ratings Group

11 21 November 214 Ratings History Issuer Debt Rated Current , Long-Term Foreign Currency Issuer Rating BBB (low) BBB (low) BBB (low), Long-Term Local Currency Issuer Rating BBB (low) BBB (low) BBB (low), Short-Term Local Currency Issuer Rating R-2 (middle) R-2 (middle) R-2 (middle), Short-Term Foreign Currency Issuer Rating R-2 (middle) R-2 (middle) R-2 (middle) 11 Sovereign Ratings Group Copyright 214, DBRS Limited, DBRS, Inc. and DBRS Ratings Limited (collectively, DBRS). All rights reserved. The information upon which DBRS ratings and reports are based is obtained by DBRS from sources DBRS believes to be accurate and reliable. DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance. The extent of any factual investigation or independent verification depends on facts and circumstances. DBRS ratings, reports and any other information provided by DBRS are provided as is and without representation or warranty of any kind. DBRS hereby disclaims any representation or warranty, express or implied, as to the accuracy, timeli ness, completeness, merchantability, fitness for any particular purpose or non-infringement of any of such information. In no event shall DBRS or its directors, officers, employees, independent contractors, agents and representatives (collectively, DBRS Representatives) be liable (1) for any inaccuracy, delay, loss of data, interruption in service, error or omission or for any damages resulting therefrom, or (2) for any direct, indirect, incidental, special, compensatory or consequential damages arising from any use of ratings and rating reports or arising from any error (negligent or otherwise) or other circumstance or contingency within or outside the control of DBRS or any DBRS Representative, in connection with or related to obtaining, collecting, compiling, analyzing, interpreting, communicating, publishing or delivering any such information. Ratings and other opinions issued by DBRS are, and must be construed solely as, statements of opinion and not statements of fact as to credit worthiness or recommendations to purchase, sell or hold any securities. A report providing a DBRS rating is neither a prospectus nor a substitute for the information assembled, veri fied and presented to investors by the issuer and its agents in connection with the sale of the securities. DBRS receives compensation for its rating activities from issuers, insurers, guarantors and/or underwriters of debt securities for assigning ratings and from subscribers to its website. DBRS is not responsible for the content or operation of third party websites accessed through hypertext or other computer links and DBRS shall have no liability to any person or entity for the use of such third party websites. This public ation may not be reproduced, retransmitted or distributed in any form without the prior written consent of DBRS. ALL DBRS RATINGS ARE SUBJECT TO DISCLAIMERS AND CERTAIN LIMITATIONS. PLEASE READ THESE DISCLAIMERS AND LIMITATIONS AT ADDITIONAL INFORMATION REGARDING DBRS RATINGS, INCLUDING DEFINITIONS, POLICIES AND METHODOLOGIES, ARE AVAILABLE ON