Electoral victory for the ruling Socialist Party has broken the political impasse in Portugal (BBB+/Stable) after the earlier failure to adopt the 2022 budget, thereby increasing political stability which improves the outlook for economic reforms. Recent snap elections after the failure to approve the 2022 state budget last October threatened to undermine the relative political stability and reform momentum the country had benefitted from under the previous two minority governments led by Socialist Party leader Antonio Costa.
Instead, the vote has ended up strengthening it, with incumbent Prime Minister Costa securing an absolute majority. Notably, the smaller left-wing parties that withdrew their support for the budget-approval process last year, experienced markedly lower voter shares in Sunday’s general election, providing popular support for Costa’s policies.
On this basis, we now expect Portugal’s government to continue striking a delicate balance between reforms to enhance the country’s competitiveness, address its social needs and maintain fiscal consolidation in the coming post-pandemic years.
Given the delays in approving the 2022 budget and the uncertainty ahead of the elections, the electoral result is credit positive, not least since the government has excluded higher recurring expenditure in the budget – as Costa’s allies had previously demanded. Portugal’s budget deficit will narrow to 2.2% of GDP next year as Covid-19 related fiscal support measures are withdrawn, with the debt-to-GDP ratio set to decline to below pre-crisis levels by 2026 at around 114% of GDP. We assume economic growth of about 5% this year and 2.5% in 2023, after the 4.9% rebound in 2021, supported by the EU’s NGEU funds – Portugal is set to receive EUR 13.9bn in grants over the lifetime of its plan – and a gradual recovery in tourism.
Sustained economic recovery, political stability and prudent policymaking are paramount to Portugal’s credit ratings, given mounting structural economic and long-term fiscal challenges which will impede a more rapid reduction in debt-to-GDP, standing at 135.2% at end-2020.
Source: IMF, Scope Ratings GmbH
With the EU’s fourth-highest old-age dependency ratio of 37% which is set to increase to 53% by 2035, which would make it the EU’s second highest, ageing dynamics in Portugal will place structural pressure on government budgets through higher healthcare and pension spending, while government revenues face a squeeze from a declining and ageing labour force. In this respect, Portugal’s reform agenda under the EU recovery fund programme includes measures to strengthen government expenditure control, enhance the resilience of the health system and raise the capacity of social services.
We also note that Portugal still has a long way to go before closing the wealth gap with its European peers, with a GDP per capita below 60% of the euro area average, constrained by low productivity and an economy concentrated in low value-added sectors. Here, the government’s reforms to address long-standing bottlenecks in the business environment, boost the skills of the workforce, with a focus on digital skills to meet the needs of the labour market, will be critical.
Finally, prospects of medium-term political stability and governance under established political parties for Portugal compare favourably with neighbouring Spain (A-/Stable), which faces similar medium-term structural challenges, but whose governance remains vulnerable to fragile ruling coalitions. We note, however, that the current Spanish administration has been able to approve budgets for 2021 and 2022.
The next calendar date for our rating review of Portugal is 13 May 2022.