Portugal Upgraded to Investment Grade
S&P upgrades Portugal’s rating to investment grade
On Friday, 15 September 2017, S&P Global Ratings upgraded Portugal’s sovereign rating to investment grade. The agency revised Portugal’s sovereign rating upward by one notch to BBB-/A-3 from BB+/B and maintained the outlook as stable. S&P became the first among the big three global rating agencies to move Portugal out of its junk status. Although the country’s debt is rated below investment grade by Moody’s Investor Services and Fitch Ratings, both the agencies recently upgraded their outlook on Portugal to positive from stable.
A falling debt trajectory and a tightening of the government’s purse strings have helped Portugal in reinstating its investment grade status after over 5 years. S&P restored Portugal’s investment grade status citing improving fundamentals. The agency also acknowledged the country’s efforts to rein in its public finances and strengthen growth in recent months. "While we view the high level of public and private sector indebtedness as a credit weakness, we observe that external financing risks have declined significantly," said S&P. Along with the rating upgrade, S&P revised up Portugal’s growth forecast; it now expects Portugal to clock an average growth rate of over 2.0% during 2017–2020, well above an earlier forecast of 1.5%.
Exhibit 1: Portugal’s 10-year sovereign yield
Portuguese debt rallied following S&P’s raising of the credit rating to investment grade. The yield on 10-year government bonds dropped to 2.53%, the lowest level since January 2016. Borrowing costs are expected to decline further, benefiting the government as well as corporations. Moreover, an upgrade to investment grade would help Portugal attract fresh funds from a broader array of investors, thereby significantly expanding its investment base. The upgrade has arrived at a crucial juncture, when the European Central Bank (ECB) is contemplating tapering its quantitative easing programme.
A lucrative investment opportunity
The risk of populist, anti-Europe candidates getting the better of their pro-Europe opponents in Europe has receded significantly in the past few months. With the threat of the bloc breaking up fading and encouraging economic performances, there are now clearer attractive fixed income investment opportunities in Europe.
Exhibit 2: Germany-Portugal 10-year yield spread
Portugal with its stable government, improving economy and shrinking budget deficit represents one such lucrative investment opportunity. Its economy advanced 2.9% y/y in the second quarter of 2017, recording the fastest pace of growth in a decade. Also, the country’s overall budget deficit is expected to drop to 2% of GDP. With the fundamentals in place, other global rating agencies are expected to revisit their ratings on Portugal soon. The Portuguese bond market has already outperformed its European peers so far this year (except little traded Greece); however, the yield spread between the 10-year sovereign Portuguese and German debt still remains considerably high and represents a lucrative investment opportunity for yield-hungry investors.