Why as an investor, one should care about Portugal’s credit rating

  • Canada's DBRS is the only credit rating agency willing to give Portugal an investment grade, which allows the European Central Bank to buy Portuguese government bonds
  • Recently the economic recovery seen in Portugal since the sovereign debt crisis has indeed begun affecting the way agencies such as Moody's and Standard & Poor's see the economy
A couple look at Alfama, one of the city's historic neighborhoods, from the Miradouro de Santa Luzia in Lisbon, Portugal.
Horacio Villalobos | Getty Images
A couple look at Alfama, one of the city's historic neighborhoods, from the Miradouro de Santa Luzia in Lisbon, Portugal.

Portugal's credit rating is set to return to the headlines Friday as Standard & Poor's updates its opinion on the southern euro zone economy. This could be just another statement if the country wasn't hanging on to its one and only investment grade.

Canada's DBRS is the only credit rating agency willing to give Portugal an investment grade, which allows the European Central Bank to buy Portuguese government bonds. Without that, Portugal's finances would be in a worse position.

The Portuguese government has often said that "it doesn't make any sense" that rating agencies have kept their grades unchanged as if nothing had improved in Portugal since the crisis.

However, recently, the economic recovery seen in Portugal since the sovereign debt crisis has indeed begun affecting the way agencies such as Moody's and Standard & Poor's see the economy, indicating that in the near future more investors could be considering buying Portuguese bonds.

"The positive outlook signals that we would expect to draw such a conclusion, or not, over the next 12-18 months, and quite possibly within 12 months," Moody's said on September 5th about moving Portugal's rating into investment grade.

"The rating would be upgraded if we conclude that the positive economic and fiscal trends are likely to be sustained and if the high debt burden moves on a steady, downward trend. The outlook could be stabilized if the government's commitment to fiscal consolidation and debt reduction or its capacity to do so was to wane," the agency added in the same note.

Porto, Portugal.
Patrik Bergstrom | Getty Images
Porto, Portugal.

What should we expect from S&P?

According to Diogo Teixeira, CEO of Optimize Investment Partners, Standard & Poor's could present similar lines on Friday updating the outlook from stable to positive. "This would let us consider that an eventual transition to investment grade would be the next step, probably in the same time frame indicated by Moody's," Teixeira added.

Portugal has been profiting from lower bond yields, but as the ECB is expected to gradually lower its government bonds purchases, yields and spreads are expected to rise, which could hamper the improvement in government finances.

"This (rating upgrade) would be really important amid the possible ending of quantitative easing," Teixeira said. "It would allow a larger group of investors to consider Portugal's debt in their portfolio selection. Otherwise, Portugal risks suffering a substantial increase in financing costs," he said.

In its last assessment, S&P said that Portugal's outlook was stable, "balancing our expectation of further budgetary consolidation and likely receding banking sector risks over the next two years against the risks of a weakening external growth environment and vulnerabilities related to high private- and public-sector debt."

Banks and public and private debt remain a burden

Though Portugal is one of the fastest growing euro zone economies, problems with non-performing loans and high debt among businesses, individuals and government are a big hurdle - mainly at a time when the government's strategy is focused on consumer spending.

"S&P could upgrade Portugal tomorrow based on the fact that economic growth is set to exceed their growth forecast of 1.6 percent for 2017 by 0.5 percent to 1.0 percent," Maartje Wijffelaars, country risk analyst euro zone at RaboResearch GEM told CNBC via email.

"That said, while it's difficult to predict what in the end effectively drives rating agencies' actions, my guess would be that they will upgrade the rating to positive, but not yet to investor grade. All the other factors S&P worried about in March have not faded: the banking sector is still very weak and susceptible to shocks and public and private (external) debt remain very large," she said.

The Portuguese government is due to present the budget for next year in October. Investors and credit rating agencies will continue monitoring whether the executive will push for legislation that will affect the country's fiscal path.