Portuguese debt shines among the safest in Europe

Portugal is now the ‘good student’ of the euro area. The spread between Portuguese 10-year bonds and their German counterparts is currently at levels not seen since 2008. With a spread of just 45 basis points – after remaining in the range of 40 to 45 basis points in August – Portugal is now one of the least risky countries in the Eurozone, on an upward trajectory that culminated last Friday with Standard & Poor’s (S&P) raising the Republic’s rating to ‘A+’.

The US agency’s decision, which raised the country’s credit rating to its highest level since January 2009, marks another chapter in a recovery that began six years ago.

Although still far from the maximum ‘AAA’ rating that Portugal held between May 1993 and May 1998, this development contrasts with the darkest period in the country’s recent financial history, when, between January 2012 and September 2017, national debt securities were traded as ‘speculative’ bonds due to the precarious financial situation of the public accounts.

Between June 2005 and August this year, credit rating agency S&P changed the Republic’s rating on 13 occasions. The first ten years were marked by successive downgrades, culminating in the rating falling to ‘junk’ ‘BB’ level in January 2012, at a time when Portugal was under the control of the “troika”. Three years later, in September 2015, S&P analysts began a cycle of rating upgrades, culminating in two upward revisions this year, first in February and now at the end of August.

“The revision, which is welcomed, did not surprise me given S&P’s previous assessments”, says António Nogueira Leite, economist and former executive vice-president of Caixa Geral de Depósitos, noting that “despite the significant and permanent increase in expenditure in 2024, the most likely scenario for debt evolution is positive and puts Portugal in a gradually more comfortable position, both in absolute and relative terms, compared to some other major economies in the Eurozone”.

The rating improvement is also recognised by Pedro Brinca, professor at Nova SBE, for whom it was not a surprise, “as the debt reduction trajectory has been impressive, thanks to several consecutive surpluses in the State Budget”.

Pedro Brinca also stresses that “there is now a broad political consensus on the need for sound accounts” and that “even though it may not appear so formally, these assessments always have a comparative performance component, and at the moment, Portugal compares well in terms of budgetary dynamics with most developed countries”.

Among the least risky in Europe

Although Treasury bond yields are not at historic lows, they are close to that point. Currently, with two-year bonds (which react more directly to monetary policy expectations) trading at 2.08% and 10-year Treasury bonds at 3.2%, Portugal also ranks among the least risky countries in the Eurozone under this indicator.

Only Germany, Ireland and the Netherlands have 10-year bond yields below national bonds, a position that Paulo Monteiro Rosa, senior economist at Banco Carregosa, considers a reflection of the “consistent improvement in the country’s economic and financial development, accompanied by a gradual consolidation of public accounts”.

In the report accompanying the decision to raise Portugal’s rating by one notch and give a positive outlook for the economy, S&P analysts justify the upgrade with “expectations of further external financial deleveraging of the Portuguese economy”, stressing that “Portugal will continue to run current account surpluses despite greater global and trade uncertainty”.

The US agency also points out that “Portugal is relatively protected from the direct effects of the trade agreement between the European Union and the US, as it is a service-based economy and only 7% of its exports go to the US”. But the good news may not end there.

With Fitch scheduled to review Portugal’s rating on 12 September and Moody’s on 14 November, experts contacted by ECO are divided on the prospects of further upgrades. “I don’t anticipate [an upgrade] given the information available on the date and the comments from previous assessments by these two agencies”, reveals António Nogueira Leite, admitting that “they convey a positive signal”, but a rating upgrade would surprise him.

More optimistic, Pedro Brinca believes that “if the debt trajectory is maintained, it will only be a matter of time” before the other agencies follow S&P. This view is shared by Filipe Garcia, economist and president of IMF – Informação de Mercados Financeiros, who anticipates that “both [agencies] will raise the rating by one level”, explaining that “the rating of these two agencies is, in both cases, two grades below that assigned by S&P, and it is not very common to have differences of this kind”.

Paulo Monteiro Rosa shares the same optimism, noting that “it is expected that Fitch may raise the rating as early as September, given that it maintains Portugal at ‘A-‘ with a positive outlook”, while “in the case of Moody’s, although traditionally more conservative, it is also likely to move forward with an upward revision in November”.

Caution in the face of external risks

The positive trend in Portuguese debt securities is undeniable, with Treasury bonds being identified by investors as a ‘safe haven’ among European securities, in a market dominated by turbulence surrounding French bonds.

“The fact that the spread between Portuguese 10-year bonds and German bonds is at its lowest since 2008 confirms investors’ strong confidence in the budgetary trajectory of the national public accounts”, emphasises Paulo Monteiro Rosa, anticipating that “these low risk premium levels will be maintained for the rest of the year, supported by budgetary credibility, the reduction in public debt and the recent upward revision of S&P’s rating”.

António Nogueira Leite shares this confidence, expecting “an evolution in line with what we have seen so far”, although he admits “stronger pressure on the European government bond market, particularly due to the enormous uncertainty surrounding the financial situation of the Eurozone’s second largest economy”.

Pedro Brinca’s perspective focuses on budget execution: “My expectation is that budget execution will correct any deviation from the surplus forecast in the State Budget for 2025 and that the achievement of this political objective will continue to instil confidence in investors and, at the same time, reduce the debt service which, as we know, is still substantial.”

However, not all experts share the same optimism for the coming months. Filipe Garcia warns that “we may have already seen the lows for the year in terms of the spread versus Germany, given that the situation in France is reigniting fears about European debt and, of course, the war in Ukraine continues to strain European relations”. Nevertheless, he believes that “under normal conditions, there will be a significant widening of the spread for the rest of the year”.

In its report, S&P projects that Portuguese public debt will continue to decline, reaching 81.9% of GDP in 2028, a significant drop from 94.9% in 2024 and 98.1% of GDP at the end of the first half of the year. This trajectory is supported by “a solid fiscal path” which, according to the credit rating agency, “puts public debt on a firm downward path”, even considering “growing pressure on defence spending and internal political instability”.

The path taken by Portugal from the darkest days of the Troika to its current position of credibility in international markets represents one of the most remarkable transformations in European public finances in the last decade.

With spreads at 17-year lows and a rating not seen since 2009, the country is demonstrating that budgetary discipline and political consensus can effectively restore investor confidence and return the country to its place among the most solid economies in the Eurozone. And, as a result, generate lower financing costs for the Treasury.