Portugal’s 10-year bond yield has almost 120 bp this year.  It is one of the few eurozone members that still pay to borrow two-year money. There are two set of drivers. One set is country specific. These may matter only to current or prospective investors. The other set of considerations may have broader applicability. This means that even those without direct exposure may want to take note of developments in Portugal.  

There are a few country-specific considerations that are worrisome. First, three of the four rating agencies that the ECB relies on rate Portugal just below investment grade. If the fourth rating agency, DBRS were to match the other rating agencies, it would have serious implications. Portuguese bonds would not longer qualify to be purchased under the ECB’s asset purchase program. In addition, it would also mean that Portugal banks could not use government bonds for collateral to borrow from the ECB as they currently do. 

Prior to last year’s election, there were expectations that Portugal could regain its investment grade status. However, the election results and the center-left success in pushing out the center-right government makes this less likely. Fitch has warned that any fiscal relaxation would be seen as credit-negative. DBRS is set to review Portugal’s debt rate at the end of April. 

Second, after much negotiating with the EC, Portugal’s 2016 budget was approved. The outgoing government had agreed to the EC’s demand for a 1.8% budget deficit. The new government submitted a budget that originally projected a deficit of 2.6%. There the negotiating process this was reduced to 2.2%, through extra taxes on fuels, tobacco, auto, and a special levy on banks. 

An often used ploy to project a smaller deficit-to-GDP ratio is to inflate growth estimates. The EC pressured the Portuguese government to reduce its 2016 growth forecast to 1.8% from 2.1%. There is some risk that this is still too high. The Bloomberg consensus, for example, is 1.5%, and this was probably predicated on lower interest rates. There is little room for maneuvering. Slower growth in H1 could prompt the EC to seek a midterm correction–, i.e., additional savings measures.