Portugal debate: Portugal perks up

Executive summary

• Investor confidence in Portugal is rising • The low savings rate has constrained the capital market, but companies are becoming less reliant on credit and are moving towards funding projects themselves • FDI flows are increasing as the labour market evolves • Doubling the size of the capital market is a realistic target • The fallout from the Banco Espírito Santo collapse continues, but such an event is unlikely to be repeated • Contagion from Greece is no longer such a threat

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Euromoney Cristina, you’ve just returned from a series of meetings with investors in northern Europe. What feedback did they give you about the prospects for the Portuguese economy?

CC, IGCP Investor confidence in the Portuguese economy is strengthening, supported by increasingly robust evidence that we’re showing very healthy signs of growth.

The early stages of the recovery were driven mainly by net exports, with domestic demand lagging behind. Today, the recovery is more broad-based and the contribution of domestic demand has picked up. Disposable income and consumer confidence have improved, not just because of low interest rates and oil prices but also because labour market conditions have improved significantly, meaning that people are more confident about their job prospects.

The corporate sector is now more comfortable with the outlook for demand. Companies are hiring again and investing in additional capacity, which will be beneficial for exports going forward. Last year, GDP grew by 0.9% and this year the ministry of finance is projecting growth of 1.6%. This growth is on the back of an acceleration in investment, which grew by 2.5% last year and is expected to expand by 3.8% in 2015. 

The export sector is now very close to full capacity utilisation. So it needs to continue to add new output capacity in order to allow export activity to gather more traction.

JS, CaixaBI I agree that the economy is clearly recovering. Rising demand from foreign investors is supporting a rebound in the real estate and construction sectors, which is having a multiplier effect on the rest of the economy. The main problem is still the lack of demand for credit. 

DG, Finantia The reforms implemented in the labour market over the last five years have led to a significant decrease in unemployment. These reforms have also encouraged entrepreneurial skills, which are supporting job creation and reducing government expenditure on social benefits. This has also reduced emigration and broadened the investor base for smaller companies, which has in turn sustained increasing exports from Portuguese SMEs. 

LL, Euronext Looking from the vantage point of the stock exchange, one major economic challenge which needs to be addressed is deleveraging in the corporate world. This can’t be done purely domestically. We have to improve our access to international capital. 

It is clear that the Portuguese capital market has been unable to deliver what a capital market should deliver. In one respect, this is frustrating. But in another it gives us grounds for hope, because I don’t see this as something that we cannot change – provided there is willingness to offer the right incentives and remove the disincentives that have prevented companies from accessing the capital market. 

Euromoney Do these incentives need to be improved to generate more supply? Or is demand also a problem in the capital market? 

LL, Euronext If I had to incentivize one of the two, I would incentivize supply, making sure that companies have fewer disincentives to use the market. 

A key priority in recent years has been to make the country credible again. And to make Portugal credible, there was a bill that had to be paid on the revenue side in the form of tax increases. But this should not be incompatible with removing the disincentives for companies to use the capital market.

JS, CaixaBI When the government began its privatisation programme in the 1980s, it chose to create local groups that controlled companies through leveraged structures and cross-shareholdings with the banking system. This was an original sin that made the crisis much worse in Portugal than elsewhere because it failed to create a real capital market. By contrast, when the UK privatised its major companies in the 1980s and 1990s, it encouraged much more widespread share ownership. It did not leave large 30% or 40% stakes in the hands of leveraged holding companies, as we did in Portugal. 

CC, IGCP Although savings have risen slightly in recent years on the back of the adjustment process, the low savings rate in Portugal has always constrained the expansion of the capital market. 

Another structural problem is that mainly because of the tax regime, companies have not been sufficiently incentivized to retain earnings. We are now seeing the first tentative signs that things are changing, which is making companies a little less reliant on banking products. It is also encouraging them to shore up their capital structures, and finance new projects through retained earnings and own funds.

The limited or constrained capacity of the banks to support the expansion of the economy is not necessarily negative, because it has forced the corporate sector to deleverage. The fact that companies are slightly less reliant on credit and more tilted towards funding projects via their own funds is beneficial, because the ratings agencies have said that the high level of indebtedness is still a drag on potential growth. The issue of indebtedness is now being addressed, with the debt stock of households coming down steadily. The same can now be said of corporates, although their deleveraging came later. The public sector is also now putting a lot of effort into diminishing its debt overhang. So although people may complain that the rate of progress is not as fast as we would like, things are clearly progressing.

We have also been seeing signs that the reforms that have been adopted are attracting rising inflows of FDI. The feedback I have been getting from investors is that the increased flexibility in the labour market, the social security system reforms, and the changes introduced in public administration have all encouraged increased FDI. 

LL, Euronext For a country like Portugal it is important to have a healthy corporate sector, because healthy companies are a fundamental instrument for attracting talent and investment. Attracting investment that is concentrated on back-office operations is fine. But you need to ensure you have front-office operations as well, and above all you need to keep some head offices in the country. 

To create and sustain those companies, you need capital. If you don’t have a strong enough national capital base, you need to ensure you have access to international capital – wherever it may be. In today’s world, capital flows very easily to wherever it finds the best opportunities. There is no reason why companies based in Portugal should be unable to tap into those capital flows.

One good example of how you can tap into these flows is the recent privatisation of [mail delivery system] CTT. This is the first case we have had of a locally listed company with a 100% free float and an international investor base which has been able to keep its headquarters in Portugal. This is important because it means that the high-value services like consultancies’ and lawyers’ fees are more likely to be kept within the local economy.

The capital market won’t be the solution for everything. But if we can double its size, which I don’t think is unrealistic, it could make a big difference in terms of the quality of growth.

Euromoney Are there other companies like CTT that could come to the market, or was its IPO very much a one-off?

JS, CaixaBI We are working on bringing more companies to the market. But because there is so much liquidity in the world today, even companies that could come to the market are being offered other pools of capital from private equity, for example. Excess liquidity means that everyone is competing for the same companies. We’ve worked on potential deals only to be outbid by private equity companies offering very high multiples. 

DG, Finantia In other peripheral economies, such as Spain or Italy, the necessary structures have already been put in place in order to provide SMEs with alternative and diversified funding sources at competitive levels. 

Since Portugal is lagging behind in creating similar structures, neither international nor domestic investors are able to deploy their capital into SMEs in the same fashion as they do in neighbouring countries.

The low yields offered by smaller Portuguese companies compared to their peers elsewhere in Europe means that Portugal is somehow overlooked by international high-yield investors. Bear in mind that Portuguese SMEs are typically less leveraged than, say, their Spanish peers. But when you tell a UK or French institutional investor that a smaller Portuguese company pays 3.5% for five years, they say they can’t even look at an unrated company offering that sort of return.

For those of us working with Portuguese small- and mid-cap corporates, it is very difficult to motivate investors to allocate resources here rather than Spain or Italy, where similar and more liquid deals offer returns in the high single digits.

These funding levels are of course very interesting for the borrowers themselves. On the flipside, the investor base is mostly domestic, which somehow limits these companies’ chances of growing their investor base internationally, developing projects abroad and increasing their exports. 

Euromoney Why are yields in Spain so much higher than they are in Portugal?

DG, Finantia It’s a reflection of the excess liquidity available in the banking system, most of which is concentrated in shorter tenors of between one month and three years. 

I think companies should be addressing their medium- and long-term funding needs while yields are so low. Unfortunately, many of these companies are unable to come to the market because they feel they are either too small or because the investor base is just not there for them. 

I know that Euronext, together with the government, has been studying models for smaller company funding such as the Spanish Marf [alternative fixed income market], and Italy’s minibond market. There needs to be a push by the government here to encourage a similar initiative in Portugal. On a recent visit to London, the Portuguese finance minister publicly identified this specific issue as part of the efforts of the current government in order to enhance the competitiveness of Portuguese companies within a struggling European economy. I believe that such a platform or market is most likely to be established by a local development bank. 

LL, Euronext I fully agree that for most companies the equity market is still a long way down the road, and that they will need to start by exploring opportunities in the bond market. For many, accessing the market on an individual basis is not an option, so they will have to do so via a collective instrument such as a fund. This is one of the initiatives we are trying to push, and it could clearly be supported by the establishment of a development bank.

Ideally, we should incentivize the use of the capital market. But if that is not possible, given the constraints, we should look at alternatives such as state guarantees for loans. If that is the case, we should ensure that the same rules and incentives apply to the issuance of bonds. 

Euromoney What about the domestic institutional investor base? Is that growing?

CC, IGCP Good question. I was in Denmark recently where the pension fund industry is roughly 1.5 times GDP and will be twice the size of GDP in 10 years’ time. That’s something we’ve never had in Portugal because we have historically had a very generous pay-as-you-go social security system that has been able to provide for the needs of the ageing population. We don’t have a second or third pillar, which means we don’t have a large pension fund industry. 

Insurance companies have been larger players in the market than pension funds. But they are still relatively insignificant compared to many other European countries. 

Everything boils down to the level of savings, which is about 9%. Portugal’s lack of capital dates back many generations. And on top of that, since the revolution of 1974, the welfare state has been catering for the needs of the population, which has not been given the necessary incentives to save. If you don’t have a high savings pool, you can’t expect to build a large capital base to deploy in the capital market, be it through equities or debt. 

JS, CaixaBI The economic system introduced after the revolution of 1974 created no incentives to develop capital markets, savings or a pension system. It created incentives to consume as much as you possibly could. And now we’re paying the bill. Our low savings rate is not a cultural legacy, it is the product of lack of incentives. 

CC, IGCP Savings are related to income, and income is a reflection of productivity. We need to make the Portuguese economy more productive, which we can only do by opening the economy to more foreign competition. The FDI stimulus has meant that Portuguese companies have started to be exposed to foreign competition in the domestic market and abroad, which has been driving higher productivity. This is encouraging, because only with higher productivity can you generate higher incomes and ultimately higher savings rates. 

We are starting to see an improvement in productivity. We are seeing a new breed of entrepreneurs in Portugal which are much more outward-looking and less reliant on the domestic market. 

Euromoney In which sectors are you seeing a recovery in productivity levels? 

CC, IGCP It’s showing up in a number of sectors. We’re even seeing a revival in some traditional sectors, such as textiles and footwear. 

Companies that have been able to withstand the competitive threat arising from the opening up of global trade are now much more efficient. They have created joint ventures with local partners in order to have better control of distribution chains and logistics, for example. They are much better at identifying niche opportunities in their core markets, and they have also been diversifying and adding more countries to their lists of trading partners. 

The new generation of entrepreneurs is more highly-skilled, more open-minded and more willing to adopt new technology, all of which has proven to be highly beneficial. 

LL, Euronext We’ve seen some positive recent surprises in the Portuguese corporate sector. For example, we’ve seen the first Portuguese ‘Unicorn’, a company launched in Portugal in 2008, reach a valuation of $1 billion this year, which is quite an achievement.

There are a number of other areas that are extremely important for the economy, including sectors like agriculture or forestry, which harness our natural resources. These have been major contributors to the economy in terms of value added, and I think there is clear potential for continued growth there.

Traditional sectors have been able to defy the laws of sustainability and have coped well with adversity, reinventing themselves and regaining market share in sectors like textiles and shoes.

The logistics sector will also be interesting for Portugal, given the new Panama Canal and the changes this will bring in global trade. Some investments are already being made with an eye to benefiting from Portugal’s location. 

Another sector where Portugal has made huge progress is in education. We have been very successful in attracting students from all over the world to our universities, some of which are already numbered among the top 25 globally. Some of these are already having to turn away applications of thousands of students because demand for places is so high. 

JS, CaixaBI We’ve seen this from our experience as a sponsor of the Nova School of Business and Economics. Forty percent of its students are from abroad, many of them from Germany. 

LL, Euronext The revenue and value-added that is generated by the educational sector is extremely important to Portugal. It also has very important implications for the future of the Portuguese economy because many of today’s students will be tomorrow’s successful entrepreneurs.

DG, Finantia At the college education level we have seen examples of international groups building substantial positions in the Portuguese market. Recently, north American investors such as the Laureate Group have acquired three private universities in Portugal that automatically include the country in a network of more than 800,000 students from 30 different countries. 

Euromoney This all sounds very encouraging for the very long term. But coming back to some more prosaic short-term issues, how damaging to Portugal’s image and to its banking sector was the collapse of Banco Espírito Santo? 

JS, CaixaBI The impact of BES is not over yet, and there have been some stories in the newspapers of problems faced by medium-sized banks such as Montepio and Banif. 

We still don’t know what the total losses to the system arising from BES will be; nor do we know who has suffered the biggest losses, and how these will be dealt with. But I think the BES crisis could have been tackled more quickly, because it was well-known that the group was in trouble.

CC, IGCP But at least it put to the test the new rule book for the public support of the banking sector, and so far the procedure has worked very well.

DG, Finantia I agree that we still haven’t seen what the final bill arising from BES will be. Because the new rule book was put in place only a few months before the Espírito Santo event, the reserves that had been accumulated up until then were minimal. Over the next three to six months it will become much clearer how much the rest of the banking system will have to contribute towards the difference between the cost of the bail-out and the proceeds generated by the sale of Novo Banco. 

More broadly, I think the most damaging impact of the Espírito Santo Group collapse was on related parties that somehow relied heavily on the support of BES. 

On the positive side, the BES collapse did not lead to an increase in unemployment. Instead, the economy continued to grow steadily and proved to be stronger than expected in 2014 and the first few months of 2015.

JS, CaixaBI What is still unclear is who is going to pay for the potential liabilities on the bad bank side. There are still huge litigation risks, and it is likely that the public will foot the bill, which could be very high. We have a rough idea of what the bill will be for the banking system, because a clear price range has been set for Novo Banco, which is the good bank. But we don’t know what the bill for the bad bank will be. 

LL, Euronext Without wanting to diminish the tremendously negative impact of the BES collapse, one important element to consider is that BES was the last of the Portuguese conglomerates. So looking to the future this is a situation which is unlikely to be repeated again. The structure of the conglomerate and the relationship between the banking and non-banking areas was shown to have been a serious weakness, and this problem is not one that will be faced by other entities in the economy.

DG, Finantia In three-to-five years’ time, the most important thing will be the capital injected by the new owner and the strategy adopted by the whole group going forward. The final cost for the Portuguese banking system from the sale of Novo Banco – the old BES – is yet to be determined, but I am certain that whatever the cost may be, Portuguese banks are now far better prepared than ever to absorb the costs. 

CC, IGCP In spite of the deleveraging we’ve seen during the Portuguese adjustment programme, and in spite of all the efforts that have been made to shore up the capital structures of the Portuguese banks, there is still a lot to be done to restore the profitability of the banking sector. This is still a major challenge for the banking sector in Portugal and at some point – depending on what the new owners of Novo Banco decide to do – new dynamics may be brought into the bank to help accelerate the changes that the banking system needs. 

On a more positive note, we were very pleased by how quickly the market absorbed the BES news. Exactly a month after the announcement of the resolution plan, we printed our first 15-year benchmark for six years, which we were able to issue at a yield below 4%. That showed how quickly the market came to understand that the BES situation was something that would not taint the whole economy, nor the creditworthiness of the sovereign. 

So in spite of all the apparent implications for the economy and the treasury, worries about contamination did not gather any traction.

Euromoney The IMF says the banking system still faces high operating costs, overcapacity and weakening asset quality. Are these valid concerns?

JS, CaixaBI Yes – there are still too many bank branches in Portugal. We need consolidation in the industry, which can reduce overall capacity, because branches need to be closed and overheads reduced. 

Euromoney Would branch closures and other cutbacks be politically acceptable?

JS, CaixaBI I think so. There is a recognition that the system needs to be more efficient, so consolidation is unavoidable. And nowadays Portuguese banks are competing with foreign banks, especially on the strongest credits where spreads are very tight. Portuguese banks therefore have no option but to become more competitive, because otherwise foreign banks would simply cherry-pick the best credits. 

Euromoney Cristina, you mentioned the 15-year deal you did last year. This year, how has your funding strategy been impacted by quantitative easing and how serious are the distortions that have been created in the secondary market as a result of the ECB programme?

CC, IGCP The implications of QE implementation are there for everyone to see. But it’s not just QE that has affected the secondary market. The fact that most intraday trading now goes through the futures market rather than the cash market says a lot, and most of that is the result of regulatory changes that deprive the banks of very significant capacity to warehouse bonds and provide their usual market-making services. 

So I don’t think we should blame QE entirely for the drying-up of liquidity, which is something that has been going on for a while. It is true that it has been intensified since QE, but it was lingering well before that. This is something we’ll all have to get used to, and try to adopt mechanisms or issuance strategies to mitigate it as far as possible, because QE will be with us until September next year.

I think the recent repricing that we’ve seen in government bonds could be beneficial for the functioning of the market. What we’ve seen since the start of QE has been a divide between pricing in the primary and secondary markets. It may be positive if secondary market pricing comes closer to the primary market, because yields had dropped so far that institutional investors had started to disengage. 

Euromoney How is Portugal affected by the Grexit discussion? Surely things are very different today to how they were in 2012? I have the impression now that whatever happens in Greece, the other so-called peripheral economies have ring-fenced themselves against any fall-out. Is this an accurate interpretation of how things have changed in the last three years? 

CC, IGCP One of the silver linings in the rather dark cloud created by Greece is that we have seen very little contagion elsewhere in Europe. The initiatives that have been introduced regarding crisis management in Europe mean we are much better equipped to deal with this crisis than we were in the past. I’m not saying that we will necessarily need to test the instruments that are now available, but the toolkit is clearly much more robust than it was in the past. ESM [European Stability Mechanism] can make funds available very quickly to stressed economies, and the ECB can also provide a very sound backstop. Mr Draghi has also recently reminded the market that he has the possibility of activating OMT [Outright Monetary Transactions] if needed. 

Euromoney More broadly, is Portugal relaxed about Greece in a way that it wouldn’t have been two years ago?

JS, CaixaBI Yes. One of the good outcomes of the Greek volatility is that it has forced Portuguese politicians to behave in a better way. They can see what the consequences of misbehaving will be. 

Euromoney But the socialists are already talking about backtracking on austerity if they win the election scheduled for this autumn, aren’t they? 

JS, CaixaBI But there is no such thing as extreme as Syriza in Portugal, which is good for our image in the investor community.

CC, IGCP The socialists have said that they are committed to the fiscal compact, which is also reassuring for investors.

Euromoney So however well Podemos does in Spain, or the Portuguese Socialist Party does in the polls, political risk in Portugal is negligible, as far as financial markets are concerned?

DG, Finantia Yes. Even if we have a change of government, there will be continuity in terms of policy. The commitments that have been made with external creditors will not be called into question. 

Euromoney So the outlook for Portugal remains bright?

JS, CaixaBI Yes, although there is still plenty of room for improvement in order to make our economic recovery sustainable. For example, labour laws still need to be improved. We have a system that is still too protective of incumbent employees. There are not enough incentives for hiring younger people, which is why we still have a huge problem with youth unemployment. I don’t know if there is sufficient political will to make the necessary changes, because it means overhauling the social security and judicial systems. But for us to have a functioning economy that attracts investment and creates new companies and new jobs, we have to build an enabling environment.