Aug. 16 (Bloomberg) -- Portugal’s fiscal reforms are giving investors the greatest confidence in its debt in more than a year, even as its economy struggles under the weight of austerity.
Credit-default swaps on Portugal dropped as low as 725 basis points today, from 1,515 in January and 1,237 in May. The contracts have fallen by the most of any government this year and by more than every nation except Ireland in the past month.
The implied probability of Portugal defaulting on its debt has declined to 46 percent from 73 percent as optimism that spending cuts and tax increases will get finances back on track outweighs a shrinking economy and rising unemployment. The government is trying to fulfill the terms of a 78 billion-euro ($122 million) bailout and return to bond markets next year.
“It’s the poster child of success for the European programs,” said Arif Husain, the London-based director of European fixed-income at AllianceBernstein Ltd., which oversees $407 billion and holds Portuguese bonds. “The reforms, unless something goes crazily, strangely wrong, will always lead to a short term contraction but put it on a better foot going forward.”
Investors are both buying bonds and paring bearish bets, with credit-default swaps protecting the smallest amount of Portuguese debt since at least 2009, when Bloomberg started collecting data from the Depository Trust & Clearing Corp. A total of 4,153 swaps contracts covering a net $4.5 billion of bonds were outstanding as of Aug. 10, down from $9.6 billion in January 2010.
The Portuguese 10-year yield was at 9.88 percent at 9:07 a.m. in London, down from a euro-era record of 18.29 percent on Jan. 31, while the rate on similar-maturity Spanish debt was 6.68 percent. German 10-year bunds yield 1.55 percent and Irish nine-year bonds pay 6.06 percent.
Portugal’s gross domestic product shrank for a seventh quarter in the three months through June, falling 1.2 percent from the previous period, while unemployment rose to a euro-era record of 15 percent.
The nation, which has 173 billion euros of debt outstanding, according to data compiled by Bloomberg, is seeking to narrow its budget deficit to 4.5 percent of GDP this year and 3 percent in 2013. It sold stakes in state-owned companies including utility EDP-Energias de Portugal SA and power-grid operator REN-Redes Energeticas Nacionais SA to bolster public finances.
Reforms are being demanded by the so-called troika of international creditors -- the European Commission, the European Central Bank and the International Monetary Fund.
“Portugal has been successful in meeting the targets required by the troika, the privatization program has been quickly implemented and the country is responding to austerity,” said Joaquim Gomes, a fund manager of Dunas Capital Gestao de Activos in Lisbon. “I’m confident that Portugal will make a successful return to the bond market in 2013.”
Gomes said he’s now buying Portugal’s 30-year bonds, after buying five-year notes starting last year. The nation’s five-year notes yield 8.38 percent, while the rate on the longer-dated securities is 8.89 percent.
In the first seven months of 2012, Portuguese debt returned 28 percent, the most of 26 markets tracked by indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German bunds rose 4.1 percent and Spanish debt fell 5.1 percent.
As austerity in Portugal wins plaudits from credit investors, Irish debt risk is also falling as the government reforms its economy. The nation sold bonds last month for the first time since it sought a 67.5 billion-euro international rescue in November 2010.
Swaps on Ireland dropped as low as 449.5 basis points today, the lowest in almost two years, from a peak of 1,181 last July.
“A lot of people are extrapolating Portuguese yields toward where Ireland has gone,” Husain said.
The troika will arrive in Lisbon on Aug. 28 for its fifth review mission ensuring that the conditions attached to the bailout program remain on track.
Risks remain and a return to the bond market next year may be “premature,” according to Gilles Moec, co-chief European economist at Deutsche Bank AG in London. But the government is doing “more than enough to justify continued support from the EU,” he wrote in an Aug. 10 note to investors.
Contagion from the crisis in neighboring Spain is one of the biggest threats to Portugal’s recovery, according to Christian Schulz, an economist at Berenberg Bank in London. The Spanish government is considering requesting aid, European Economic and Monetary Affairs Commissioner Olli Rehn signaled in a Bloomberg Television interview this week.
“As long as Spain is in trouble, returning to the markets for Portugal will be difficult,” Schulz said. “One big advantage for Portugal is politically stability, the country has a stable government and the success of the adjustment program acts as glue.”
Portugal’s President Anibal Cavaco Silva last week called on the ECB to buy its debt to help the government return to markets. The central bank said this month it may intervene in tandem with Europe’s bailout funds if troubled nations commit to improving their economies and fiscal positions.
“The Portuguese government has exceeded expectations,” said Schulz. “The real test for the Portuguese economy will be whether or not it can return to the market in 2013 at a sustainable level.”
To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net