Annual Report 2007 - IGCP€¦ · Ensure stable Government financing and efficient management of the debt portfolio; Minimize the cost of the government debt in a long-term perspective,

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Annual Report 2007

Government Debt and Cash Management

Av. da República, 57 - 6º

1050-189 LISBOA | Portugal

Tel.: +351 21 792 33 00

Fax: +351 21 799 37 95

www.igcp.pt

e-mail: [email protected]

REUTERS pages: IGCP01

BLOOMBERG pages: IGCP

Editor:

Design:

Production:

ISSN

April 2008

Instituto de Gestão da Tesouraria e do Crédito Público, I.P.

FPGB - Consultoria e Design

Modos de Ver, Design e Comunicação, Lda

0874-4815

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Annual Report 2007

Government Debt and Cash Management

Abbreviations

BASBTCACaRCEDICCIRCPICSACTTCULDDSDGCIDUCEAFRDEAGFEAGGFEBTECECBEFFEMUEPEERDFESFEUEuroMTSFIFGGBRGDPHBHICPIEFPIGCPILBINEIRSISDAVATMEDIPOECDOEVTOMPOTSGPPOCPPRACEReposRTESEPASFASISIBSSPGTTARGETTEITSIRVAR

Bloomberg Auction SystemTreasury BillsSaving CertificatesCost-at-RiskSpecial Certificates of Government DebtCox-Ingersoll-RossConsumer Price IndexCredit Support AnnexPortuguese Postal ServicesSingle Settlement AccountDirect Debit SystemDirectorate-General for TaxationSingle Collection DocumentEuropean Agricultural Fund for Rural DevelopmentEuropean Agricultural Guarantee FundEuropean Agricultural Guidance and Guarantee FundTreasury Bill SpecialistsEuropean CommissionEuropean Central BankThe European Fisheries FundEuropean Monetary UnionPublic CorporationsEuropean Regional Development FundEuropean Social FundEuropean UnionPan-European Electronic Trading Platform for Government Benchmark BondsFinancial Instruments for Fisheries GuidanceGross Borrowing RequirementsGross Domestic ProductHomebankingHarmonised Index of Consumer PricesEmployment and Vocational Training InstituteInstituto de Gestão da Tesouraria e do Crédito PúblicoInflation-Linked BondNational Statistics InstituteInterest Rate SwapInternational Swaps and Derivatives AssociationValue Added TaxSpecial Market for Public DebtOrganisation for Economic Co-operation and DevelopmentPrimary Dealers of the Portuguese Government Bond MarketOther Auction ParticipantsPortuguese Fixed-Rate Government BondsStability and Growth PactOfficial Chart of Public AccountingCentral Government Restructuring ProgrammeRepurchase AgreementsGovernment Cash Management RegimeSingle Euro Payments AreaAutonomous Services and FundsIntegrated ServicesInterbank Service CompanyPortuguese Real-Time Gross Settlement SystemsTrans-European Automated Real-Time Gross Settlement Express TransferInterbank Electronic TransferTerm Structure of Interest RatesVector Autoregression

Contents

Introduction 4

15

10

16

38

62

12

26

42

63

32

45

63

49

64

76

90

82

77

77

94

84

101

108

37

61

89

81

99

Box - Financing Programme for 2008

Box - Primary Market Participants for 2008

The Economy and Financial Markets in 2007

Government Debt Market

Financing, Cash and Active Debt Management Operations

Direct Government Debt and Costs

Cash Management

Risk Management

International Environment

The Portuguese Economy

Box - Stability and Growth Programme 2007 - 2011

Euro area

The Portuguese Government Debt Management Stategy in 2007

The Primary Market of Portuguese Government Debt

The Secondary Market of Portuguese Government Debt

Financing Programme

Borrowing Requirements

Debt Buyback Programme

Financing Activity

Operations within the Framework of the Repo Facility

Active Debt Management Operations

Cash Management Operations

Direct Government Debt

Current Debt Costs

Box - Centralised Cash Management

Central Government Cash Accounts

Characterisation of the Debt Portfolio and Cost Indicators

Risk Indicators

Box - Model for Generating Interest Rate Scenarios

100

Introduction

T

!

!

aking into account the important changes that occurred throughout 2007, for the first time the annual

report includes not only the government debt management report, but also a reference to cash

management.

Decree-Law no. 273/2007 of July 30 brought about the reform of the central government's cash

management, centralising all activities related to the management of public funds in IGCP – Instituto de

Gestão da Tesouraria e do Crédito Público, I.P. and integrating them with government debt

management.

The integration of the central government's cash management in IGCP involved changing IGCP's

“business model” in order to bring it in line with the new functions and objectives that were defined. The

adaptation of the business model comprised five major steps:

Adopting a strategy to reduce cash surpluses so as to minimise the (consolidated) debt outstanding,

whilst keeping an optimal minimum level of cash balances, and to minimise the cost of government

debt (net of the return on cash investments), subject to pre-defined risk limits and controls;

Adopting an integrated view of the risks of both assets and liabilities impacting the benchmark

model and the Guidelines approved by the Ministry of Finance, namely with regard to the

refinancing risk, interest rate risk, and credit risk;

04 Government Debt and Cash Management | Annual Report 2007

!

!

!

Changing the financial instruments offered to public institutions, making it possible to improve the

efficiency of the overall financial management of the public sector by widening the range of

institutions with access to these instruments, by making their placement conditions more flexible

and by ensuring that the rate of return on these instruments is determined by the debt's marginal

cost;

Providing banking services by offering public institutions common banking operations, with the

exception of lending, so as to contribute to the reinforcement of centralised cash management;

Carrying out back-office operations, such as operational support to the participation in national

and international payment systems, as well as operations related to payments and receipts, and

accounting and control of all central government cash transactions.

These five steps designed to adapt the business model gave rise to changes in the legislation and

guidelines in force and, when relevant, to consultation and negotiation with market players.

Against this backdrop, the development in 2007 of actions aimed at reinforcing the centralisation of

public funds, within the framework of centralised cash management, take on particular relevance. This

process is aimed at using cash surpluses generated by public institutions to minimise the government

debt outstanding and thereby its cost. In this regard, IGCP managed to successfully reduce the daily

average cash surpluses.

With regard to the government debt management, it is important to note that the effective borrowing

needs in 2007 were significantly lower than the amount initially estimated (EUR 11.9 billion against EUR

15 billion), which made it possible to cancel one of the syndicated issues initially planned for the year.

The lower borrowing needs resulted from higher-than-expected tax revenues and the efficient use of

cash surpluses to reduce the debt outstanding. The only syndicated issue of 2007 – in the 10-year

maturity – was successfully launched in April with record demand.

The second half of 2007 was characterised by the onset of the turmoil in financial markets, which spilled

over to 2008, with no end in sight in the short term. In the Euro-zone government debt market, the

financial crisis has translated into a significant widening of spreads in most countries vis-à-vis the

German benchmark. Nonetheless, European government bond yields, including Portuguese yields, have

shown a downward trend. In this context, the market has proved to be highly volatile and less liquid of

late, making it difficult to anticipate financing conditions in the coming months.

This naturally gave rise to the need to adapt financing strategies to market conditions with a very

flexible approach in terms of maturities and execution strategies, in order to take advantage of windows

of opportunity, so as to obtain the best execution possible, in a context of very unstable market

Introduction

05Government Debt and Cash Management | Annual Report 2007

Introduction

conditions.

Finally, we would like to highlight the competence and motivation of IGCP's staff and the commitment

and demanding collaboration of the Advisory Board and the Supervisory Committee, which were the

mainstay of the results achieved and whose contribution is considered vital to meet the major challenges

of the forthcoming year. To all we extend our most heartfelt appreciation.

The Board of Directors

March 2008


Mission

T

!

!

!

he mission of Instituto de Gestão da Tesouraria e do Crédito Público, I.P. (IGCP)/Portuguese Treasury

and Government Debt Agency is to manage the cash and direct debt of the Portuguese Central

Government so as to:

Ensure stable Government financing and efficient management of the debt portfolio;

Minimize the cost of the government debt in a long-term perspective, in accordance with the risk

strategies defined by the Government;

Reduce the cash balances to acceptable minimum levels in view of the goal of reducing the debt

outstanding, thereby lowering the Government's financial costs.

It is also IGCP's mission to contribute towards the development of financial markets within the

framework of the duties assigned by the Ministry of Finance of carrying out the Government's economic

and financial policy.

As a provider of a service of public interest, IGCP is governed by principles of efficiency and rationality in

the management of resources, as well as of transparency and accountability in the pursuit of its activity.



Board of Directors

Advisory Board

Audit Committee

Alberto Manuel Sarmento Azevedo Soares

António Abel Sancho Pontes Correia

Luís Adriano Alberti de Varennes e Mendonça

(Chairman)

(Executive Director)


Alberto Manuel Sarmento Azevedo Soares

António Nogueira Leite

João Luís Correia Duque

José António Ferreira Machado

Maria Teodora Pereira Cardoso

José Agostinho de Matos

(Chairman)

José Martins de Sá

Pedro Leandro & António Belém, Offic auditor,

represented by

Pedro Manuel da Silva Leandro

Pedro Lage Raposo Braz Teixeira

(Chairman)



e

Statutory Bodies of IGCP


Organisation Chart

Board of Directors(CD)

Legal Affairs(GA)

Operations Department(AOP)

Customer Department(ACL)

Trading Room (NSM)Settlements Documentation

(SAO)Retail Debt (SDR)

Issuing and Markets (NEM) Accounting (SOC)Treasury AccountsManagement (SGT)

Accounts Control (SCC)Customer AccountsManagement (SGC)

Financial Control (NCF)

Research and Reporting(GES)

Administration (SGA)

ITC Systems (NSI)

Debt and Cash ManagementDepartment (AGDL)

Luis Quintaneiro

Rita Queiroz

Maria Luís Albuquerque Edite Gonçalves Carlos Gonçalves

Luciano SilvaFátima SilvaRosário Alcobia

Carla Silva

Ana Maria Santos Paulo LeiriaCélia Galrinho

Ana Boto Rui Nascimento Rita Granger

Financing Programme for 2008

10

I

!

!

n 2008, Portuguese Government debt management will continue to observe the principles of accuracy

and efficiency set out in the Debt Framework Law (Law no. 7/98, of 3 February), meeting the borrowing

requirements resulting from the execution of the budget, whilst pursuing the objectives of minimising

the long-term direct and indirect debt cost and of ensuring a balanced distribution of these costs over

different annual budgets, thereby preventing an excessive concentration of redemptions over time and

the exposure to excessive risks.

In addition, following the integration of the government debt and cash management in 2007, the

Financing Programme will also be aimed at adjusting the debt issuance to the time profile of the

borrowing needs so as to minimise cash balances, thereby contributing to reduce the debt stock and

costs. To meet this objective, IGCP will make more frequent use of short-term financing instruments,

which are flexible enough to achieve a more accurate matching between borrowing needs and financing

sources, so as to meet the goal of stable financing.

Setting up the conditions to promote market liquidity and the efficient functioning of the primary and

secondary market will remain a strategic objective.

In addition to the implementation of the Financing Programme, active debt management operations will

be carried out with the aim of adjusting the impact of the strategy defined to the debt portfolio's market

risk and of pursuing efficient management objectives.

The gross borrowing needs of the central Government, resulting from the Budget approved for 2008, are

expected to be approximately EUR 15.5 billion.

The strategy to be followed in 2008 takes into account the following main aspects:

The financing programme concentrates funding in the OT market, with a total issuance of between

EUR 10 and 12 billion. The borrowing needs to be financed via this market will be met with the

issuance of two new series, whose maturities and dates will be announced to the market in due time,

and with the reopening throughout the year of the new series and of other series issued in previous

years;

The net financing resulting from the issuance of BT should be positive in 2008 – around EUR 1 billion.

Six new lines will be launched during the year, in line with the BT programme in force since 2003,

which foresees the issue of 4 to 6 new lines each year. IGCP may also buy and sell BT via the OTC

market;

Government Debt and Cash Management | Annual Report 2007

11

!

!

!

The Republic will also resort to very short-term financing, using repurchase agreements and credit

lines, in order to increase the flexibility of the borrowing programme vis-à-vis changes in cash

needs. The remaining net financing will be met through the issuance of other non-marketable debt,

namely Saving Certificates and CEDIC;

The debt buyback programme initiated in 2001 will continue in 2008, with the main objective of

reducing the refinancing risk. The buyback auctions to be held will be announced in due time;

The management of interest-rate risk and the adjustment of the debt portfolio cost structure will be

carried out through the derivatives market.

As usual, IGCP will remain flexible to introduce adjustments to this programme as required by market

developments and by the Republic's financing needs throughout the year.


Financing Programme for 2008

12

Primary Market Participants for 2008

OT – GOVERNMENT BONDS

OEVT – Primary Dealers

ABN – Amro Bank, NV

Banco Espírito Santo, SA

Banco Santander Central Hispano

Barclays Capital, plc

Bayerische Hypo-und Vereinsbank, AG

BNP Paribas

Caixa Banco de Investimento, SA

Calyon

Citigroup Global Markets Limited

Deutsche Bank, AG

Goldman Sachs International

HSBC France

ING

Lehman Brothers International

Morgan Stanley & Co International

Société Générale

OMP – Other Auction Participants

Caixa Central de Crédito Agrícola Mútuo

Credit Suisse

Dresdner Bank

Millenniumbcp

Nomura International

BT – TREASURY BILLS

EBT – Treasury Bill Specialists

ABN – Amro Bank, NV

Banco Espírito Santo, SA

BNP Paribas

Caixa Geral de Depósitos, SA

Calyon

Citigroup Global Markets Limited

Deutsche Bank, AG

Dresdner Bank, AG

Goldman Sachs International

HSBC France

Millenniumbcp

Natixis



13

Primary Market Participants for 2008


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Montesinho Natural Park


15



Box - Stability and Growth Programme 2007- 2011

16

26

32

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The world economy continued to grow briskly in 2007, with an estimated annual average growth of 1approximately 5.1 per cent , 0.3 percentage points lower than in the previous year. Euro area and US

growth slowed down to 2.5 and 2.1 per cent respectively (a 0.2 and 0.8 percentage point decline), while 2in Japan GDP decelerated by 0.3 percentage points to 1.9 per cent . This slowdown was more pronounced

in the second half of the year, which was accompanied by turbulence in financial markets.

While growth was less dynamic than in 2006, the output gap improved in both the Euro area and Japan.

In the Euro area, the output gap remained in negative territory but narrowed from -0.9 to -0.3 per cent 3of potential GDP .


1 European Commission, Autumn Forecasts, November 2007.2

European Commission, Autumn Forecasts, November 2007.3

OECD, Economic Outlook No. 82, December 2007.


Government Debt and Cash Management | Annual Report 2007 17


REAL GDP GROWTH

Annual growth rate Output gap

Source: European Commission and OECD

In the US economy, domestic demand was the main driver of growth, while contrary to 2006, net exports

made a positive contribution to GDP. By contrast, the modest slowdown in the Euro area was a result of a

deceleration of exports, with domestic demand's contribution to growth practically unchanged from

the previous year.

Most European countries experienced a slowdown in economic activity, with the exception of Portugal,

where GDP growth picked up from 1.3 to 1.9 per cent in 2007. Slovenia was the most dynamic economy

(6.0 per cent) in EMU, followed by Luxemburg and Ireland, with 5.2 and 4.9 per cent growth respectively.

According to the European Commission's autumn forecasts, global growth will continue to decelerate in

2008, not only in the main economic areas, but also, to a lesser extent, in emerging market economies.

The EC expects GDP to grow by 1.7 and 2.2 per cent in the US and the Euro area, respectively, while

maintaining a 1.9 per cent pace in Japan.

Oil and other commodity prices rose in 2007, fuelled by rising world demand, particularly from China

and the US, limited spare capacity and growing geo-political tensions. Brent prices increased

throughout the year, with the price per barrel remaining above USD 85 in November and December,

peaking at above-USD 96 levels.

-1

0

1

2

3

4

5

1999 2001 2003 2005 2007 E

%

Euro area US Japan

-3

-2

-1

0

1

2

3

1999 2001 2003 2005 2007 E

Euro area US Japan

As % of potencial GDP

18

REAL GDP GROWTH IN THE EURO AREA

2006 2007 E

Source: European Commission

Annual average consumer prices decelerated in the US and the Euro area during the first eight months of

the year, subsequently accelerating, primarily as a result of rising energy and food prices in international

markets. In the US, year-on-year headline inflation accelerated to 4.1 per cent in December (1.6

percentage points above end-2006 levels), although in annual average terms inflation dropped from 3.2

to 2.9 per cent. In the Euro area, the year-on-year HICP remained above 2.0 per cent in the last quarter of

2007, while in annual average terms inflation was 2.1 per cent, 0.1 percentage points lower than in 2006.

US core inflation, which excludes energy and food prices, decelerated throughout the year in annual

average terms, dropping by 0.2 percentage points to 2.3 per cent in 2007. The year-on-year rate reached

2.4 per cent in December, 0.2 percentage points lower than in 2006. On the other hand, core inflation in

the Euro area, which excludes energy, food, alcohol and tobacco, accelerated during the year, reaching

1.9 per cent in December 2007, up from 1.4 per cent at end-2006.

With regard to public finances, progress was seen overall in terms of budget consolidation, although

most countries continued to show budget deficits. In Japan, the budget deficit narrowed by 0.6

percentage points to 4.0 per cent of GDP, while in the US the deficit widened slightly from 2.6 to 2.7 per

cent of GDP.

-1

0

1

2

3

4

5

6

7

POR ITA FRA GER Euroarea

NET BEL AUS SPA GRE FIN IRE LUX ESL

%



19

PRICE DEVELOPMENTS

Core inflation

Source: Reuters and Eurostat

Inflation and oil prices

Jan2005

Jun2005

Nov2005

Apr2006

Sep2006

Feb2007

Jul2007

Dec2007

YoY inflation rate (%)

Euro area (HICP) US (CPI) Brent (USD)

Jan2005

Jun2005

Nov2005

Apr2006

Sep2006

Feb2007

Jul2007

Dec2007

YoY inflation rate (%) Price/Crude per barrel

In the Euro area, the budget deficit is expected to narrow for the fourth consecutive year, reaching 0.8

per cent of GDP (equivalent to a 0.7 percentage point decline). In structural terms, the cyclically-

adjusted budget deficit is expected to narrow by 0.5 percentage points to 0.7 per cent of GDP, reflecting

a less expansionary stance of budgetary policy. The cyclically-adjusted primary surplus also improved in

2007, reaching 2.2 per cent of GDP (up from 1.6 per cent in 2006). As a result of this improvement in the

budget balance, the debt-to-GDP ratio dropped in 2007 to 66.5 per cent, a 2.1 percentage point decline

from end-2006.

In 2007, ECB and Federal Reserve intervention rates diverged. In the US, the Federal Reserve held the Fed

Funds rate at 5.25 per cent until August 2007 (unchanged since June 2006), but following the turmoil in

housing, money and capital markets, the Fed cut interest rates by 50, 25 and 25 basis points in the

September, October and December meetings respectively, amounting to a 100 basis points reduction, in

view of the potential negative spillover effects of this turmoil to the real economy.

1

2

3

4

5

25

40

55

70

85

100

1.0

1.5

2.0

2.5

3.0



Euro area (HICP) US (CPI)

20

Government debt

Budget deficit

BUDGET DEFICIT AND GOVERNMENT DEBT IN 2007(as % of GDP)

Source: European Commission

The ECB on the other hand continued to raise its main refinancing rate, with two 25 basis point hikes in

the March and June meetings, thus accumulating an additional 0.5 percentage point tightening, in the

context of above-trend growth and the strong dynamism of monetary and credit aggregates. However,

the tightening of monetary conditions by the ECB was interrupted following the subprime crises in the

US and the financial market turmoil.

In the UK, the Bank of England tightened monetary policy by 25 basis points in the January, May and July

meetings, raising its base rate to 5.75 per cent. However, given the signs of slowdown in economic

activity, the central bank subsequently cut rates by 25 basis points in December to 5.5 per cent.

In Japan, the central bank hiked its main intervention rates from 0.25 to 0.5 per cent in February 2007.

In the US, 2-year Treasury yields remained within a fairly narrow range of between 4.5 and 5.0 per cent

during the first half of the year. Nevertheless, following the turmoil in mortgage and subprime markets

and the easing of monetary policy as from September, 2-year yields fell to 4.0 per cent. The drop was

more pronounced in the last three months of the year, reaching 92 basis points. At year-end yields stood

at 3.1 per cent.

-5.0

-3.5

-2.0

-0.5

1.0

2.5

4.0

5.5

0 30 60 90 120 150 180

LUX

FIN

IRE

POR

FRA

GRE

ITA

BELNET

SPA

AUS

GER

Euroarea

US

JAP

ESL



21

%

ECB FED Bank of england

Dec2003

Apr2004

Aug2004

Dec2004

Apr2005

Aug2005

Dec2005

Apr2006

Aug2006

Dec2006

Apr2007

Aug2007

Dec2007

CENTRAL BANK INTERVENTION RATES

Source: Reuters

In the Euro area, 2-year bond yields were little changed in the first three months of the year, ranging

between 3.81 and 3.96 per cent. Yields increased during the second quarter, reaching 4.45 per cent at

the end of June, up 0.45 percentage points from the first quarter. But as a result of rising uncertainty in

international markets, 2-year yields dropped again (turning more volatile) in the third quarter to 4.04

per cent. In the last three months of the year and despite unchanged monetary policy, these yields were

highly volatile, ranging between 3.65 and 4.24 per cent.

Long-term bond yields followed a path similar to that of short-term yields. In line with the trend

observed in late 2006, in January 2007 10-year Treasury and Bund yields saw a modest increase,

primarily fuelled by a favourable economic outlook. By early February, however, investors started to

scale down their expectations of a Fed tightening and there were growing concerns that the US

slowdown could prove more protracted than previously anticipated. As a result, long-term yields started

to drop, particularly in the US. The negative mood intensified after former Fed-chairman Alan

Greenspan commented on a possible recession in the US in the short run. In a context of falling equity

markets and the re-pricing of risk, the flight-to-safety move boosted demand for government bonds.

Although long-term Treasury and Bund yields were somewhat synchronised in the first three months of

the year, when compared to the end of the year, the former dropped 5 basis points to 4.65 per cent, while

the latter increased 9 basis points to 4.05 per cent.

In the second quarter, long-term Treasuries and Bunds saw a sharp sell-off, with 10-year yields reaching

0

2

4

6



22

five-year records. In the US, 10-year yields jumped 38 basis points to 5.03 per cent at the end of June.

Following a period of moderate growth in the first three months of the year, favourable data pointed to

a pick-up in economic activity, leading to a change in markets' perception of monetary policy with

growing anticipation of further Fed tightening. In the Euro area, the robust growth environment and

inflation concerns expressed by members of the Governing Council of the ECB led to a more pronounced

increase of 10-year Bund yields, which jumped 51 basis points to 4.56 per cent at the end of the quarter.

Between July and September, 10-year Treasury yields plunged 44 basis points, thereby totally reversing

the increase in the second quarter, while 10-year Bunds dropped 23 basis points to 4.34 per cent.

However, during the third quarter there were two different periods worthy of note. The first two months

were characterised by some instability in financial markets, which led to a fall in both US and European

bond yields. This was the result of a continued deterioration of the US housing market and growing

uncertainty on the size and distribution of the losses associated to financial institutions' exposure to

investments in the US subprime mortgage sector, which led to a rise in risk aversion and a flight-to-

quality move from riskier assets to more liquid instruments. By contrast, in September 10-year yields

increased slightly on both sides of the Atlantic against a backdrop of gains in equity markets and

following the 50 basis points cut in the Fed Funds rate.

By the end of November, 10-year Treasury and Bund yields had resumed their downward trend,

particularly evident in the former. This was essentially due to investors' concerns with the economic

outlook, particularly in the US, in a context of rising oil prices and financial market turmoil, given

growing evidence of the severe consequences of certain financial institutions' exposure to the subprime

sector. Finally, in December, economic data suggesting a new rise in inflationary pressures and evidence

of stabilisation in equity and credit markets helped to bring 10-year yields back up. In the case of

Treasuries, the increase in yields only partially reversed the drop of the previous two months, so that at

year-end yields were at 4.03 per cent, still 56 basis points below the level of late September. Ten-year

Bunds on the other hand ended the year close to September levels at 4.35 per cent.

As a result, the 10-year spread between Bunds and Treasuries, which was 75 basis points at end-2006,

narrowed throughout 2007, reaching negative territory in the last quarter of the year (-32 basis points).

This negative spread resulted from the fact that Treasury yields dropped more sharply than Bund yields

and the latter bounced back more significantly afterwards.



23

Spread (US Treasury-Bund) Bund US Treasury Treasury Gilt

Jan2005

Jul2005

Jan2006

Jul2006

Jan2007

Jul2007

Jan2008

Jan2005

Jul2005

Jan2006

Jul2006

Jan2007

Jul2007

Jan2008

LONG-TERM INTEREST RATES(10-year government bonds)

Correlation vs. Bund (10 years)

Source: Reuters

Long-term yield

Correlation (of last 60 observations)

% b.p.

2

3

4

5

6

-75

0

75

150

225

-0.50

-0.25

0.00

0.25

0.50

0.75

1.00



For the year as a whole, the slope of the yield curve, as measured by the spread between 10 and 2-year

yields, increased on both sides of the Atlantic. In the US, the yield curve steepened significantly from a

slight inversion of -12 basis points at the end of 2006 to 97 basis points in December 2007, mainly as a

result of sharp gains in two-year Treasury bonds. In the Euro area, the steepening of the yield curve was

more modest – approximately 27 basis points – with the spread between 10 and 2-year yields reaching

34 basis points at the end of 2007, mainly due to the underperformance of 10-year bonds.

24

Spread Spread31 Dec 2006 31 Dec 200631 Dec 2007 31 Dec 2007

1 y

ear

2 y

ears

5 y

ears

10 y

ears

2 y

ears

5 y

ears

10 y

ears

% %b.p. b.p.

TERM STRUCTURE OF INTEREST RATES

Euro area US

Source: Reuters

The 10-year spread between government bond yields and swap rates (swap spreads) widened in both the

US and the Euro area. In the US, the swap spread increased 16 basis points during 2007, reaching 62 basis

points in December. In Germany, swap spreads rose by 12 basis points to 37 basis points. This widening

was primarily explained by the turmoil observed in the credit and money markets and growing risk

aversion.

In a context of robust global growth, equity markets had an overall positive year in 2007, in tandem with

the previous year's performance. However, equities went through periods of great instability, where

prices dropped quite dramatically as a result of investors' growing concerns with the US housing market

crises, particularly in the subprime sector. In Germany, the Xetra Dax was up 22.3 per cent, whereas in the

US the S&P 500 and the Nasdaq gained 3.5 and 18.7 per cent respectively.

Bond markets on the other hand had different performances in the US and Germany. In the former, the

government bond index (FTSE GovTop) was up 4.2 per cent, while in the latter the index was down 2.1 per

cent.

3.0

3.5

4.0

4.5

5.0

5.5

-200

-160

-120

-80

-40

0

40

80

120

3.0

3.5

4.0

4.5

5.0

5.5

-200

-160

-120

-80

-40

0

40

80

120



25

Germany (FTSE GovTop Price vs Xetra Dax) US (FTSE GovTop Price vs S&P 500)

Price index: Government bonds/equility (31 Dec 2003=100)

Jan2004

Jul2004

Dec2004

Jun2005

Dec2005

Jun2006

Dec2006

Jun2007

Dec2007

RELATIVE PERFORMANCE OF EQUITY AND BOND MARKETS

Source: Reuters

In the foreign exchange market, the Euro continued to strengthen against the Dollar, reaching USD 1.46

in December 2007, up 10.5 per cent from end-2006. The key factors supporting the single currency were

the narrowing of the interest rate spread between the US and Euro area as well as the more negative

outlook for US economic growth.

The Euro also strengthened against the Pound, with the EUR/GBP gaining 9.1 per cent in nominal terms,

reaching 0.74 at year-end. Against the Yen, the Euro strengthened only modestly, the EUR/JPY gaining

3.4 per cent to 162.55.

In nominal effective terms, the single currency appreciated approximately 4.7 per cent in 2007.

40

60

80

100

120



26

Index: 31 Dec 2003 = 100

Source: Reuters

Jan2004

May2004

Sep2004

May2005

Dec2004

Aug2005

Dec2005

May2006

Sep2006

Jan2007

May2007

Sep2007

Jan2008

EUR / USD EUR / JPY EUR / GBP

EURO EXCHANGE RATES


T 4he Portuguese economy grew 1.9 per cent in 2007 , a 0.6 percentage point acceleration from the 5previous year . Business investment and the export sector were the main drivers of this acceleration,

which was unable to prevent a further deterioration of the labour market.

Both the monetary and fiscal policy influenced the Portuguese economy in 2007. The external

environment was characterised by rising short-term interest rates, essentially resulting from the

tightening of the ECB monetary policy, while the internal environment remained conditioned by a

restrictive budgetary policy, associated to the ongoing consolidation of public finances.

According to the European Commission's growth forecast for the Euro area of 2.5 per cent in 2007,

Portugal's growth rate continued to diverge from the European average (by 0.6 percentage points),

although to a lesser extent than in the previous year (1.6 percentage points).

4 National Statistics Institute (INE), Quarterly national accounts (February 2008).

5 Quarterly national accounts (February 2008) of INE point to a 1.3 per cent growth in 2006.

90

95

100

105

110

115

120

125

130



27

The breakdown of spending components shows that domestic demand made a significant contribution

to growth, amounting to 1.4 percentage points, up from 0.2 percentage points in 2006. This was mainly a

result of the pick-up in investment (which had been negative in the last few years) brought about by an

improvement in business confidence in services and manufacturing. Private consumption continued to

grow at a moderate pace, given the increase in the unemployment rate and the rise in short-term

interest rates. Government consumption was unchanged in real terms after falling 0.7 per cent in 2006.

Net exports had a positive contribution to growth of 0.6 percentage points, which was nevertheless 0.4

percentage points lower than in the previous year. This was essentially associated to a deceleration of

exports, against a backdrop of a slowing down in international trade.

According to Banco de Portugal forecasts, the economy is expected to continue to recover in 2008, with

growth reaching 2.0 per cent, similarly to the European Commissions' outlook for the Euro area as a

whole. Net exports' contribution to GDP should reduce somewhat, due to a slowdown in exports, while

domestic demand, particularly business investment, is expected to accelerate further.

Labour market conditions should continue to deteriorate. The unemployment rate reached 8.0 per cent

of the labour force in 2007, equivalent to a 0.3 percentage point year-on-year increase. Sluggish growth

momentum and the restructuring of economic activities contributed to the upward pressure on

unemployment.

Euro area Portugal Domestic demand Net exports GDP

% %

Portugal's GDP - breakdownAnnual growth rate

REAL GDP GROWTH AND DEMAND COMPONENTS

Source: European Commission, National Statistics Institute (INE) and Banco de Portugal

-2

-1

0

1

2

3

4

5

1998 2001 2004 2007E

-4

-2

0

2

4

6

8

1998 2001 2004 2007E



28

Headline inflation, as measured by the HICP, reached 2.4 per cent in 2007, down 0.6 percentage points

from 2006. This decline resulted from a deceleration in energy prices, as well as from slower growth in

both labour costs per unit produced in the private sector and in import and consumer goods' prices. The

significant decline in the energy cost's contribution to the 2007 inflation rate resulted from a positive

base effect associated to the elevated levels of oil prices in the same period of 2006. Portuguese inflation

was 0.3 percentage points above the Euro area average, therefore narrowing the gap between the two,

which was 0.8 percentage points in 2006.

In terms of public finances, the commitment of the Portuguese Government to meet a medium-term

structural deficit of 0.5 per cent of GDP in 2010 has led to a cut in public spending since 2005. In 2007,

public spending as a percentage of GDP dropped by 1 percentage point when compared to 2006. Total

revenue declined modestly as a percentage of growth (from 41.4 to 41 per cent), although tax revenue

increased by 0.4 percentage points of GDP, due to a more effective tax collection by the tax

administration.

On a National Account basis, the public administration deficit was probably 3 per cent of GDP in 2007, a

0.9 percentage point drop from 2006. If confirmed, this would mean that in 2007 Portugal would meet

the 3 per cent limit for the deficit of the Stability and Growth Pact (SGP).

Spread Euro area Portugal

INFLATION RATE

Source: Eurostat

-1

0

1

2

3

4

5

Jan-0

2

Apr-

02

Jul-

02

Oct

-02

Jan-0

3

Apr-

03

Jul-

03

Oct

-03

Jan-0

4

Apr-

04

Jul-

04

Oct

-04

Jan-0

5

Apr-

05

Jul-

05

Oct

-05

Jan-0

6

Apr-

06

Jul-

06

Oct

-06

Jan-0

7

Apr-

07

Jul-

07

Oct

-07

Annual average HICP (%)



29

6According to the Stability and Growth Programme for 2007-2011 , the cyclically adjusted deficit of

public administrations is expected to be 2 per cent of GDP in 2007, down from 2.8 per cent in 2006. In

this programme, the Government said that it expects the cyclically adjusted budget deficit to reach 0.4

per cent of GDP by 2010, reiterating its commitment to the consolidation of public finances.

6 See box on the Stability and Growth Programme

Government debt (right) Budget deficit (left) Cyclically adjusted budget deficit (left)

As % of GDPAs % of GDP

BUDGET DEFICIT AND GOVERNMENT DEBT IN PORTUGAL

Source: European Commission and Ministry of Finance and Public Administration

0

1

2

3

4

5

6

7

2003 2004 2005 2006 2007E

52

55

58

61

64

67

70



The improvement in the budget deficit, particularly the primary deficit, against a backdrop of growth

acceleration led to a decline in the debt-to-GDP ratio. This ratio is expected to have reached 64.4 per

cent of GDP in 2007 (0.4 percentage points less than in 2006). For the Euro area as a whole, the debt-to-

GDP ratio reduced by 2.1 percentage points to 66.5 per cent at the end of 2007.

Following the trend initiated in 2005 and in tandem with Greek and Italian government bonds, the 10-

year interpolated spread of Portuguese Government bonds (OT) versus German Bunds continued to

widen during 2007, reaching 20.7 basis points at year-end, up from 16.9 basis points in January. In the

same period, the OT swap spread increased more significantly, from 6.7 to 18.9 basis points.

30

Long-term government bond yields increased in most advanced economies during the first six months of

2007, but this trend was subsequently reversed. In this context, the price of Portuguese government 7bonds was down 2 per cent year-on-year at the end of 2007, thus slightly outperforming EMU countries

as a whole (2.4 per cent). By contrast, US Treasuries gained 4.2 per cent.

International equity markets had a positive performance in the first semester. But following the turmoil

in financial markets, equities were under pressure in the third quarter. In the second half of September

and in the first half of October, equity markets recovered some of these losses, as volatility eased

somewhat. Nevertheless, the PSI 20 index gained approximately 16.3 per cent in 2007, significantly

outperforming the European global index Euronext (3.4 per cent).

Euro area EuronextUS S&P 500Portugal PSI 20

Jan-0

3

May

-03

Sep-0

3

Jan-0

4

May

-04

Sep-0

4

Jan-0

5

May

-05

Sep-0

5

Jan-0

6

May

-06

Sep-0

6

Jan-0

7

May

-07

Sep-0

7

Jan-0

8

FINANCIAL MARKETS

Government Bond indices Equity indices

Source: Reuters

Index: 31 Dec 2002=100 Index: 31 Dec 2002=100

7 According to the FTSE GovTop bond index.

90

95

100

105

110

Jan-0

3

May

-03

Sep-0

3

Jan-0

4

May

-04

Sep-0

4

Jan-0

5

May

-05

Sep-0

5

Jan-0

6

May

-06

Sep-0

6

Jan-0

7

May

-07

Sep-0

7

Jan-0

8

60

80

100

120

140

160

180

200

220

240





32

According to the so-called “preventive arm” of the Stability and Growth Pact (SGP), every year all Euro

area countries have to submit an updated version of their Stability Programme to the Commission and

Council. This update has to include a medium-term goal for the budgetary position, which should meet

the following two conditions: on the one hand, it must be sufficiently conservative so as to prevent the

deficit from rising above 3 per cent of GDP should the economy experience a cyclical downturn. On the

other, it must ensure the long-term sustainability of public finances.

After Portugal recorded a 6.1 per cent deficit of public administrations in 2005, the “preventive arm” led

the Council to start an excessive deficit procedure, recommending that measures should be adopted in

order to correct the deficit by 2008.

In the December 2007 update, Portugal is expected to present a global deficit of 3 per cent of GDP,

therefore correcting the excessive deficit before the deadline imposed by the Council.

The macroeconomic scenario of the Programme points to a progressive acceleration of GDP growth in

the 2007-2011 period, starting from an estimated 1.8 per cent real growth rate in 2007, reaching 3.0 per

cent in 2010, and an unchanged pace in the following year.

Economic activity is expected to be supported by domestic demand, which should gradually replace net

exports as the main driver of growth. Investment, particularly business investment, is expected to be the

key driver of GDP, benefiting from robust exports, which should reflect competitiveness gains brought

about by wage moderation and the restructuring of economic activities.

Private consumption should grow moderately in 2008 and accelerate afterwards, based on employment

gains and the stabilisation of interest rates. At the end of the Programme's period it is expected to

accelerate to 2.4 per cent.

The inflation rate is expected to remain stable at around 2.1 per cent until 2011.


Stability and Growth Programme 2007- 2011

33

In terms of public finances, the Programme's main objective is to bring down the budget deficit, first

towards the 3 per cent limit of GDP and later to a balanced budget, which is expected to be reached in

2011. The path for improving the primary balance should be similar, as the effort to bring down the

deficit will essentially be concentrated in curbing primary current spending via the restructuring of

Central Government services and by a tight control over social security and health sector spending.

The structural deficit is expected to improve from 2.1 per cent of GDP in 2007 to 0.4 per cent in 2010,

with an annual average decline of 0.6 percentage points of GDP during this period. In 2011, the last year

of the Programme, the structural deficit is expected to be identical to that of 2010.

In tandem with budgetary consolidation and as result of growth acceleration and a channelling of the

largest share of companies' privatisation revenue to debt redemption, the debt-to-GDP ratio is expected

to reduce by 7.7 percentage points between 2007 and 2011, when it should reach 56.7, below the limit

of the SGP.

MAIN MACROECONOMIC ASSUMPTIONS(as a percentage)

Source: Ministry of Finance and Public Administration – Stability and Growth Programme 2007-2011, December 2007.

GDP

Private consumption

Government consumption

Gross fixed capital formation

Exports of goods and services

Imports of goods and services

Growth of relevant external demand

Oil price (Brent, USD per barrel)

Short-term interest rate (annual average)

Long-term interest rate (annual average)

EUR/USD exchange rate (annual average)

2007 2008 2009 2010 2011



1.8

1.2

-0.4

1.0

6.9

3.8

6.8

72.5

4.3

4.4

1.36

2.2

1.4

-1.1

4.0

6.7

3.9

6.2

80.8

4.2

4.4

1.42

2.8

2.1

-0.6

6.7

6.0

4.8

5.8

77.9

4.2

4.4

1.42

3.0

2.3

-0.3

7.0

6.3

5.6

5.8

77.9

4.0

4.2

1.42

3.0

2.4

1.1

7.2

6.5

6.6

5.8

77.9

4.0

4.2

1.42

34

PUBLIC FINANCES: MEDIUM-TERM FORECASTS(as a percentage of GDP)

Source: Ministry of Finance and Public Administration – Stability and Growth Programme 2007-2011, December 2007.

Total expenditure

Interest

Gross fixed capital formation

Total revenue

Total balance

Primary balance

Government debt

Total structural balance

Cyclically-adjusted primary balance

2007 2008 2009 2010 2011



45.4

2.9

2.2

42.4

-3.0

-0.1

64.4

-2.1

0.9

45.1

2.9

2.2

42.7

-2.4

0.5

64.1

-1.6

1.3

44.4

2.8

2.3

42.8

-1.5

1.3

62.5

-1.1

1.7

43.5

2.7

2.4

43.1

-0.4

2.2

59.7

-0.4

2.3

43.3

2.7

2.6

43.1

-0.2

2.5

56.7

-0.4

2.2



4647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873837664339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339846479896543398729687693673894878108876382982537208265765866432039802764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611

International Douro Natural Park


37Euro Area

The Portuguese Government Debt Management Strategy in 2007



Yields overview

Strategic objectives

Government bond market – OT

Spreads

Euro area issuance

Financing strategy

The Treasury Bill market – BT

Turnover

38

42

45

49

38

42

46

49

40

43

48

52

464798965433987296876936738948781088763829825372082657658664320398027643865291064387611229876550873837664798965433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738

38

Euro Area

Yields overview

Medium and long-term government bond yields increased in the Euro area in 2007 while they fell in the

US, when compared to 2006. But the upward trend in the Euro area was not uniform throughout the

year: although 10-year Bund yields climbed from 3.95 per cent at the start of the year to a peak of 4.70

per cent in June, they ended the year at 4.35 per cent, 40 basis points above the end-2006 level

The rise in the European government bond yields, particularly in long-term maturities, led to a

steepening of the yield curve. By contrast, in the US the steepening of the yield curve (2-10 years) was

mainly a result of a significant decline in short-term yields. In this context, the spread between the 10-

year benchmark Bund and 2-year Schatz started the year at 4.2 basis points and ended at 34.5 basis

points. In the US, the curve steepening was much more pronounced, with the spread between the 10-

and 2-year benchmark Treasuries jumping from -10.6 basis points at the beginning of 2007 (inverted

yield curve) to +97 basis points at the end of December.



39

Source: Bloomberg

THE SWAP CURVE

3M

6M 1Y

2Y

3Y

4Y

5Y

6Y

7Y

8Y

9Y

10Y

20Y

15Y

30Y

% b.p.

Change (right) 28-12-2007 (left) 02-01-2007 (left)

Source: Bloomberg

THE BUND CURVE

3M

6M 1Y 2Y

3Y

4Y

5Y

6Y

7Y

8Y

9Y

10Y

20Y

30Y

% b.p.

Change (right) 28-12-2007 (left) 02-01-2007 (left)

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

0

40

80

120

160

200

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

0

40

80

120

160

200



40

Euro area issuance

Total gross issuance of Euro area sovereigns in the government bond market amounted to approximately

EUR 520 billion in 2007. Nominal bond issuance, i.e. excluding inflation linked bonds (ILB) and floating

rate notes issued by the Republic of Italy, accounted for approximately 89 per cent of this total, while ILB

issues represented approximately 7 per cent. As in the previous year, the three largest sovereign issuers –

Germany, Italy and France – were responsible for about 73 per cent of the primary government bond

market (nominal segment).

In 2007, the Republic of Portugal accounted for approximately 1.9 per cent of the gross bond issuance of 1Euro area sovereigns in 2006, which was slightly less than the amount issued in the previous year (2.7

per cent). This decline reflects less borrowing requirements as well as the minimisation of cash surpluses.

Throughout 2007, the spread between swap rates and government bond yields (swap spread) widened,

primarily as a result of growing risk aversion, following the US housing market crises which boosted

investors' demand for government bonds (lower risk), therefore significantly widening the gap between

government yields and swap rates for similar maturities.

GOVERNMENT BOND ISSUANCE IN EUROS IN 2007

Source: IGCP and OEVT

1 Excluding the issuance of Inflation Linked Bonds (ILB) and CCT (floating rate notes) by Italy.



Italy - 24.8%

Germany - 29.7%

France - 18.6%

Greece - 5.8%

Spain - 5%

Belgium - 4.9%

Netherlands - 4.5%

Austria - 3.8%

Portugal - 1.9%

Finland - 1.1%

41

In the euro debt market, the Republic of Portugal is a small sovereign issuer competing with other

sovereigns, agencies and supranational agencies for the same market, as well as the same investor base,

in an environment characterised by the supply of homogeneous financial products, issued according to

harmonised procedures and traded in efficient and transparent market structures.

In a context of the homogenization of the financing strategies of Euro area sovereigns, namely as

regards issuance methods, types of instruments, market practices and conventions, the main

developments of the Euro sovereign debt market in 2007 were an increase in the amount of issuance in

the 5- to 10-year bucket (+3.2 percentage points) and in the long-term segment of above-20-year

maturities (+1.7 percentage points). In the latter, the new 30-year sovereign issues by Germany, Italy,

Spain, Austria and Greece are worth noting. Greece launched the benchmark with the longest maturity:

September 2040.

Source: IGCP, OEVT and websites of Euro area sovereign issuers

EURO GOVERNMENT BOND ISSUANCE BY MATURITY

2003 2004 2005 2006 2007

%

In 2007, the issuance of inflation-linked bonds was similar to that seen in 2006. Germany, France, Italy

and Greece continued to be present in this particular market segment. When compared to the previous

year, total issuance by the Greek Treasury increased by +4.5 percentage points, while issuance by the

German Treasury dropped by 6.1 percentage points.

With regard to issuance methods, the weight of debt placed by syndicate as a percentage of total

issuance was similar to that of 2006.

0

5

10

15

20

25

30

35

40

2 - 5 years 5 - 10 years 10 - 15 years 15 - 20 years more than 20 years



42

The Portuguese Government Debt Management Strategy in 2007

Strategic objectives

In 2007, the Portuguese Government debt management naturally continued to observe the principles of

accuracy and efficiency set out in the Debt Framework Law (Law no. 7/98 of 3 February), ensuring the

funding necessary for the execution of the budget and pursuing the goals of direct and indirect cost

minimization in a long-term perspective, whilst smoothing their distribution over several annual

budgets and preventing an excessive concentration of redemptions over time and the exposure to

excessive risks.

The structural objectives foreseen in the Law have been translated into a set of guidelines approved by

the Government for debt and cash management. These guidelines have established a benchmark

portfolio from which quantified goals for expected debt costs (net of revenues) are obtained, as well as

limits for the risks that can be taken by the management.

With the integration of the government debt management with the cash management in 2007, the

annual Financing Programme included as a by-product of the debt management strategy two additional

components which follow from the objectives of cost minimization and risk containment: a strategy for

reducing cash surpluses and a strategy for managing the investment of cash surpluses. By reducing cash

balances it was possible to limit the increase of the debt stock and therefore its cost. The management of

cash surpluses was aimed at maximizing the return of the investment of the amounts remaining after

debt reductions. These amounts are naturally the result of the difficulty of obtaining a perfect match

between cash needs and financing on a daily basis.

In order to meet the strategic goals of the government debt management, IGCP continued to promote

the efficient functioning of the primary and secondary markets of Portuguese government debt, whilst

maintaining a policy of transparency and predictability in the financing of the Republic,

notwithstanding the need to ensure the necessary flexibility to adapt the financing amounts to the real

borrowing needs. The active management of the debt portfolio was carried out through the derivatives

market (namely through interest rate swaps) with the objective of minimizing the debt cost and

adjusting the portfolio risks to the goals and limits resulting from the guidelines and the benchmark

approved for the management.



43

Financing strategy

The management of the Portuguese government debt is based on a financing strategy focused on the

development of a liquid yield curve in the Euro sovereign debt market, using the most advanced

technical infrastructures in the primary and secondary markets. This strategy is based on the use of

standard instruments and issuance methods; an international distribution network which includes a

group of financial intermediaries with renowned capacity to place and trade Portuguese government

debt; a secondary market driven by a wholesale segment among specialists and supported by market

making obligations (MEDIP – Special Market for Public Debt); and the active marketing of Portuguese

government debt among final investors.

In 2007, financing was once again concentrated in OT issuance and the roll-over of BT lines. Although

two new OT series were expected to be launched throughout the year, IGCP decided to start only a new

10-year benchmark in view of the better-than-expected budgetary results. The remaining OT borrowing

needs were met via the reopening of old series. As a result, most OT series have now reached an

outstanding of EUR 6 billion, which should help to promote their liquidity in the secondary market and

the interest of international investors.

PORTUGUESE GOVERNMENT BOND YIELD CURVE AT END-2007

Benchmarks issued before 2007 Benchmarks issued in 2007

yields Outstanding (EUR million)

BT

Jan

2008

BT

Mar

2008

BT

May

2008

BT

Sep

2008

BT

Nov

2008

OT

Jul

2009

OT

May

2010

OT

Apr

2011

OT

Jun

2011

OT

Jun

2012

OT

Sep

2013

OT

Jun

2014

OT

Oct

2015

OT

Oct

2016

OT

Oct

2017

OT

Apr

2021

OT

Apr

2037

3.0%

3.5%

4.0%

4.5%

5.0%

0

2,000

4,000

6,000



38% OT 68% OT 69% OT

38% Others 7% Others 7% Others

21% Retail (CA) 16% Retail (CA) 16% Retail (CA)

3% BT 9% BT 8% BT

44

At the end of 2007, the outstanding of BT was approximately EUR 9.4 billion, corresponding to five lines

which will naturally mature during 2008. As announced to the market, following prior consultation with

Treasury bill Specialists (EBT), no new line was launched in July so as not to excessively concentrate

redemptions at the beginning of the summer of 2008, as two OT series will mature in June and July of this

year.

Other non-marketable instruments – Saving Certificates and CEDIC – offered a positive contribution to

the annual borrowing needs.

Once again, temporary cash needs continued to be met with very short-term instruments, namely

through the repo market, which is a cost-effective and flexible alternative. The credit lines held with

Primary Dealers (OEVT) were also used.

DEBT STOCK STRUCTURE BY TYPE OF INSTRUMENT

1998 2006 2007



45

FINANCING STRUCTURE BY TYPE OF INSTRUMENT

%

OT BT (net issuance) Repos (net issuance) Others ( )net issuance

-40

-20

0

20

40

60

80

100

120

140

1999 2000 2001 2002 2003 2004 2005 2006 2007


The main components of the annual financing programme were announced to the market at the start of

2007. Following the guidelines of this programme, priority was given to the setting up and maintenance

of conditions necessary to develop the Portuguese government yield curve and to increase the liquidity

and efficiency of the OT market. In this context, the 2007 issuing programme was concentrated on the

issuance of a new OT series in the 10-year bucket and the strengthening of the liquidity of several

maturities of the yield curve, by increasing the outstanding of series issued in previous years. The

Financing Programme also considered the need to increase the flexibility of the BT programme launched

in 2003, in line with the goals set in terms of the refinancing risk and the implementation of the strategy

for reducing cash surpluses. One of the flexibility measures introduced in the 2007 programme was the

possibility of issuing between four and six new BT lines (instead of the six lines issued annually in the

previous years). In this context, five new BT lines were launched in 2007, as expected and announced to

the market, with maturities in January, March, May, September and November of 2008.



22% 3% 3% 5%

5%

-1% -4% -6%-20%

98% 97%

25%

75%62%

35%42%

48%

12%

92% 96%82%

25%

-2%

-22%

12%

14%

101%

46

Government bond market – OT

The issuance of OT is the Republic's main source of funding. The new OT series are launched via syndicate

and their amount is subsequently increased through auctions, using an electronic multi-price auction

system (Bloomberg Auction System). The syndicated placement includes a pot system for the book-

building, which enables IGCP to intervene in the allocation of investors and to the select those of greater

quality, which will ensure a good performance of the new issue in the secondary market, thereby

facilitating the placement of subsequent reopenings via auction.

In order to ensure that OT meet the liquidity requirements of the euro debt market, an outstanding of at

least EUR 5 billion six months after its launch date was set as the target size for new series. The new OT

series are launched with an initial size of EUR 3 billion, which normally corresponds to approximately 50

per cent of the final size foreseen for each series, thereby ensuring that they are traded in the secondary

market with benchmark status under market-making obligations.

OT ISSUANCE SIZE

0

1,000

2,000

3,000

2000

2001

2002

2003

2004

2005

2006

2007

2000

2001

2002

2003

2004

2005

2006

2007

EUR million EUR million

Syndicated issues Competitive auctions (average amounts)

0

300

600

900

1,200

2,4

00

3,0

00

2,0

00

2,5

00

2,0

00

2,5

00

3,0

00

3,0

00

742

936

503

770

637

840 925

963



47

The Primary Dealers (OEVT) play a strategic role in the OT market as a distribution channel – they have 2exclusive access to the primary market , and preference in the constitution of syndicates – and as

suppliers of reference prices and liquidity in the secondary market, as well as advisers to the Republic in

the definition and implementation of the financing strategy. They are also vital in promoting and

marketing the Portuguese government debt among final investors. In 2007, the Primary Dealers group

included 14 banks.

2There is also a second-tier group of primary market participants – the Other Auction Participants (OMP) – which included 6 banks at the end

of 2007: Caixa de Crédito Agrícola Mútuo, Credit Suisse, ING, Nomura International, Banco Millennium BCP Investimento and Banco

Santander Central Hispano. These institutions also contribute to the development of the Portuguese government debt market but they do

not comply with all the criteria of the Primary Dealer status. The participation in the market as OMP is usually a first step towards becoming a

Primary Dealer (OEVT).

MOST DISTINGUISHED PRIMARY DEALERS 2007 *

Société GénéraleBarclays BankHSBC France

CalyonLehman Brothers

* Evaluation based on an overall performance indicator, which includes a set of criteria covering the different intervention areas of the Primary Dealers in the OT market (participation in the primary and secondary market, participation in buyback operations, their advice to IGCP, the marketing and broadening of their investor base).



OT PLACEMENT (auctions and syndicates) BY PRIMARY DEALERS *

%

Non-residents Residents

* The amounts subscribed by non-resident Primary Dealers in the auctions were used as proxy for the amounts bought by non-resident investors.

0

20

40

54.7%

11.4%11.3%11.0%14.4%15.5%21.4%19.5%17.2%27.3%

45.3%

72.7%82.8% 80.5% 78.6% 84.5% 85.6% 89.0% 88.7% 88.6%

60

80

100

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Jan 08 Mar 08 May 08 Sep 08 Nov 08

Outstanding on 31 December 2007 Final outstanding per line

BT CURVE AT END-2007

48

The Treasury Bill market – BT

BT lines are placed via multi-price auctions, using the electronic Bloomberg Auction System. These were

held on the first and third Wednesday of each month, according to a quarterly-announced auction 3calendar. All BT lines have benchmark status in MEDIP and are thus under market-making obligations ,

thereby ensuring the existence of a liquid short-term segment in the Portuguese yield curve.

In 2007, five new BT lines were launched with a residual maturity of 12 months via two launching 4auctions each, and were subsequently reopened with a residual maturity of six and three months . At the

end of year, the outstanding of BT was EUR 9.4 billion.

3 Until they reach a one-month residual maturity.

4 The exceptions to this rule were BT July 2007 (which was not reopened with a 3-month residual maturity) and BT March 2008, which was

reopened in July with a residual maturity of eight months (and which was therefore not reopened in September with a 6-month residual

maturity), for which the auction scheduled for December 2007 (when the line had a 3-month residual maturity) was cancelled due to the

strategy to reduce cash surpluses, as a result of a higher-than-expected cash balance.

0

500

1,000

1,500

2,000

2,500

3,000



The credibility and consistency of the Portuguese financing strategy, as well as the efficiency and

liquidity of the OT market, have contributed to a large participation of non-resident investors and

financial intermediaries in both syndicated placements and auctions. This participation reached

approximately 93 per cent in 2007.

49

Access to the BT primary market is limited to Treasury bill Specialists (EBT) – a group created in 2003,

which includes financial intermediaries with a strong domestic and international placement capacity.

EBT are committed to promoting the liquidity of the secondary market, by acting as market makers of

the BT segment of MEDIP/MTS Portugal, where they have to comply with maximum bid-offer spreads

and minimum trading quantities. They also play a vital role in promoting and marketing BT among

investors.

MOST DISTINGUISHED EBT IN 2007 *

ABN - Amro BankSociété Générale

BNP ParibasHSBC France

Citigroup

* Evaluation based on an overall performance indicator, which includes a set of criteria covering the different intervention areas of the Treasury Bill Specialists in the BT market (participation in the primary and secondary market, participation in buyback operations, their advice to IGCP, the marketing and broadening of their investor base).




Spreads

Throughout 2007, the funding cost of the Portuguese government experienced two clearly distinct

periods: during the first half of the year the debt's funding costs saw a modest upward trend, in absolute

terms, as a result of a more restrictive monetary policy stance introduced by the European Central Bank.

But after July the absolute cost of funding started to trend lower, in line with a similar trend observed in

both core (Germany and France) and peripheral countries (Italy and Greece).

The fall in European government bond yields (funding cost) – particularly German bond yields – during

the second half of the year, was especially pronounced in July and August, with signs of stabilisation in

September and October. In November, risk aversion returned to financial markets, leading to a further

drop in yields. As can be seen in the graphs below, the German yield curve outperformed the swap curve

by more than all other curves of Euro area countries, thereby leading to a widening of spreads between

the Portuguese and German government debt. By contrast, Portuguese government bonds

outperformed their Belgian counterparts suggesting that in relative terms investors saw a more positive

outlook for the former. In line with previous years, Portuguese government bonds were priced between

peripheral (Italy and Greece) and core countries (Germany and France).

50

In the 10-year maturity, the new benchmark was launched in April and subsequently underperformed

its peers somewhat, partially because market participants started to anticipate additional supply coming

with the reopening of this series until its minimum EUR 5 billion outstanding was reached, as initially

announced. During this period, in asset swap terms the spread versus Italy narrowed, albeit modestly,

and widened, also modestly, against Germany and Belgium. Afterwards, the spread re-widened towards

the initial levels against Italy and improved significantly versus Belgium, whose government bonds were

negatively affected by the protracted uncertainty with regard to the formation of a new government.



Jan 0

6

Feb 0

6

Mar

06

Apr

06

May

06

Jun 0

6

Jul 06

Aug 0

6

Sep 0

6

Oct

06

Nov

06

Dec

06

Jan 0

7

Feb 0

7

Mar

07

Apr

07

May

07

Jun 0

7

Jul 07

Aug 0

7

Sep 0

7

Oct

07

Nov

07

Dec

07

Portugal Germany Belgium Italy

b.p.

10-YEAR ASSET SWAP SPREADS

-50

-45

-40

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

In the 15-year maturity, OT April 2021 had a performance close to the French bond with a similar

maturity, except during mid-June, when the Portuguese yield curve underperformed the French curve.

As in 2006, the curve remained inverted between 10 and 15 years, although the extent of the inversion

diminished as from mid-May and there were even periods where the curve had a positive slope.

51

Jan 0

6

Feb 0

6

Mar

06

Apr

06

May

06

Jun 0

6

Jul 06

Aug 0

6

Sep 0

6

Oct

06

Nov

06

Dec

06

Jan 0

7

Feb 0

7

Mar

07

Apr

07

May

07

Jun 0

7

Jul 07

Aug 0

7

Sep 0

7

Oct

07

Nov

07

Dec

07

Portugal France Italy

b.p.


-35

-30

-25

-20

-15

-10

-5

0

5

10

15




Jan 0

6

Jan 0

7

Feb 0

6

Feb 0

7

Mar

06

Mar

07

Apr

06

Apr

07

May

06

May

07

Jun 0

6

Jun 0

7

Jul 06

Jul 07

Aug 0

6

Aug 0

7

Sep 0

6

Sep 0

7

Oct

06

Oct

07

Nov

06

Nov

07

Dec

06

Dec

07

Portugal Germany Italy Belgium

b.p.

The performance of the 30-year OT has been relatively stable, closely following Italy. Until mid-July the

OT outperformed the core countries (namely Germany), whose yield curves were relatively stable. During

the more unstable summer period, these spreads naturally re-widened, while subsequently the OT

approached the Belgian bonds.

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

52

Turnover

The efficiency and transparency of MEDIP, the quality of its participants and the financing strategy of

the Republic of Portugal continued to contribute to the persistently high levels of liquidity in this

market – the benchmark venue for the wholesale trading of Portuguese government debt where prices

are used as guidance for both the issuer and other secondary market segments.

As a result of the debt management strategy followed by IGCP, in 2007 the outstanding of the debt

admitted to trading in MEDIP continued to grow. The increase in the outstanding was particularly

evident in the OT segment, as a result of the launch of a new benchmark series and the decision to

increase the final size of each series so as to promote the market turnover and the liquidity of these

series. On 31 December 2007, the outstanding of the 14 OT admitted to trading in MEDIP amounted to

EUR 77.7 billion, around EUR 69.1 billion of which corresponded to the outstanding of the benchmark

OT, which compares to EUR 65.3 billion in 2006.

The outstanding of the BT segment at the end of 2007 amounted to approximately EUR 9.4 billion (five

lines outstanding), which compares to EUR 9.5 billion at the end of 2006, as BT have reached steady state

in terms of annual issuance and their net contribution to the borrowing requirements tended towards

zero.



PARTICIPANTS IN THE OT SEGMENT OF MEDIP/MTS PORTUGAL ON 31 DECEMBER 2007

ABN-AMRO Bank, NVBanco Espirito Santo, SA

Banco Santander Central HispanoBarclays Bank plc

Bayerische Hypo-und VereinsbankBNP Paribas

Caixa Banco de Investimento, SACalyon

Citigroup Global Markets LimitedDeutsche Bank AGDresdner Bank AG

Fortis BankGoldman Sachs International

HSBC FranceING Bank, NV

Lehman Brothers Internacional (Europe)Morgan Stanley & Co International


Bank of America Securities LimitedCaixa Central de Crédito Agrícola Mútuo

CECACommerzbank AG

Credit Suisse Securities (Europe) LtdJP Morgan Securities LTD

Landesbank Baden-WurttembergMillenniumbcp

Mitsubishi UFJ Securities International LtdNatixis

Nomura InternationalWestLB

Source: MTS Portugal

Market makers Market dealers



A large number of domestic and international financial intermediaries participate in MEDIP. At the end

of 2007, this group included 31 credit institutions. Of these, the most important role is played by

institutions with market-maker status, among which Primary Dealers (OEVT) and EBT. In the OT segment,

there were 18 market makers and 11 market dealers, while the BT segment had 13 market makers and 6

market dealers.

ABN-AMRO Bank, NVBanco Espirito Santo, SA

BNP ParibasCaixa Geral de Depósitos, SA

CalyonCitigroup Global Markets Limited

Deutsche Bank, AGDresdner Bank, AG

Goldman Sachs InternationalHSBC France

MillenniumbcpNataxis


Banco Santander Central HispanicoCaixa Central de Crédito Agrícola Mútuo

Fortis BankING Bank, NV

Landesbank Baden-WurttembergMorgan Stanley & Co International


PARTICIPANTS IN THE BT SEGMENT OF MEDIP/MTS PORTUGAL ON 31 DECEMBER 2007

Market makers Market dealers

In the BT secondary market, the price of Portuguese government bills increased significantly as from

mid-July (with BT interest rates dropping and the spreads against money market rates widening) as a

result of the turmoil in the US subprime market referred to above, which boosted investors' demand for

short-term government debt, in a typical flight-to-quality reaction.

The daily average turnover in the OT segment on MTS Portugal increased from 2006. In other MTS

markets – Amsterdam, Belgium and Finland – turnover was similar to that of the previous year. In the BT

segment, turnover in MEDIP was slightly higher than in 2006.

Taking into consideration both the OT and BT market segments, total turnover in MEDIP amounted to

EUR 158.5 billion in 2007, representing a 25 per cent increase year-on-year. This amount corresponded

to a daily average of EUR 626.4 million, which compares to EUR 497 million in the previous year.

The breakdown per segment shows that total turnover in the OT segment was EUR 140.9 billion,

equivalent to a daily average of EUR 556.8 million, up from an average EUR 443.5 million in 2006. The

monthly turnover peaked in July when EUR 18.4 billion were traded, equivalent to a daily average

turnover of EUR 838.1 million. In the BT segment, turnover in MEDIP totalled EUR 17.6 billion, equivalent

to a daily average turnover of EUR 69.6 million, which was higher than in 2006.



0

100

200

300

400

500

600

700

800

900

1,000

EUR million

MTS Portugal EuroMTS

DAILY AVERAGE TURNOVER OF OT IN MEDIP AND EUROMTS

Source: MTS Portugal and EuroMTS

Jan 2

003

Mar

2003

May

2003

Jul 2003

Sep 2

003

Nov

2003

Jan 2

004

Mar

2004

May

2004

Jul 2004

Sep 2

004

Nov

2004

Jan 2

005

Mar

2005

May

2005

Jul 2005

Sep 2

005

Nov

2005

Jan 2

006

Mar

2006

May

2006

Jul 2006

Sep 2

006

Nov

2006

Jan 2

007

Mar

2007

May

2007

Jul 2007

Sep 2

007

Nov

2007

EUR million

OT Jul2008*

OT Jul2009

OT May2010

OT Apr2011

OT Jun2011

OT Jun2012

OT Sep2013

OT Jun2014

OT Oct2015

OT Oct2016

OT Oct2017

OT Apr2021

OT Apr2037

DAILY AVERAGE TURNOVER IN MEDIP IN 2007 BY BENCHMARK OT


* Series no longer under market-making obligations as from August 2007.

0

20

40

60

80

100

120



Trading in the spot market is supported by a highly liquid repo market and by a repo window of last

resort provided by IGCP to all market makers in MEDIP. In 2007, the wholesale trading of OT repos in the

BrokerTec and EuroMTS electronic platforms reached a daily average turnover of EUR 3.312 billion, 1.2

per cent more than in 2006. The daily average turnover of OT repos in these trading platforms was

approximately sixfold the daily average turnover in MEDIP, which compares to approximately sevenfold

in 2006.

In line with previous years, the participation of foreign investors in the secondary market remained 5particularly significant. According to monthly data reported by Primary Dealers and EBT on secondary

market trading, approximately 85 per cent of OT trades and 81 per cent of BT trades were made by

foreign investors.

5According to the harmonised format adopted in the EU since January 2006.

DAILY AVERAGE TURNOVER AND OUTSTANDING OF BT

Source: MTS Portugal and IGCP

Outstanding (EUR million) Daily average turnover (EUR million)

Outstanding Daily average turnover

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Jul2003

Sep Nov Jan2004

Mar May Jul Sep Nov Jan2005



Mar May Jul Sep Nov0

20

40

60

80

100

120

140

160



Source: OEVT

GEOGRAPHICAL DISTRIBUTION OF BT TURNOVER IN THE SECONDARY MARKET IN 2007

GEOGRAPHICAL DISTRIBUTION OF OT TURNOVER IN THE SECONDARY MARKET IN 2007

Source: EBT

United Kingdom - 18.7%

France - 35.4%

Portugal - 18.8%

Germany - 7.9%

Netherlands - 4.5%

Spain - 6.4%

Others - 8.4%

Portugal - 15.2%

United Kingdom - 29.1%

France - 24.0%

Germany - 9.1%

Spain - 4.9%

Netherlands - 5.2%

Others - 12.5%

57



Liquidity in MEDIP is supported by the quote-driven characteristics of this market, where market makers

agree to provide firm quotes with minimum quantities and maximum bid-offer spreads for at least five

hours a day.

Since this market went live in 2000, the minimum quantities quoted by market makers have increased

progressively, while the maximum bid-offer spreads have narrowed, which reflects the rise in the

market's efficiency and liquidity. This narrowing effect ceased as from mid-2007, however.

The abnormal conditions of financial markets since July, including the sharp decline of liquidity, led to a

significant deterioration in the compliance of quoting hours by market participants in MEDIP (which

was close to zero by certain institutions on more turbulent days) and to an unusual widening of bid-offer

spreads. In this environment, the average bid-offer spreads observed in MEDIP for 10-year bonds was

around 3 ticks until July and jumped significantly after that. The widest average was seen in August,

when this spread reached 9 ticks. After this month, the spread narrowed once again to around 5 ticks,

which was the top limit for this bucket until November 1, when it was revised to 7 ticks.

Spreads in the 15 and 30-year maturities were around 7 and 14 ticks respectively until July, widening as

from August to 14 and 25 ticks on average. After mid-September these spreads started to narrow back

below the quoting limits of 10 (12 ticks after November 1) and 20 ticks, respectively.

The bid-offer spread of 12-month BT was around 2 basis points until April and widened after that

towards 3.5 basis points. The spread started to narrow as from August, although this was a short-lived

improvement as it re-widened again as from October.



10-YEAR OT BID-OFFER SPREAD IN MEDIP


Ticks


Note: Based on the best bid and ask prices observed daily in MEDIP/MTS Portugal. The bold line represents the 10-day moving average.

Ticks



0

12

3

45

6

7

8

9

10

Maximum of 5 cents

Maximum of7 cents

Jan 0

6

Feb 0

6

Mar

06

Apr

06

May

06

Jun 0

6

Jul 06

Aug 0

6

Sep 0

6

Oct

06

Nov

06

Dec

06

Jan 0

7

Feb 0

7

Mar

07

Apr

07

May

07

Jun 0

7

Jul 07

Aug 0

7

Sep 0

7

Oct

07

Nov

07

Dec

07

02468

101214161820

Maximum of 10 cents

Maximum of12 cents

Jan 0

6

Feb 0

6

Mar

06

Apr

06

May

06

Jun 0

6

Jul 06

Aug 0

6

Sep 0

6

Oct

06

Nov

06

Dec

06

Jan 0

7

Feb 0

7

Mar

07

Apr

07

May

07

Jun 0

7

Jul 07

Aug 0

7

Sep 0

7

Oct

07

Nov

07

Dec

07

59





Ticks



b.p.

0

5

10

15

20

25

30

Maximum of 20 cents

Mar

06

Apr

06

May

06

Jun 0

6

Jul 06

Aug 0

6

Sep 0

6

Oct

06

Nov

06

Dec

06

Jan 0

7

Feb 0

7

Mar

07

Apr

07

May

07

Jun 0

7

Jul 07

Aug 0

7

Sep 0

7

Oct

07

Nov

07

Dec

07

Maximum: 4 basis points

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5


1-YEAR BT BID-OFFER SPREAD IN MEDIP

Jan 0

6

Feb 0

6

Mar

06

Apr

06

May

06

Jun 0

6

Jul 06

Aug 0

6

Sep 0

6

Oct

06

Nov

06

Dec

06

Jan 0

7

Feb 0

7

Mar

07

Apr

07

May

07

Jun 0

7

Jul 07

Aug 0

7

Sep 0

7

Oct

07

Nov

07

Dec

07

4647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873837664339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339846479896543398729687693673894878108876382982537208265765866432039802764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611

Serra da Estrela Natural Park


61Financing Programme





Financing Activity

Operations within the framework of the Repo Facility

Issuance of Portuguese Government bonds

Financing reposIssuance of Treasury bills (BT)

Repo window operations

Saving CertificatesCEDIC

62

77

77

63

63

64

76

65

7370

73

7574

75

464798965433987296876936738948781088763829825372082657658664320398027643865291064387611229876550873837664798965433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738

Credit lines (Stand-by facilities)

62

Financing Programme

Taking into account the assumptions of the State Budget for 2007, namely an estimate of the net

borrowing requirements of EUR 7.1 billion, the State Financing Programme for 2007 – approved in

January 2007 – anticipated a total financing amount to be obtained in the calendar year of

approximately EUR 15 billion. The Programme was announced to the market in January 2007 and its

guidelines envisaged the following:

Gross issuance of OT in an amount of between EUR 12 and EUR 14 billion, through the reopening of

OT issued in previous years and the launch of two new OT series with an initial amount of no less

than EUR 3 billion with their subsequent reopening via auction until an amount of no less than EUR

5 billion is reached;

Net issuance of BT in a marginally positive amount in 2007 through the launch of five new lines

maturing in January, March, May, September and November 2008, and reopening auctions of

these lines (and of those issued in 2006 and still outstanding) with a 6- and 3-month residual

maturity;

Use of short-term financing, through repo operations and credit lines, in order to increase the

flexibility of the financing programme vis-à-vis the fluctuation of cash needs;

!

!

!



63



According to available data, net borrowing requirements resulting from the execution of the budget in

2007 amounted to EUR 11.8 billion. These requirements were met through the gross issuance of

medium- and long-term instruments and by net short-term financing.

BORROWING REQUIREMENTS(EUR million)

1. Net borrowing requirements resulting from the execution of the budget

Budget deficit

Net change of financial assets

Regularisation of past situations

Privatisation proceeds used for debt redemption (-)

2. Medium- and long-term debt redemption

OT

Other loans

Note: redemption of debt maturing in subsequent years

3. Borrowing requirements of the Budget (1 + 2)

Note: borrowing requirements to be met in the calendar year civil

8,195

7,400

400

1,600

1,205

7,655

6,406

1,250

612

15,850

14,429

5,112

5,235

179

452

755

7,575

6,677

898

0

12,686

11,830

2006E

2007

! Continuation of the debt buyback programme, with the main goal of reducing the refinancing risk.


The debt buyback programme was continued in 2007 with the main objective of reducing the

refinancing risk. Since 2004, the first OT series issued in accordance with the minimum size of a

benchmark security in the euro Government bond market – i.e. EUR 5 billion – started to mature. These

securities are included in the buyback programme when they reach a twelve-month residual maturity,

coinciding with the suspension of the market-making obligations in MEDIP/MTS Portugal or when their

status is changed from 'liquid' to 'regular' in the secondary market.


64


During 2007 two buyback auctions of OT 4.875% August 2007 were held in a total of EUR 512 million,

whose outstanding at the end of 2006 was EUR 4.6 billion (since EUR 507 million had already been

bought back in 2006). In the first half of 2007, IGCP together with the Primary Dealers studied the

possibility of no longer quoting buyback prices through the MTS Portugal electronic functionality –

PBB-Portuguese Buyback Functionality – since the amount traded through this platform has been

practically zero in recent years. It was therefore decided to discontinue this functionality as from the

third quarter of 2007. However, IGCP informed the Primary Dealers that it would remain available to

provide buyback prices on an OTC basis whenever requested. Since the buyback auctions involved OT

maturing during 2007, there was no increase in the year's borrowing needs.

Financing Activity

The gross issuance of medium- and long-term debt plus the short-term debt financing totalled EUR 11.8

billion in 2007. The issuance of OT plus the net issuance of BT amounted to approximately EUR 9.5 billion,

while the net contribution of CEDIC, financing repos, saving certificates and the use of stand-by

facilities was positive in an amount of approximately EUR 2.1 billion.

ISSUANCE OF MEDIUM-AND LONG-TERM DEBT AND SHORT-TERM FINANCING *(EUR million)

Euro-denominated debt

Medium- and long-term (gross)Fixed-rate Government bonds (OT)< 5 years5 years>= 10 years

Short-term (net)Treasury bills (BT)CEDICSaving certificatesFinancing reposOther debt (stand-by facility)

Appreciation (premiums or discounts)**Swaps (capital)

Total

11,835.3

9,732.89,732.8

900.01,000.07,832.8

2,102.5-186.8

1,076.6777.4

-714.81,150.0

-48.342.5

11,829.5

14,456.5

13,911.413,111.41,000.03,000.09,111.4

545.1-3,163.01,002.91,003.41,701.8

0.0

-66.238.4

14,428.8

100.0%

82.3%82.3%7.6%8.5%

66.2%

17.8%-1.6%9.1%6.6%

-6.0%9.7%

-0.4%

0,4%

100%

100.2%

96.4%90.9%6.9%

20.8%63.1%

3.8%-21.9%

7.0%7.0%

11.8%0.0%

-0.5%0,3%

100%

2007

Amount Amount

2006

Structure Structure

* At nominal value (discounted valued for BT and CEDIC). Does not include promissory notes

** Difference between nominal value and placement value.


65

EUR billion % do GDP

amount as % of GDP

ANNUAL FINANCING AMOUNTS *

* Medium-and long-term gross issuance and short-term net financing.

0

3

6

9

12

15

18

21

1999 2000 2001 2002 2003 2004 2005 2006 2007E

0

3

6

9

12

15

Issuance of Portuguese Government bonds

The OT issuance programme for 2007 envisaged the issuance of an amount of between EUR 12 and EUR

14 billion. Its main components were the launch of two new OT series and the reopening of other OT

issued in previous years.

This programme started in January with the reopening via auction of OT 4.20% October 2016 in an

amount of EUR 1 billion, the outstanding of which reached the EUR 5 billion target announced to the

market when it was launched (July 2006) within a six-month period.

The regular issuance of benchmark securities in the 10-year segment is vital to maintain a yield curve of

manifest liquidity as this is the benchmark maturity for Euro area capital markets. Given the decision to

start the financing programme for 2007 with the issuance of a new OT in this segment, the new series –

OT 4.35% October 2017 – was launched in April via banking syndicate with an amount of EUR 3 billion.

This OT was subsequently reopened via 3 auctions in June, August and September, having reached an

outstanding of around EUR 6 billion by year-end.



66

EUR million

0

500

1,000

1,500

2,000

2,500

3,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Auction Syndicate

OT ISSUANCE IN 2007

Following the strategy of the last few years, this new OT series was launched through a banking

syndicate with all Primary Dealers.

An initial amount of EUR 3 billion and a commitment by IGCP to increase this amount up to no less than

EUR 5 billion over a six-month period made it possible for the new OT series to be traded, right from the

start, under market-making obligations in the main business-to-business (B2B) and business-to-

customer electronic (B2C) platforms.

Considering the financing ensured by this new series plus that resulting from the reopening of old OT

series, the gross amount obtained through the issuance of OT therefore totalled approximately EUR 9.7

billion in 2007.

OT

2016

OT

2017

OT

2017

OT

2017

OT

2017

OT

2013

OT

2010 &

2037



67

SYNDICATED PLACEMENT IN 2007

OT 4.35% October 2017

Pricing

Syndicate Structure

Joint Lead Managers

Co-Lead Managers

Amount placed: EUR 3 billion

+ 18 b.p. over OAT 3.75% January 2017mid swap – 8.4 b.p.

Under market-making obligations in MTS Portugal's grey market straight after launch. Immediately included in IGCP´s repo window of last resort.

80% placed by 5 joint-leaders through a pot20% placed by 9 co-leads, through a co-lead pot complemented by retention

Banco Espírito Santo, HSBC, Lehman Brothers, Morgan Stanley and Société Générale

The remaining 9 Primary Dealers

Distribution by investor type Geographical distribution

30% United Kingdom 5% Portugal

10% Germany 5% Others30% France 5% Italy

8% Benelux 2% Spain5% Scandinavia

34% Fund Managers

14% Insurance Companies and Pensions Funds

31% Banks

10% Bank Treasury

4% Others4% Central Banks

3% Hedge Funds



68

In the course of 2007, a total of seven OT auctions were held. The average amount placed per auction was

EUR 936 million (considering only the competitive phase), which represents a 2.8 per cent drop versus

the average placement in auctions in the previous year. Demand in these auctions remained strong, with

an average bid-to-cover ratio of 2.2. Primary dealers exercised the non-competitive option only in the

13 June auction (of OT 2017) in a total amount of EUR 183 million.

OT PLACED BY PRIMARY DEALERS *

%

Non-residents Residents

* The amounts bought by foreign banks in auctions are used as a proxy for the amounts bought by non-residents.

45.3%

72.7%82.8% 80.5% 78.6% 84.5% 85.6% 89.0% 88.7% 92.6%

54.7%

27.3%17.2% 19.5% 21.4% 14.4% 11.0% 11.3% 7.4%15.5%

0

20

40

60

80

100

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007



OT ISSUANCE - AUCTIONS HELD IN 2007

Non-competitive

phase

vs swapcurve

10-Jan-07 1,000

13-Jun-07 900

22-Aug-07 1,000

12-Sep-07 1,000

11-Jul-07 750

25-Jul-07 900

OT 4.2%Oct 2016

OT 4.35%Oct 2017

OT 4.1%Apr 2037

OT 5.85%May 2010

OT 5.45%Sep 2013

10-Oct-07 1,000

4.128%

4.807%

4.504%

4.364%

4.884%

4.428%

4.271%

4.132%

4.810%

4.508%

4.370%

4.891%

4.438%

4.280%

2.0

1.9

2.0

1.8

2.7

2.1

2.7

0.4 b.p.

0.3 b.p.

0.4 b.p.

0.6 b.p.

0.7 b.p.

1.0 b.p.

0.8 b.p.

3.2 tick

2.0 tick

3.0 tick

5.0 tick

10.0 tick

3.0 tick

5.0 tick

17.2 tick

19.0 tick

18.0 tick

20.0 tick

23.0 tick

15.0 tick

16.0 tick

-2.2 b.p.

-2.4 b.p.

-2.3 b.p.

-2.5 b.p.

-1.6 b.p.

-5.5 b.p.

-2.9 b.p.

-9.6 b.p.

-16.6 b.p.

-18.5 b.p.

-14.3 b.p.

-6.5 b.p.

-26.0 b.p.

-27.1 b.p.

0

183

0

0

0

0

0

* Weighted average rate1 OT ask price in MEDIP

OT Date

Amountplaced

(EUR million)

Weightedaveragerate *

Amountplaced

(EUR million)

Spread of weightedaverage rate

vs secondary1market

Competitive Phase

Stoprate

Bid-to-Cover Tail

69

OT AUCTIONS HELD IN 2007(amounts placed and bid-to-cover)

OT 4.2% OCT

2016OT 4.35% OCT

2017OT 4.1% APR

2037OT 5.85% MAY

2010OT 4.35% APR

2017OT 4.35% OCT

2017

10-Jan-07 13-Jun-07 11-Jul-07 25-Jul-07 22-Aug-07 12-Sep-07

OT 5.45% SET

2013

10-Oct-07

OT 4.2% OCT

2016OT 4.35% OCT

2017OT 4.1% APR

2037OT 5.85% MAY

2010OT 4.35% APR

2017OT 4.35% OCT

2017

10-Jan-07 13-Jun-07 11-Jul-07 25-Jul-07 22-Aug-07 12-Sep-07

OT 5.45% SET

2013

10-Oct-07

EUR million Bid-to-Cover

Amount placed in competitive auction (left) Bid-to-cover competitive auction (right)

OT AUCTIONS HELD IN 2007(other indicators)

b.p. %

Placed at stop price/Total placed in comp. auction (right)

Tail = Stop rate - Weighted average rate (left)

Dispersion = Stop rate - median of accepted bids (left)

0

300

600

900

1,200

1.0

1.4

1.8

2.2

2.6

3.0

0.0

0.5

1.0

1.5

0

5

10

15

20

25

30



70

22.5% Residents

77.5% Non-residents

BT PLACED BY THE EBT IN 2007 *

* The amounts bought by non-resident EBT in auctions are used as a proxy for the amounts bought by foreign investors.

In 2007, the net issuance of BT totalled a negative amount of EUR 187 million, generally in line with the

goals of the borrowing programme adopted at the beginning of the year and the implementation of the

strategy to reduce cash surpluses.

Twenty BT auctions were held during the year, through which a gross discounted amount of EUR 11.1

billion (EUR 11.5 billion in gross nominal terms) was placed. Twenty-two auctions were initially

scheduled but the reduction in the borrowing needs resulting from the better-than-expected budget

execution made it possible to cancel two of them. Auctions were efficient both in terms of demand and

of financing costs. On average, the demand from EBT in the auctions was two and a half times the

amount placed. The average cost was around 29.7 basis points through Euribor interpolated to the

corresponding maturity. This spread reflects very favourable market conditions for the issuance of

short-term Portuguese government paper (in terms of cost) following the turmoil in financial markets

during the second half of the year, which boosted institutional investors' demand for short-term

government debt, leading to an unusual widening of the money market spreads (versus Euribor) of this

debt.

Issuance of Treasury bills (BT)



71



BT ISSUANCE - AUCTIONS HELD IN 2007

Non-competitive

phase

vs Euriborcurve(b.p.)Date Line

Residualmaturity(months)

Weightedaverage

rate

Amountplaced

(EUR million)

Amountplaced

(EUR million)

Spread of weightedaverage rate

vs secondary1market

(b.p.)

Competitive phase

Stoprate

Bid-to-

Cover

Tail(b.p.)

03-Jan-07

17-Jan-07

07-Feb-07

21-Feb-07

07-Mar-07

21-Mar-07

04-Apr-07

02-May-07

16-May-07

06-Jun-07

20-Jun-07

04-Jul-07

18-Jul-07

15-Aug-07

19-Sep-07

03-Oct-07

17-Oct-07

07-Nov-07

21-Nov-07

05-Dec-07

BT 20-Jul-2007

BT 18-Jan-2008

BT 18-Jan-2008

BT 18-May-2007

BT 25-Mar-2008

BT 25-Mar-2008

BT 23-Nov-2007

BT 23-May-2008

BT 23-May-2008

BT 21-Sep-2007

BT 18-Jan-2008

BT 25-Mar-2008

BT 23-Nov-2007

BT 19-Sep-2008

BT 19-Sep-2008

BT 18-Jan-2008

BT 23-May-2008

BT 21-Nov-2008

BT 21-Nov-2008

6

12

12

3

6

12

12

6

12

12

3

6

6

12

12

3

3

6

12

12

300

750

500

294

300

1,000

495

400

1,000

400

300

500

400

505

1,000

500

500

600

1,000

300

3.730%

3.908%

3.919%

3.714%

3.846%

3.995%

4.050%

4.023%

4.227%

4.327%

4.032%

4.189%

4.306%

4.114%

4.102%

4.031%

4.011%

4.072%

4.002%

3.981%

3.735%

3.917%

3.925%

3.720%

3.850%

3.999%

4.055%

4.025%

4.234%

4.329%

4.035%

4.194%

4.313%

4.130%

4.125%

4.039%

4.020%

4.077%

4.010%

3.995%

3.5

2.1

2.3

3.0

2.6

2.0

2.8

3.5

2.3

4.2

3.7

2.3

2.5

1.7

1.5

2.1

1.5

2.6

2.2

1.8

0.5

0.9

0.6

0.6

0.4

0.4

0.5

0.2

0.7

0.2

0.3

0.5

0.7

1.6

2.3

0.8

0.9

0.5

0.8

1.4

-0.6

-1.0

-1.1

-0.6

-0.1

0.0

-0.1

-0.7

-0.1

-0.4

-0.8

-0.1

-0.9

-0.1

0.5

0.0

-0.5

0.1

0.9

0.0

-14.7

-14.7

-13.3

-11.3

-12.2

-13.1

-14.4

-13.5

-14.1

-15.0

-12.0

-15.2

-13.8

-41.4

-58.7

-68.0

-61.6

-52.5

-60.4

-74.3

15.8

10.3

53.5

0.0

0.0

52.7

0.0

0.0

0.0

43.2

0.0

0.0

18.5

0.0

84.7

0.0

0.0

27.7

136.4

0.0

Ask yield MEDIP1

BT 21-Sep-2007

72

BT AUCTIONS HELD IN 2007(Amounts placed and bid-to-cover)

EUR million Bid-to-cover

Amount issued in competitive auction (left)

Bid-to-cover in competitive auction (right)

BT

20-J

ul-

07

03-J

an-0

7

BT

18-J

an-0

817-J

an-0

7

BT

18-J

an-0

807-F

eb-0

7

BT

18-J

an-0

804-J

ul-

07

BT

18-J

an-0

817-O

ct-0

7

BT

18-M

ay-0

721-F

eb-0

7

BT

21-S

ep-0

707-M

ar-0

7

BT

21-S

ep-0

720-J

un-0

7

BT

25-M

ar-0

821-M

ar-0

7

BT

25-M

ar-0

804-A

pr-

07

BT

25-M

ar-0

818-J

ul-

07

BT

23-N

ov-

07

02-M

ay-0

7

BT

23-N

ov-

07

15-A

ug-0

7

BT

19-S

ep-0

819-S

ep-0

7

BT

19-S

ep-0

803-O

ct-0

7

BT

21-N

ov-

08

21-N

ov-

07

BT

21-N

ov-

08

05-D

ec-0

7

BT

23-M

ay-0

816-M

ay-0

7

BT

23-M

ay-0

807-N

ov-

07

BT

23-M

ay-0

806-J

un-0

7

b.p. b.p.

Weighted average rate - Euribor curve (left) Weighted average rate - BT ask yield MEDIP (right)

BT AUCTIONS HELD IN 2007Weighted average rate of the competitive phase vs. market rates

0

200

400

600

800

1,000

1,200

0

1

2

3

4

5

-80

-70

-60

-50

-40

-30

-20

-10

0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5



BT

20-J

ul-

07

03-J

an-0

7

BT

18-J

an-0

817-J

an-0

7

BT

18-J

an-0

807-F

eb-0

7

BT

18-J

an-0

804-J

ul-

07

BT

18-J

an-0

817-O

ct-0

7

BT

18-M

ay-0

721-F

eb-0

7

BT

21-S

ep-0

707-M

ar-0

7

BT

21-S

ep-0

720-J

un-0

7

BT

25-M

ar-0

821-M

ar-0

7

BT

25-M

ar-0

804-A

pr-

07

BT

25-M

ar-0

818-J

ul-

07

BT

23-N

ov-

07

02-M

ay-0

7

BT

23-N

ov-

07

15-A

ug-0

7

BT

19-S

ep-0

819-S

ep-0

7

BT

19-S

ep-0

803-O

ct-0

7

BT

21-N

ov-

08

21-N

ov-

07

BT

21-N

ov-

08

05-D

ec-0

7

BT

23-M

ay-0

816-M

ay-0

7

BT

23-M

ay-0

807-N

ov-

07

BT

23-M

ay-0

806-J

un-0

7

73

In 2007, very short-term treasury needs continued to be met via the repo market. The increased use of

this instrument resulted from the integration of the cash management and the strategy of minimising

daily cash balances, which naturally translated into a greater demand for this instrument. The repo

operations carried out totalled approximately EUR 33 billion (equivalent to a total collateral with a

nominal amount of EUR 33.9 billion). Although both OT and BT can be used as collateral for financing

repos, only BT were used in 2007.

Financing repos

Repo window operations

EUR million

Net changeIssuance Redemptions

Dec-07Nov-07Oct-07Sep-07Aug-07Jul-07Jun-07May-07Apr-07Mar-07Feb-07Jan-07

FINANCING REPOS

At the start-up of MEDIP in the year 2000, IGCP opened a repo window of last resort where the Primary

Dealers could obtain OT under a repurchase agreement in order to help them comply with their market

making obligations in MEDIP. When the current BT programme was launched in 2003, this repo window

was extended to the new instruments. The operations carried out during 2007 through this window

totalled approximately EUR 1.5 billion (equivalent to a total collateral with a nominal amount of EUR 2

billion).

-6,000

-5,000

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000



74

EUR million

EUR million


Dec-07

Dec-07

Nov-07

Nov-07

Oct-07

Oct-07

Sep-07

Sep-07

Aug-07

Aug-07

Jul-07

Jul-07

Jun-07

Jun-07

May-07

May-07

Apr-07

Apr-07

Mar-07

Mar-07

Feb-07

Feb-07

Jan-07

Jan-07

REPO WINDOW OPERATIONS

CEDIC

- 400

- 300

- 200

- 100

0

100

200

300

400

CEDIC

-5,000

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000




75

Saving Certificates

Credit lines (Stand-by facilities)

The gross issuance of saving certificates (SC) during the year amounted to approximately EUR 2.1 billion,

EUR 1.4 billion of which concerned new subscriptions. As redemptions totalled around EUR 1.3 billion,

the contribution of this instrument to the year's net financing was EUR 800 million.

Following the integration of cash management and the strategy previously mentioned of minimising

cash surpluses, IGCP strived to avoid excessive financing. To this end, it was necessary to ensure the

possibility of using credit lines (stand-by facilities) to meet unexpected very short-term borrowing

needs. Some of these lines, of a non-committed nature, were set up and a total of EUR 2.8 billion was

withdrawn during the year.

EUR million

Net subscriptionsNew subscriptions Redemptions


SAVING CERTIFICATES

-150

-100

-50

0

50

100

150

200



76

Operations within the Framework of the Repo Facility

In order to promote liquidity and increase the efficiency of the Portuguese government debt market,

IGCP provides market makers in MEDIP/MTS Portugal with a repo window of last resort for OT and BT

quoted in this market.

Within the framework of this facility, the number of operations carried out and their total amount

increased in 2007. In total, there were 114 operations (compared to 62 operations in 2006), 91 of which

involved the lending of BT and 23 the lending of OT. In relation to 2006, there was a significant increase

in BT repo operations (91 operations in 2007 versus 40 operations in 2006) which totalled EUR 960

million, which compares to EUR 508.5 million in 2006. In regard to OT, 23 operations were carried out

(versus 22 in 2006), in a total amount of EUR 921 million (EUR 1,131 million in 2006).

EUR million



STAND-BY FACILITIES

- 600

- 400

- 200

0

200

400

600

800

1,000

1,200

1,400

1,600



77


In order to enhance the performance of the debt portfolio, the management of market risk is carried out

using derivative instruments, particularly interest rate plain-vanilla swaps. During 2007, a total of 61

new operations and 42 unwindings were negotiated. In total, the nominal amount of contracts

involving derivative instruments was EUR 18 billion.

At the end of 2007, the nominal value of outstanding contracts in the derivatives' portfolio amounted to

EUR 44 billion, equivalent to 39 per cent of the total outstanding of the State's direct debt.

TRANSACTIONS WITH FINANCIAL DERIVATES

IRS 61 12,940 42 1035,340 18,280

Swap type

Total

CIRS

IRS

Pay Leg

FixFloat

FixFloat

NV Total

44,385

3130

23,56020,512

0-2 years

7,980

900

6,8901,000

5-10 years

15,093

2230

8,2006,670

>=15 years

5,861

00

05,861

2-5 years

9,450

00

7,9201,530

10-15 years

6,001

00

5505,451


The integration of cash management in 2007 was aimed inter alia at making it possible to reduce the

amount of debt and thereby its cost.

This objective was firmly pursued by avoiding excessive financing at all costs, i.e. obtaining funds in

amounts and maturities which lead to high cash balances.



Instrument Nº. transactions Nº. transactions Nº. transactions

New contracts Unwindings Total

EUR million EUR million EUR million

FINANCIAL DERIVATIVES PORTFOLIOas at December 31, 2007

Note: Notional amount (EUR million).

78

It is naturally impossible to achieve a perfect matching, where cash balances would be close to zero at

the end of each day. Despite the greater accuracy in forecasting cash flows, there are always unforeseen

operations or unexpected changes in the operation date, which give rise to an unanticipated excess or

shortage of funds.

Furthermore, the issuance of BT and OT – the Republic's main source of funding – follows a pre-

announced calendar, which cannot be freely adjusted to match the time profile of cash inflows and

outflows.

Despite all these constraints, since the early stages of cash integration, IGCP managed to systematically

ensure that the accumulation of cash surpluses, which could be invested, occurred only occasionally.

Where cash surpluses could not be avoided, a careful identification procedure of the most profitable

investment alternatives was implemented, subject to strict principles of credit risk control. Preference

was given to very short-term investments in the domestic interbank market and to financial institutions

with high solvability standards, reflected in the rating given by the top rating agencies.

These were almost entirely one-day investments, as the short-term financing profile was designed to

prevent cash surpluses, which only occurred when unexpected revenues were received or when, for

various reasons, cash payments were made on dates different than scheduled.

Although these investments were made with high-rated banking institutions, their return was broadly

above the money market benchmark rates (Eonia and Euribor) quoted on the corresponding days for the

relevant maturities.



79



4647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873837664339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339846479896543398729687693673894878108876382982537208265765866432039802764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611

Sintra-Cascais Natural Park

Cash Management

81


Box - Centralised Cash Management

84

82

464798965433987296876936738948781088763829825372082657658664320398027643865291064387611229876550873837664798965433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738

Centralised Cash Management

D

!

!

!

!

!

ecree-Law no. 191/99 of 5 June established the legal framework of the Central Government Cash

Management Regime (RTE), with the aim of centralising public funds and optimising their management.

This legal measure laid down the principle of centralised cash management, according to which all

public funds are held in accounts with the entity responsible for cash management (currently IGCP),

where the holders of these funds have their cash surpluses, make their payments and deposit their

revenues.

The integration of cash management in IGCP (Decree-Law no. 273/2007 of 30 July) made it possible to

jointly manage cash surpluses and government debt, thereby offering an overall perspective of the

central Government's financial assets and liabilities, whilst making it possible to optimise financial

returns, improve risk control and reduce the debt outstanding.

In order to reinforce the centralisation of cash management, the group of public institutions subject to

RTE has been enlarged in the last few years, currently including integrated services, autonomous funds

and services and public corporations.

Several banking services tailored to the specific needs of Public Administration are offered by cash

management. In order to adequately carry out its banking role, IGCP's cash management activities cover

five strategic areas:

The clearing of banking operations via the Single Settlement Account (CUL), held at Banco de

Portugal;

The foreign exchange cash facility, which makes it possible to receive and make payments in foreign

currencies;

The collection network, through which central Government revenues are deposited;

The possibility of clients carrying out financial investments in CEDIC;

The offer of homebanking services to clients, via the Internet.

The reinforcement of the cash management centralisation also involves improving and increasing the

range of banking services offered to public institutions. In this context, IGCP is currently adjusting the

clearing system for debits and credits to the Single Euro Payments Area (SEPA), with the aim of

standardising the payment instruments throughout the Euro area. IGCP also aims to make available the

Direct Debit System (DDs) in 2008 and to promote direct debit payments, thereby reducing the use of

cheques and preparing for the start-up of pan-European DDs, foreseen for 2010.


Cash Management


84

Payments and receipts of public institutions made through IGCP's cash management give rise to cash

balances, surpluses and liabilities. The following tables offer an overview of these balances.

This table shows the central Government cash accounts.

As shown in the table above, cash management essentially covers a group of public services which

collect funds, holding only the amounts collected daily. Also relevant are the accounts supporting

foreign currency cash management, the balances of which reflect the last movements of the year.

To observe the evolution of third party cash accounts, the number of public institutions subscribing the

Cash Management



CENTRAL GOVERNMENT CASH ACCOUNTS(EUR million)

Accounts at Banco de Portugal

Financial Investments at Credit Institutions

Foreign Exchange Accounts

Consular Accounts

Receipt Accounts IGCP-

Cash Accounts at Credit Institutions

Customs

Local Tax Services

Treasury Cash Accounts

Customs

Local Tax Services

Treasury Cash Accounts

CTT (postal services)

SIBS

Foreign Exchange Deposits at Credit Institutions

Outstanding Cheques

TOTAL

0.0

1,350.8

13.1

3.9

21.1

380.7

216.8

5.6

196.1

78.2

1.0

6.2

6.2

2,279.7

m

m

m

0.5

1,545.9

25.2

5.6

96.8

437.8

1,170.9

1.3

461.6

100.1

0.0

0.0

11.5

3,857.2

m

m

m

0.0

977.3

27.1

3.8

99.6

165.4

280.0

89.9

238.7

301.3

18.0

19.3

1.2

2,221.5

m

m

m

0.0

1,633.5

22.7

2.2

55.4

568.7

295.3

3.4

168.4

77.6

1.7

0.0

10.2

2,839.1

m

m

m

2007

Dec Dec

2004

Dec Dec

2005 2006

DUC

85

homebanking (HB) system is taken as a reference, since this system is the most frequently used to comply

with the RTE.

The table, (Number of Institutions and Accounts with HB), shows the use of cash management services

by public institutions covered by the RTE, using the number of institutions and accounts with HB, which

offers an on-line access to the accounts of these institutions.

NUMBER OF INSTITUITIONS AND ACCOUNTS WITH HB

December 2000

December 2001

December 2002

December 2003

December 2004

December 2005

December 2006

December 2007

-

-

-

-

-

33

109

179

53

356

1,081

1,410

1,521

1,555

1,766

1,895

51

60

71

78

83

88

87

78

-

-

-

258

369

737

955

1,346

No. of Accounts(community funds)

No. of

Institutions

No. of

Accounts

No. of Accounts

(autonomous funds

and services)

No. of Accounts

(integrated services)

No. of Accounts

(public corporations)

55

245

543

700

787

861

800

755

104

416

1,153

1,756

2,053

2,470

2,991

3,498

Reflecting the restructuring of PRACE (Central Administration Restructuring Programme), in 2007 HB

had a total of 755 institutions, 45 less than in the previous year, which is nevertheless partially offset by

the new membership of secondary schools and school groupings. This membership in part justifies the

number of bank accounts opened by the integrated services in 2007, which reached 1,346.

The table also shows a significant increase in the number of HB members and accounts between 2000

and 2007, from 60 institutions and approximately 100 accounts in 2000 to around 800 institutions and

3,500 accounts in 2007.

The strong demand for IGCP cash management services is also evident in the amount of cash surpluses

invested by public institutions (next table).


Cash Management

86

The table below shows the breakdown of payments and receipts reflected in the accounts of the

Community Funds held with IGCP for the period 2005-2007.

CASH SURPLUSES INVESTEDat 31 December 2007 (EUR million)

TOTAL

Sight

DepositsTYPE OF INSTITUTION

Weight Weight WeightCEDIC

FINANCIAL TRANSFERS BETWEEN PORTUGAL AND EUROPEAN UNION(EUR million)

1. Transfers from Portugal to the EU

Agricultural and Customs Duties

VAT Own Resources

GNP-based Own Resources

UK Compensation

Returns and Reimbursements/Miscellaneous

2.Transfers from the EU to Portugal

EAGGF-Guarantee/EAGF

ERDF

ESF

EAGGF Guidance

EAFRD

FIFG

EFF

Cohesion Fund

Miscellaneous

Total Balance (2-1)

1,628.0

117.8

315.3

1,147.7

128.9

-81.4

3,489.2

946.4

1,265.9

753.1

225.2

-

42.9

-

203.5

52.2

1,861.2

1,438.0

137.1

269.4

1,015.9

115.1

-99.5

3,760.0

658.3

1,260.6

534.7

492.0

221.3

20.3

0.0

490.3

82.5

2,322.0

1,382.2

108.0

217.9

946.3

115.9

-5.9

3,763.1

891.9

1,602.9

696.2

251.9

-

17.6

-

270.3

32.3

2,380.9

20072005 2006


Cash Management

Autonomous Funds

Public Corporations

European Union Funds

Integrated Services

European Union

TOTAL

2,829.4

281.4

40.9

1,021.4

176.7

4,349.8

65.0%

6.5%

0.9%

23.5%

4.1%

100%

3,358.7

813.0

-

-

-

4,171.7

0.8

0.2

-

-

-

100%

6,188.1

1,094.4

40.9

1,021.4

176.7

8,521.5

72.6%

12.8%

0.5%

12.0%

2.1%

100%


Cash Management

4647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873837664339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339846479896543398729687693673894878108876382982537208265765866432039802764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611

Sudoeste Alentejano and Costa Vicentina Natural Park


89

Current Debt Costs


94

90

464798965433987296876936738948781088763829825372082657658664320398027643865291064387611229876550873837664798965433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738

90


The nominal amount of the State's direct debt outstanding on 31 December 2007, evaluated at end-of-

period exchange rates, amounted to EUR 112,804.1 million. Taking into account the effect of exchange

rate hedging operations, the debt outstanding totalled EUR 112,852.2 million.

Excluding the effect of exchange rate hedging using derivative instruments, which declined by EUR 3.9

million, the State's direct debt rose by EUR 4,247.0 million in 2007. This rise was due to the net issuance

of debt instruments, which amounted to EUR 4,219.9 million (the difference between issuing proceeds

and redemptions, net of premiums and discounts) and to other less important factors including

exchange rate fluctuations, which reduced the debt outstanding in euros by EUR 22.4 million, and net

discounts in an amount of EUR 49.5 million.

Debt redemptions totalled a settlement amount of EUR 86,797.6 million, EUR 63,892.3 of which concern

floating debt (debt issued and redeemed in the same year to meet occasional cash needs). Early debt

redemptions (i.e. before the maturity date) amounted to EUR 1,153.7 million in nominal terms, of which

EUR 542 million concerned the buyback of OT and other Bonds, EUR 463.9 million relate to BT buybacks

and EUR 147.8 million to early redemptions of CEDIC.



91


In 2007, only one new OT series– OT 4.35% October 2017 – was launched through a syndicated

placement in April. This series was subsequently reopened via auction in June, August and September.

Also reopened via auction were: OT 4.2 October 2016 (issued in 2006), in January; OT 4.10 April 2037 and

OT 5.85% May 2010 in July; and OT 5.45% September 2013 in October. Total net discounts of OT

placements amounted to EUR 48.3 million. The early redemption of debt (OT 4.875% August 2007) also

led to discounts in the order of EUR 1.6 million.

The evolution of the euro in relation to the yen, the US dollar and the sterling had a positive effect on the

debt portfolio before swaps, bringing about a EUR 22.4 million decrease in the debt outstanding.

The outstanding amounts are in nominal value, with the exception of instruments issued at discount (which are at present value), converted

at the end-of-month exchange rate, while issues and redemptions are net of premiums and discounts. The "Others" column includes

exchange rate fluctuations, premiums or discounts of issues and redemptions and changes in the value of perpetuities.


1. Euro-denominated debt

Marketable

Treasury bills (BT-discounted value)

Fixed-rate Government bonds (OT)

Other bonds

MTN

Retail bonds

Non-marketable

Saving Certificates

Subscription value

Accrued interest

CEDIC

Others

2. Non-euro denominated debt

Marketable

Other bonds

MTN

Non-marketable

3. Total debt (1.+ 2.)

4. Exchange rate effect of hedging

with derivatives (net)

5. Total debt after derivatives

(3. + 4.)

108,202.2

85,916.2

9,230.8

74,603.7

1,745.9

322.0

13.8

22,286.1

17,249.5

11,136.0

6,113.4

3,045.0

1,991.6

354.9

350.8

223.4

127.4

4.1

108,557.1

52.0

108,609.1

99.7%

79.1%

8.5%

68.7%

1.6%

0.3%

0.0%

20.5%

15.9%

2.8%

1.8%

0.3%

0.3%

0.2%

0.1%

0.0%

100%

99.8%

77.9%

8.0%

68.8%

0.9%

0.2%

0.0%

21.8%

16.0%

3.7%

2.1%

0.2%

0.2%

0.2%

0.1%

0.0%

100%

91,017.4

20,811.0

11,126.4

9,684.5

-

-

-

70,206.5

2,061.1

1,388.2

672.9

30,795.8

37,349.5

-

-

-

-

-

91,017.4

86,730.5

18,883.9

11,313.2

6,677.1

771.1

122.0

0.0

67,846.6

1,260.6

939.9

320.7

29,669.2

36,916.8

67.1

61.4

-

61.4

5.6

86,797.6

49.5

49.7

-

49.9

-

-

(0.2)

(0.2)

-

-

(0.2)

(22.4)

(24.2)

(18.8)

(5.4)

1.8

27.1

112,538.7

87,892.9

9,044.1

77,661.0

974.2

200.0

13.6

24,645.8

18,050.0

11,584.4

6,465.6

4,171.7

2,424.1

265.5

265.2

204.5

60.6

0.3

112,804.1

48.1

112,852.2

January - December 2007Outstanding

31-Dez-06 Structure Issues Redemptions Others Structure

Outstanding

31-Dez-07

DIRECT GOVERNMENT DEBTPublic account basis (EUR million)

92


However, the appreciation of the single currency versus the yen and the sterling in 2007 led the swap

portfolio's net exchange rate effect to be negative, in an amount of EUR 3.9 million.

In the breakdown of debt by interest rate type, the percentage of fixed-rate debt in total debt continued

to grow in 2007, albeit marginally, rising from to 83.7 to 83.8 per cent before swaps.

The share of originally non-euro-denominated debt in the total portfolio decreased in 2007,

representing only 0.2 per cent of stock (0.3 per cent in 2006) by year-end.

After swaps, the percentage of fixed-rate debt rose from 85.5 to 86.5 per cent of the total debt

outstanding, while the exchange rate exposure remained close to zero.

With regard to the maturity of debt by instruments, the drop in the relative weight of BT and repos was

more than offset by the increase in the percentage of the other short-term instruments (CEDIC and

monetary market credit lines) in the annual financing, implying the increase in the percentage of the

short-term component in the total portfolio in relation to 2006 from to 12.9 to 13.6 per cent.

BT contributed less significantly to the year's net financing, reducing its weight from 8.5 to 8.0 per cent

in 2007. Financing repos also dropped from 1.6 per cent at the end of 2006 to 0.9 per cent in December

2007.

CEDIC, on the other hand, increased their importance in the debt stock, growing from 2.8 to 3.7 per cent,

while money market credit lines rose from zero in December of the previous year to 1.0 per cent at the

end of 2007.

The weight of (medium- and long-term) OT in the debt portfolio rose, albeit marginally, from 68.7 to

68.8 per cent, while other medium- and long-term instruments continued their downward trend

registered over the last few years, falling from 2.5 to 1.5 per cent. There was also a slight increase in the

percentage of debt represented by saving certificates, from 15.9 to 16.0 per cent.


93

DIRECT GOVERNMENT DEBT BY INSTRUMENT

31-Dec-06 31-Dec-07

The outstanding of saving certificates rose by EUR 800.5 million in 2007, in comparison to EUR 1,003.4

million in the previous year. This increase was a result of the rise in net subscriptions (the difference

between new subscriptions and redemptions, including accrued interest) of EUR 127.7 million and

interest capitalisation in an amount of EUR 672.9 million.

68.8% - OT

16.0% - CA

8.0% - BT

1.5% - Other medium-and long-term debt

5.6% - Other short-term debt

68.7% - OT

15.9% - CA

8.5% - BT

2.5% - Other medium-and long-term debt

4.4% - Other short-term debt

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

1,186.3

686.2

138.5

486.2

1,176.6

1,071.1

793.0

317.8

48.8

343.0

1,003.4

800.5

815.9

661.8

558.2

449.2

551.1

667.8

578.3

500.2

460.3

473.1

557.5

672.9

370.4

24.4

(419.6)

37.0

625.5

403.3

214.7

(182.4)

(411.5)

(130.1)

445.9

127.6

Stock change Accrued interestNet subscriptionsYear

STOCK OF SAVING CERTIFICATES(EUR million)



94

SAVING CERTIFICATES - B SERIES - HOLDING PERIOD

31-Dec-06 31-Dec-07

13.4% Up to 1 year 11% Up to 1 year

27.1% Between 1 and 5 years 27.9% Between 1 and 5 years

59.6% More than 5 years 61.1% More than 5 years

Current Debt Costs

In 2007, the current costs of the direct Government debt totalled EUR 4,727.8 million, EUR 4,703.8

million of which pertain to interest and EUR 24.0 million to other costs.

The average term of saving certificates outstanding at the end of 2007 continued to rise as in the last

years. The number of saving certificates subscribed over five years ago, as a percentage of total, rose

from the 59.6 to 61.1 per cent while the weight of certificates subscribed between 1 and 5 years rose

from 27.1 to 27.9 per cent. The weight of saving certificates subscribed less than a year ago, on the other

hand, dropped from 13.4 to 11.0 per cent.

Considering the present value, including accrued interest, of certificates outstanding at year-end, and

assuming that this stock is being built up since the initial subscription date, the relative weight of

certificates subscribed over five years ago increased from 72.3 to 73.5 per cent.



95

%

Interest / Average stock (with SC) Interest / GDP

CHANGES IN DIRECT GOVERNMENT DEBT INTEREST PAID

The implicit interest rate of the direct Government debt, calculated as the ratio between the year's

interest (on a national account basis) and the average debt stock, saw a 0.1 percentage point increase in

2007, from 4.2 to 4.3 per cent when compared to 2006.

The interest of saving certificates increased by EUR 147.3 million year-on-year, in line with the trend

observed in the previous year. This increase reflects not only an increase in the average stock but also the

rise in the short-term interest rates. The implicit interest rate of saving certificates rose from 4.2 per cent

in 2006 to 4.8 per cent.

* Other costs include costs associated to the placement of debt in the market (issuance, distribution, redemption and custody of securities), as

well as IGCP's management fee and other expenses related to the rating of the Republic's credit risk.

** Unlike public accounts, in which flows are recorded on a cash basis, in national accounts flows are registered on an accrual basis.

0

2

4

6

8

10

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007



CURRENT COST OF THE DIRECT GOVERNMENT DEBT(EUR million)

Interest

Other costs *

Total costs

Note

Interest on a National

Accounts basis **

2001

3,746.3

17.6

3,763.9

3,768.3

2002

3,804.3

22.8

3,827.2

3,893.7

2003

4,006.9

21.3

4,028.3

3,831.1

2004

3,721.6

18.5

3,740.0

3,837.7

2005

3,936.9

30.3

3,967.2

4,068.3

2006

4,365.6

31.0

4,396.6

4,393.8

2007

4,703.8

24.0

4,727.8

4,728.9

96

The interest of total debt excluding saving certificates rose by EUR 187.9 million in 2007, while the

average stock increased by EUR 4,621.1 million. The rise in interest resulted exclusively from the stock

increase. The implicit interest rate remained unchanged at 4.2 per cent in 2007.

2000

2001

2002

2003

2004

2005

2006

2007

13,084.1

14,207.9

15,140.0

15,695.4

15,878.7

16,074.6

16,747.8

17,649.7

708.9

803.4

705.8

596.5

566.7

582.6

705.2

852.5

5.4%

5.7%

4.7%

3.8%

3.6%

3.6%

4.2%

4.8%

94.5

(97.6)

(109.3)

(29.8)

15.9

122.6

147.3

60.9

52.7

25.9

7.0

7.0

24.4

38.0

31.0

(141.1)

(130.4)

(36.4)

8.8

94.3

103.7

2.7

(9.3)

(4.8)

(0.4)

0.1

3.9

5.6

Contributions to interest changes

Year (1)

Averagedebt

stock (2) Interest (3)

Implicitinterestrate (4)

Interestchange (5)

Stockeffect (6)

Priceeffect (7)

Crosseffect (8)

CHANGES IN THE INTEREST OF SAVING CERTIFICATES(EUR million)

2000

2001

2002

2003

2004

2005

2006

2007

51,481.7

55,104.9

60,822.4

65,730.5

71,179.4

80,174.0

88,409.8

93,030.9

2,926.1

2,964.9

3,187.9

3,234.6

3,271.9

3,485.8

3,688.6

3,876.4

5.7%

5.4%

5.2%

4.9%

4.6%

4.3%

4.2%

4.2%

38.8

223.1

46.6

37.3

213.9

202.8

187.9

205.9

307.6

257.2

268.1

413.4

358.1

192.8

(156.1)

(76.6)

(194.9)

(213.2)

(177.2)

(140.8)

(4.7)

(11.0)

(7.9)

(15.7)

(17.7)

(22.4)

(14.5)

(0.2)

Contributions to interest changes

Year (1)

Averagedebt

stock (2) Interest (3)

Implicitinterestrate (4)

Interestchange (5)

Stockeffect (6)

Priceeffect (7)

Crosseffect (8)

CHANGES IN THE INTERESTS OF DIRECT GOVERNMENT DEBTexcluding Saving Certificates (EUR million)

Note: see previous table



97



4647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873837664339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339846479896543398729687693673894878108876382982537208265765866432039802764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611229876550873764386529106438761122987655087383766479896543398729687693673894878108876382982537208258664320398027643865291064387617383766479896543398729687693673894878108876379896543398729687693673894878108876382982537208265765866432033980276438652910643876112298765508738376643398729687693673894878108876382982537208258664320398027646876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298286643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433984647989654339872968769367389487810887638298253720826576586643203980276438652910643876112298765508738376647989654339872968769367389487810887638298253720825866432039802764386529106438761738376647989654339872968769367389487810887637989654339872968769367389487810887638298253720826576586643203398027643865291064387611

Ria Formosa Natural Park

Risk Management

99Characterisation of the Debt Portfolio and Cost Indicators

Risk Indicators

Marked-to-market cost

CaR – Cost at Risk

Refinancing risk

Interest rate risk

Exchange rate risk

Credit risk

100

101

101

102

104

105

106

107

Box - Model for Generating Interest Rate Scenarios 108

464798965433987296876936738948781088763829825372082657658664320398027643865291064387611229876550873837664798965433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738948781088763798965433987296876936738948781088763829825372082657658664320339802764386529106438761122987655087383766433987296876936738948781088763829825372082586643203980276438652910643876173837664798965433987296876936738

100

Characterisation of the Debt Portfolio and Cost Indicators

Risk Management

O 1n 31 December 2007, the market value of the total debt portfolio was EUR 116 billion, reflecting a 2.9

per cent premium in relation to its nominal value. The portfolio's average coupon rose slightly in 2007 to

4.35%. The average debt redemption term also increased slightly to around 6 years.

1 As from 2003, the market value of the OT portfolio has been based on secondary market prices. This methodology was subsequently

extended to the BT portfolio. Prior to this, the market value of debt instruments was obtained by discounting cash-flows with benchmark

market rates so that credit spreads versus these rates had to be estimated. Currently, all instruments with a liquid secondary market (OT and

BT quoted on MEDIP) are evaluated according to prices quoted in this market. For non-liquid instruments, price estimates are calculated by

interpolating the yields of liquid instruments.


Outstanding (EUR million)

Average coupon

Average yield

Average redemption term (years)

Modified duration

Market value (EUR million)

Premium (incl. accrued interest)

62,584

5.55%

4.54%

4.17

2.87

64,774

3.5%

65,823

5.82%

4.96%

4.61

2.96

69,592

5.7%

72,023

5.31%

4.69%

4.57

2.98

76,444

6.1%

79,554

5.14%

3.68%

4.55

3.19

86,159

8.3%

83,611

4.50%

3.18%

4.31

2.92

89,638

7.2%

90,821

4.43%

2.73%

3.66

2.98

97,901

7.8%

101,810

4.09%

2.96%

4.89

3.41

108,997

7.1%

108,609

4.28%

3.93%

5.84

2.91

112,585

3.6%

DEBT PORTFOLIO AT YEAR-END(after swaps)

1999 2000 2001 2002 2003 2004 2005 2006

112,852

4.35%

4.16%

6.03

2.71

116,071

2.9%

2007

101

Risk Management

Risk Indicators

The Guidelines for the Management of Government Debt (Guidelines) identify the risk indicators

considered most relevant for the debt portfolio and set limits to its exposure in relative (i.e. deviations

vis-à-vis similar figures of the benchmark portfolio) and absolute terms. The Guidelines set absolute

maximum limits to the refinancing profile, exchange rate risk and credit risk and relative limits to the

interest rate risk (refixing profile and modified duration) of the adjusted portfolio.

In addition to the restrictions to be observed in the debt management, the guidelines establish the

benchmark as a long term reference for the management.

The model to define a benchmark portfolio for the management of the Portuguese government debt 4was developed by IGCP in 1998. After using it during a trial period (1999) , this model and the Guidelines

have been reviewed approximately every 3 years, with the first revision having been adopted in the

2000-03 period and the second in the 2004-06 period. A third revision was made in 2006, which should

remain effective during the 2007-09 period.

2The marked-to-market cost of the Adjusted Debt Portfolio was 3.026 per cent in 2007. A cost of 3.035

per cent was calculated for the benchmark portfolio in the same period, resulting in a favourable cost

differential of 0.8 basis points.

In cumulative terms, since 1999 the total annual cost of the real portfolio was 4.06 per cent, 2 basis 3points lower than that of the benchmark. On a Public Account basis (POCP) , the cost of the debt

portfolio was EUR 224 million lower that the benchmark in the last 7 years.

Marked-to-market cost

2 The Adjusted Debt Portfolio refers to all the instruments that make up the direct Government debt portfolio, including financial derivatives,

with the exception of promissory notes, retail debt and CEDIC.3

Calculated since 2001.4 See Government Debt Management - Annual Report 1999.


ANNUAL COST OF THE DEBT PORTFOLIO AND OF THE BENCHMARK

20001999 2001 2002 2003 2004 2005 20061999/2007

Portfolio

Benchmark

Difference (em b.p.)

-1.38%

-0.97%

-41.0

6.30%

6.14%

16.0

6.19%

6.23%

-3.6

8.41%

8.44%

-3.5

3.81%

3.79%

2.4

5.93%

5.95%

-2.0

3.76%

3.59%

16.9

0.64%

0.64%

0.0

4.04%

4.06%

-2.0

Internal Rate of Return (annualised)

2007

3.026%

3.035%

-0.8

102

Risk Management

5CaR - Cost at Risk

In the portfolio CaR estimate, the portfolio position at the beginning of the year was used as a starting

point.

In 2007, IGCP adopted a multifactor model to calculate the CaR – the choice was the Nelson and Siegel 6(1987) model. To create a dynamic model, a VAR(1) process proposed by Diebold and Li (2006) was

incorporated. Besides being a very popular model in the literature and financial markets, a study carried

out by IGCP with a sample of data between 1999 and 2007 concluded that this model's simulations

appropriately describe the distribution of rates, spreads and curvatures of the term structure of interest

rates over time. The methodology followed in the implementation of the model is described in more

detail in the Box - Model for Generating Interest Rate Scenarios.

7Using the Stability and Growth Programme scenario for 2007-2011 for projecting annual borrowing

needs; the benchmark financing strategy approved by the Minister of Finance, and used in both 8portfolios ; as well as different scenarios for the yield curve dynamics simulated with a CIR model, the

9estimated CaR resulting from simulating the portfolio and yield dynamics over time is as follows:

In January 2007, the new Guidelines became effective, the grounds and main results of which are given

in the Box – Risk Management Model, in the 2006 annual report.

5 The CaR (Cost at Risk) is a budgetary risk measure whose follow-up is foreseen in the Guidelines. In 2002, IGCP developed a model to estimate

this indicator whose theoretical framework and characteristics were presented in the 2002 Government Debt Management Report. CaR is a

statistical estimator of the cash-flow cost of debt aimed at measuring the maximum variation of this cost in a given time frame. This

indicator may be presented in two forms: the absolute CaR represents the maximum value of the cash-flow cost for a given probability; the

relative CaR reflects the maximum deviation of that cost in relation to its expected value.6

First-order vector auto-regression.7

December 2007 update.8

This decision stems from the fact that in addition to the financing operations, the debt portfolio also includes derivatives in order to adjust

its risk profile to that of the benchmark, so that ultimately its cost depends to a large extent on the financing strategy of the benchmark. 9

Calculated on a National Accounts basis.


103

In accordance with the estimated absolute CaR, the expected value of the portfolio costs for 2008 is

EUR 5,037 million, with a mere 5 per cent probability of this figure exceeding EUR 5,166 million. The

relative CaR for the same significance level is EUR 129 million.

In relative terms and in comparison to GDP, the probability of the deficit-to-GDP ratio increasing by

more than 0.08 percentage points in 2008 as a result of changes in interest rates is lower than 5 per cent.

To assess the degree of dispersion of the cost distribution and to gain sensitivity to the impact of extreme

cases, the potential costs for different confidence intervals were also calculated.

National Accounts

Expected cost

Absolute CaR (I.C. 95%)

Relative CaR (I.C. 95%)

Relative CaR / Expected cost

Relative CaR / GDP

2008

5,037

5,166

129

2.6%

0.08%

2008

5,034

5,166

132

2.6%

0.08%

EUR million Portfolio / Benchmark

DEBT PORTFOLIO AND BENCHMARK CaR FOR 2008 AND 2009(for a confidence interval of 95%)

2009

5,145

5,626

481

9.3%

0.27%

2009

5,111

5,611

500

9.8%

0.28%

EUR million

SENSITIVITY ANALYSIS OF THE PORTFOLIO'S CaR FOR 2008

Expected cost

Absolute CaR (I.C. 95%)

Relative CaR (I.C. 95%)

Relative CaR / Expected cost

Relative CaR / GDP

5,037

5,217

179

3.6%

0.11%

5,037

5,130

92

1.8%

0.05%

5,037

5,106

68

1.4%

0.04%

Confidence interval

National Accounts 99% 90% 80%

Risk Management


104

The following graph shows the relative CaR-to-expected cost ratio until 2012.

RELATIVE CaR / EXPECTED COST(for a confidence interval of 95%)

% National Accounts

Portfolio Benchmark

0

2

4

6

8

10

12

14

16

18

2008 2009 2010 2011 2012

Refinancing risk

In addition to market variables (tradability, liquidity, maintaining a benchmark yield curve, among

others), the management of the debt portfolio takes into account the refinancing profile of the debt, so

as to avoid an excessive concentration of redemptions that may lead to higher financing costs in the

future.

The absolute limits set on the percentage of the portfolio maturing in a 12-month, 24-month and 36-

month period are 25 per cent, 40 per cent and 50 per cent, respectively.

Risk Management


105

Interest rate risk

Refinancing profileRefinancing profile at the end of 2007

REFINANCING PROFILE OF THE DEBT PORTFOLIO AND OF THE BENCHMARK

% of the portfolio to mature % of the portfolio to mature

0-1

Y

1-2

Y

2-3

Y

3-4

Y

4-5

Y

5-6

Y

6-7

Y

7-8

Y

8-9

Y

9-1

0Y

+10Y

Portfolio Benchmark 1Y 2Y 3Y

1999

Port

f.B

ench

.Port

f.

Ben

ch.

Port

f.B

ench

.Port

f.

Ben

ch.

Port

f.B

ench

.Port

f.

Ben

ch.

Port

f.B

ench

.

Port

f.

Ben

ch.

Port

f.B

ench

.

2000 2001 2002 2003 2004 2005 2006 2007

A 10t the end of 2007, the modified duration of the debt portfolio was around 2.71, which represents a

sharp decrease in relation to the 3.41 recorded at the end of 2006. Throughout the year, the modified

duration of the portfolio varied between -0.05 and +0.08 in relation to the benchmark, remaining well

within the limits defined by the Guidelines: [-0.5;+ 0.75].

10 The modified duration measures the elasticity of the portfolio's market value to changes in market yields.

0

5

10

15

20

25

0

5

10

15

20

25

30

Limits according to the Guidelines

Dec

97

MODIFIED DURATION OF THE DEBT PORTFOLIO

Modified duration of the portfolio

Jun 9

9

Jun 0

0

Jun 0

1

Jun 0

2

Jun 0

3

Jun 0

4

Jun 0

5

Jun 0

6

Jun 0

7

Dec

98

Dec

99

Dec

00

Dec

01

Dec

02

Dec

03

Dec

04

Dec

05

Dec

06

Dec

07

Jun 9

8

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Risk Management


106

Considering that the relevant risk is the cash-flow risk, i.e. the degree of sensitivity of the debt cost

payments (and not of the portfolio's market value) to the volatility of interest rates, the Guidelines also 11set limits to the deviations of the portfolio's refixing profile vis-à-vis the benchmark .

The percentage of the nominal value of the portfolio to be refixed or maturing in a 12-month, 24-month

and 36-month period cannot stray more than 10 per cent, 15 per cent and 20 per cent, respectively, from

the corresponding values of the benchmark. These limits were observed throughout the year. At the end

of 2007, the debt portfolio and the benchmark had the following refixing profile:

Refixing profile at year-endRefixing profile at end-2007

% of the portfolio to refix % of the portfolio to refix

1Y 2-3Y 3-5Y 5-7Y 7-10Y +10Y

1Y

2Y

3Y

4Y

5Y

6Y

7Y

8Y

9Y

10Y

+10Y

Portfolio Benchmark

REFIXING PROFILE OF THE DEBT PORTFOLIO AND OF THE BENCHMARK

Exchange rate risk

At the end of 2007, the net exchange rate exposure of the debt portfolio after swaps was zero, in line

with previous years.

The primary exchange rate exposure (not including hedging operations) at year-end was 0.3 per cent of

the total portfolio, far lower than the 20 per cent limit set by the Guidelines.

0

5

10

15

20

0

20

40

60

80

100

1999

Port

f.B

ench

.Port

f.B

ench

.Port

f.B

ench

.Port

f.B

ench

.Port

f.B

ench

.Port

f.B

ench

.Port

f.B

ench

.Port

f.B

ench

.Port

f.B

ench

.

2000 2001 2002 2003 2004 2005 2006 2007

Risk Management


10 The refixing profile reflects the distribution over time, in nominal terms, of the debt cost (re)fixing periods.

EUR

USD

JPY

Others

NET EXCHANGE RATE EXPOSURE

97.2%

1.6%

0.4%

0.7%

97.3%

1.7%

0.4%

0.6%

97.2%

1.6%

0.5%

0.7%

99.3%

0.4%

0.0%

0.3%

99.9%

0.1%

0.0%

0.0%

100%

0.0%

0.0%

0.0%

100%

0.0%

0.0%

0.0%

100%

0.0%

0.0%

0.0%

100%

0.0%

0.0%

0.0%

100%

0.0%

0.0%

0.0%

19991998 2000 2001 2002 2003 2004 2005 2006 2007

107

EUR million %

CREDIT RISK – COMPONENTS

Market value Add-on Market value of collateral % of total limit

Jan 0

7

Feb 0

7

Mar

07

Apr

07

May

07

Jun 0

7

Jul 07

Aug 0

7

Sep 0

7

Oct

07

Nov

07

Dec

07

Credit risk

T 12he assumption of credit risk by the Republic results from operations involving derivatives, repos and

money market applications.

The Guidelines foresee an overall limit for the total credit risk exposure resulting from operations with

derivative instruments of 3 per cent of the outstanding of total debt and also define the criteria to be

followed in the selection and rating of counterparties, the limits assigned to each counterparty

(depending on the type of operation involved) and the exposure assessment methods.

The list of counterparties for operations involving credit risk currently includes 24 financial institutions

with signed ISDA contracts, 11 of which have already signed the CSA for the collateralisation of

derivative operations.

As shown in the graph below, the portfolio's exposure remained below the overall limit throughout

2007.

-100

0

100

200

300

400

500

600

700

800

900

1,000

10

15

20

25

12 The credit risk associated to each contract is evaluated using a methodology that takes into account two components: its current market

value, which represents the substitution value of the operation, and an Add-on, which is aimed at estimating the potential variation of that

value in the future.

Risk Management


108

Model for Generating Interest Rate Scenarios

The calculation of the CaR (Cost-at-Risk) of the Portuguese debt portfolio requires the generation of a

significant set of interest rate scenarios for a time horizon of 5 years. In the analyses of previous years,

the scenarios were generated using a 1-factor CIR model, which nevertheless revealed serious

limitations as to the type and variety of curves generated. In order to simulate interest rate paths

consistent with their historical characteristics, a multifactor model was necessary.

By applying the principal components analysis to the term structure of interest rates (TSIR), three factors

are almost always sufficient to explain between 95% and 99% of its change over time. For this reason,

the TSIR models very often use structures relating interest rates of different maturities to a small number

of factors and associated weights.

We decided to use a rather popular model among market participants and central banks, which is based

on fitting the Nelson and Siegel (1987) curve and the dynamic modelling of the time series of the

corresponding estimated coefficients, according to the Diebold and Li (2005) method. It is possible to

demonstrate that this representation is actually a dynamic model with three factors related to the level,

slope and curvature of the TSIR.

The Nelson and Siegel methodology

Diebold and Li's dynamic model

Introduction

Given that the parameters of the model may vary over time, reflecting changes in the shape of the TSIR, 13Diebold and Li (2005) interpreted Nelson and Siegel by using a dynamic three-factor model and

suggesting the use of time series estimation methods to model and forecast changes in the model's

parameters. Assuming a VAR(1) model, we estimate the following system:

13 In the original Nelson and Siegel model, changes over time. However, according to Diebold and Li (2005), in most cases it is possible to

assume a constant , equal to the average of the values estimated for the whole sample.tλ

λ

In their original model, Nelson and Siegel (1987) proposed to fit the TSIR with a smooth and flexible

parametric function capable of representing, with a reduced number of parameters, a wide range of

shapes assumed by the yield curve over time. The relationship between the interest rate and the

maturity , is given by:

where , , and are the parameters to be estimated with the interest rate cross-section sample

in time .

()

−−+

−+= −−−

t

tt

eee

y

y

t

t

t

t

ttt

t

λτλτλτ

λτβ

λ

tλ

τββτ

τ

11,3

tβ,3

,2

tβ,2

,1

tβ,1


109

Implementation in IGCP

For the more recent CaR calculation, market rates for maturities between 1 month and 30 years for the

period between 1999 and 2007 were used.

In a first stage, the Nelson and Siegel curve was fitted to the daily market data, estimating the

3 factors by ordinary least squares. In a second stage, a dynamic formulation was assumed for the

factors, estimating a VAR(1) model with the time series of the factors obtained in the first stage.

With the parameters estimated by the VAR(1) model, 250 random paths were simulated for the factors

with a time horizon of 5 years. By replacing the factors simulated in the Nelson and Siegel equation, the

corresponding interest rate paths for all maturities were obtained.

Finally, with this large number of interest rate scenarios, it was possible to analyse the statistical

distribution of the cash-flow cost of debt and to calculate the CaR, with different probability levels, i.e.

the maximum change of this cost in a given period.

Using the estimated and , parameters, we can generate paths for the factors and corresponding 14interest rates via a Monte Carlo simulation for the error terms, .

With a very simple and intuitive structure, this model provides a better representation of the empirical

properties of the TSIR observed over time.

14 The Monte Carlo method is a computer algorithm based on the repeated generation of random numbers according to a probability

distribution, which is particularly appropriate when it is not possible to obtain a solution in the form of an analytical expression.

υ

β

+

+

=

−

−

−

t

t

t

t

t

t

t

t

t

,3

,2

,1

1,3

1,2

1,1

333231

232221

131211

3

2

1

,3

,2

,1

υυυ

βββ

φφφφφφφφφ

µµµ

βββ

µ̂ φ̂

Risk Management


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Documents

Annual Report 2007 - IGCP€¦ · Ensure stable Government financing and efficient management of the debt portfolio; Minimize the cost of the government debt in a long-term perspective,