Moody’s Investors Service has today downgraded Greece’s government bond rating to Caa2 from Caa1. The short-term rating is unaffected by this rating action and remains at Not Prime(NP). The outlook on the rating is negative. Moody’s government bond rating applies to debt issued on private sector terms only.
This rating action concludes the review for downgrade that commenced on 6 February 2015.
The key drivers behind the downgrade are:
1) The high uncertainty over whether Greece’s government will reach an agreement with official creditors in time to meet upcoming repayments on marketable debt.
2) The significant implementation risks of a follow-up, medium-term financing programme even if an agreement is reached, given the weakened economy and a fragile domestic political environment.
The negative rating outlook reflects Moody’s view that the balance of economic, financial and political risks in Greece is slanted to the downside.
Concurrently, Moody’s has lowered the country’s local- and foreign-currency bond ceilings to B3 from Ba3, which reflects the increased probability that Greece may exit the euro area in the event of a sovereign default.
In addition, Moody’s has also lowered the local- and foreign-currency bank deposit ceilings to Caa3 from Caa1 to capture the heightened risk of a deposit freeze, if depositor confidence weakens further. The short-term local- and foreign-currency bond and deposit ceilings remain Not Prime (NP).
RATINGS RATIONALE
FIRST DRIVER — CONTINUED UNCERTAINTY ON FUTURE OFFICIAL SECTOR SUPPORT PROGRAMME
Negotiations between official creditors (European Financial Stability Facility (EFSF, (P)Aa1 stable), International Monetary Fund (IMF), European Central Bank (ECB) and European Commission) and the Greek government appear to have achieved little over the past two months. The Greek government and its official creditors remain far apart on key objectives, with no immediate prospect of agreement being reached on a new financing package. Both sides have reiterated their desire to reach an agreement that would avert a Greek default, and there are indications that the process has taken a new sense of urgency, with a change of negotiators on the Greek government side. However, Moody’s believes that the final outcome will be driven primarily by political decisions both at the European level and in Greece. As such, the outcome of these decisions is highly uncertain and the potential for a policy accident resulting in Greece defaulting on its marketable (or commercially traded) debt, including that held by the ECB, has risen. In Moody’s view, the risks to bondholders are appropriately reflected by a Caa2 government bond rating, which is historically associated with a roughly one in four probability of default over a two-year horizon.
Amid these faltering negotiations, the economy continues to face severe liquidity constraints. Greece’s ability to finance its budgetary expenditures and debt repayments has been under pressure since the official sector programme went off track last year. Ordinary net revenues, which include tax revenues, were around 5% below target between January and March. The government has lost market access, facing challenges in rolling over maturing T-bills: foreign investors have largely withdrawn from the Greek T-bill market, and Moody’s understands that Greek banks are restricted by the ECB from increasing their own holdings of T-bills. Low investor confidence has adversely affected banking sector deposits: Moody’s estimates that private sector deposits have fallen by around EUR32 billion (18% of GDP) since early December 2014 to an estimated EUR132 billion (74% of GDP) at the end of April.
As a result, the government has been drawing on internal reserves, including tapping deposits of the social security funds, state-owned enterprises and more recently local governments. The government has also been forced to curb expenditures and run arrears to suppliers (expenditures have been around 11% below budgetary targets for the first three months of the year). Rising liquidity constraints and the absence of any material progress on negotiations imply a high level of uncertainty over the Greek government’s ability to meet upcoming repayments on both official and marketable debt. Amortisation and interest payments are estimated at EUR3.6 billion from May 1 to June 30, of which around EUR2.4 billion is due to the IMF. Moody’s does not rate official sector debt, including obligations to the IMF, and a delayed or missed payment on IMF obligations need not necessarily trigger a debt acceleration that would lead to a default on the marketable debt instruments. However, non-payment or unilateral restructuring of official sector debt would be a strong sign of lack of progress in negotiations. It would suggest a high probability of Greece being unable to obtain the funds it needs to service marketable debt, including the EUR3.5 billion and EUR3.2 billion payments due on bonds held by the ECB on 20 July and on 20 August respectively.
SECOND DRIVER— ELEVATED IMPLEMENTATION RISKS AGAINST THE BACKDROP OF A WEAKENED ECONOMY AND CONTINUING POLITICAL UNCERTAINTY
Moody’s believes that there are significant implementation risks associated with a follow-up, medium-term financing programme even if an agreement is reached, given the backdrop of a weakened economy and a fragile domestic political environment.
Locked out of the capital markets, Greece is highly likely to need to agree and implement a new programme as a condition of receiving additional financing from its official creditors. Greece would also need to achieve and sustain primary surpluses over many years in order to make slow inroads into its extremely high debt burden. To overcome those challenges, Greece will need higher medium-term growth and political resolve. Recent events make both doubtful, raising further concerns over Greece’s ability to sustain financial support from official creditors over the coming years.
Moody’s also notes that the economy’s fragile recovery and the government’s fiscal consolidation efforts have been derailed. The rating agency’s current forecast of 0.5% growth this year is markedly different from the structural adjustment programme target of 2.9% and Moody’s previous forecast of 1.2%. Moreover, risks to the growth outlook are firmly towards the downside as lingering uncertainty is likely to have a negative impact on investment and the nascent recovery in consumption.
The primary balance will also likely be close to, or in deficit this year (after registering a surplus of 0.4% of GDP last year), complicating the government’s management of its fiscal and debt position further. Looking ahead, lingering uncertainty regarding the economy’s medium-term growth path and the government’s willingness and ability to record primary surpluses over a number of years complicates the task of bringing the headline debt ratio down.
In addition to the challenges posed by lower growth, the political and social environment will likely continue to affect the implementation of further fiscal consolidation and structural reform agenda, which Moody’s expects would form a condition for future financial support. In the near term, a critical challenge for the government will be its management of the disparate views of the groups that form Syriza, in particular the far left wing of the party. The passage of any follow-up agreement with official creditors and successive reform bills in the Greek parliament will test the strength of the governing coalition. Already, it appears that a range of options including a possible referendum on any new financing agreement have been discussed, all of which results in an elevated level of political uncertainty, which increases the implementation risks to any follow-up programme.
RATIONALE FOR THE NEGATIVE OUTLOOK
The negative outlook on the Caa2 rating reflects Moody’s view that the balance of economic, financial and political risks in Greece remains slanted to the downside. The probability of a default on official sector, and hence the increasing risk of default on private sector debt, continues to rise with every week that passes without some form of resolution. Compared with Moody’s base case, scenarios incorporating either a longer stand-off with official creditors and/or greater negative impact to the economy from prolonged uncertainty have a higher probability than more positive outcomes.
LOCAL AND FOREIGN-CURRENCY BOND AND DEPOSIT CEILINGS
Moody’s has also today lowered Greece’s local and foreign currency bond ceilings to B3 from Ba3. The short-term bond ceiling remains Not Prime (NP). The bond ceilings essentially reflect the risk of Greece leaving the euro area and the impact of the resulting currency redenomination on holders of Greek debt. Moody’s acknowledges that default need not entail exit, which would ultimately reflect a political decision. However, the lower ceiling reflects Moody’s view that the probability of the one leading to the other has risen.
Concurrently, Moody’s has lowered the local- and foreign-currency bank deposit ceilings to Caa3 from Caa1 reflecting the increase in the risk of the government placing restrictions on accessing foreign- and local-currency deposits. The short-term bank deposit ceiling remains Not Prime (NP). Moody’s decision to lower the deposit ceilings to one notch below the level of the government bond rating reflects the rating agency’s view that the risk of the government imposing deposit freezes or similar capital restrictions in order to contain deposit outflows and preserve financial stability is now slightly higher than the risk of the government defaulting on its own debt.
WHAT COULD MOVE THE RATING UP/DOWN
Moody’s would consider downgrading Greece’s government bond rating if the probability of a default and/or severity of loss to investors in the event of default were to rise and no longer commensurate with a Caa2 rating. That would most likely occur in the context of a further deterioration in the relations between the Greek government and its creditors, or evidence that the Greek electorate is supportive of a more confrontational stance, potentially including exit from the euro area.
Although not likely in the near term given the prevailing downside risks, Moody’s could consider upgrading Greece’s government bond rating in the event of (1) an increase in the pace of fiscal consolidation and structural reforms; (2) sustained economic growth and primary surpluses, both would support a continued decline in debt levels; and (3) more certainty and visibility on future external financial support and the political environment.
In Moody’s assessment, the conclusion of the review, which began in February 2015, necessitates this rating action being released on a date not listed for this entity on Moody’s 2015 sovereign release calendar published on www.moodys.com.
GDP per capita (PPP basis, US$): 25,859 (2014 actual) (also known as Per Capita Income)
Real GDP growth (% change): 0.8% (2014 actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): -2.6% (2014 actual)
Gen. Gov. Financial Balance/GDP: -3.5% (2014 actual) (also known as Fiscal Balance)
Current Account Balance/GDP: 0.9% (2014 actual) (also known as External Balance)
External debt/GDP: [not available]
Level of economic development: Low level of economic resilience
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 27 April 2015, a rating committee was called to discuss the rating of Greece, Government of. The main points raised during the discussion were: The issuer’s economic fundamentals, including its economic strength, have materially decreased. The issuer has become increasingly susceptible to event risks as there is increased uncertainty over whether Greece’s new government will come to an agreement with official creditors in time to meet its near-term funding and liquidity needs.
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