Key Drivers of the Greece Downgrade
London, 07 March 2011 -- Moody's Investors Service has today downgraded Greece's government bond ratings to B1 from Ba1, and assigned a negative outlook to the rating. The rating action completes a review that commenced on December 16, 2010. Moody's decision to downgrade Greece's rating is driven by three reasons:
1.) The fiscal consolidation measures and structural reforms that are needed to stabilise the country's debt metrics remain very ambitious and are subject to significant implementation risks, despite the progress that has been made to date.
2.) The country continues to face considerable difficulties with revenue collection.
3. ) There is a risk that conditions attached to continuing support from official sources after 2013
will reflect solvency criteria that the country may not satisfy, and result in a restructuring of existing debt. Moreover, the risk of a post-2013 restructuring might lead the Greek authorities and investors to participate in a voluntary distressed exchange before that time.
The negative outlook on the B1 rating reflects Moody's view that the country's very large debt burden and the significant implementation risks in its structural reform package both skew risks to the downside.
Greece's country ceilings for bonds and bank deposits are unaffected by today's rating action and remain at Aaa (in line with the Eurozone's rating). Greece's Non Prime (NP) short-term rating is also unaffected by this action.
RATINGS RATIONALE
Moody's recognises the very significant progress that Greece has made in implementing a large fiscal consolidation and introducing the legislation required to support a wide-ranging structural reform programme. However, Moody's believes that the Greek government still faces a very significant challenge in its continued execution of the measures required to both increase revenue and achieve efficiency savings as part of the austerity programme. Whether relating to improvements in the operating efficiency of state-operated enterprises, to the savings required in the health service or in military expenditure, or to the implementation of deregulation measures passed by parliament, the task facing officials and managers remains enormous. Moody's therefore continues to see large implementation risks to the government's reform plans and, while much of the enabling legislation has been passed, implementation progress has not been sufficiently rapid to mitigate the rating agency's concerns.
Secondly, government revenues have been slow to rebound, which is in part the result of a continued weakness in tax collection mechanisms that Moody's anticipates will improve only slowly. Moody's has long attached great importance to the implementation of measures to increase government revenues alongside the planned cost-cutting measures. As previously stated, the rating agency continues to place particular emphasis on measures to combat the endemic tax evasion that has contributed to the deterioration in Greece's creditworthiness. While the Greek government has made some progress with the collection of value-added taxes (VAT), Moody's notes that progress on income tax collection has been slower to improve -- indeed, revenue shortfalls recorded in 2010 contributed to the upward revision in the country's deficit projections for that year. Moreover, Moody's expects income tax collections to be adversely affected by significant administrative hurdles and by the inevitable resistance to tax compliance among parts of Greek society. Legislation to address these issues is currently before parliament, but will be challenging to implement, both because of human resource limitations (such as skills shortages) and because of vested interests that will be resistant to change.
The third driver of the rating action is the lack of certainty surrounding (i) the precise nature and conditions of support that will be available to Greece after 2013, and (ii) its implications for bondholders. Moody's acknowledges that
the IMF and European authorities have expressed very strong support for Greece provided that the country follows through with this economic programme.
The rating agency's baseline assumption is that this support will continue to be forthcoming and that the Greek authorities will continue to do their best to comply with the conditions contained in the Memorandum of Understanding. However, public statements by European officials have suggested that additional liquidity support after 2013 would be conditional on a solvency evaluation, the result of which is uncertain at this point in time. If Greece were viewed as insolvent at this time, there is some possibility that private creditors would be expected to bear some losses.
Moody's also notes that discussions are reportedly underway among Eurozone policymakers on the design of a longer-term support mechanism, and those discussions may result in changes to the terms of credit provided to Greece by the Troika. Although such changes may reduce the pace and magnitude of the deterioration in Greece's debt affordability metrics, they are unlikely to have a very large impact on the overall debt burden, and would not therefore directly address the issues that are of greatest concern.
MOODY'S CENTRAL SCENARIO -- AND WHAT COULD UNDERMINE IT
Moody's central scenario remains that bondholders will not bear losses. However, the rating agency believes that the likelihood of a default or distressed exchange has risen since its last downgrade of the Greek government debt rating in June 2010.
Moody's does not believe that continued liquidity support by the Troika and an event of default (including, but not limited to, a distressed exchange via a debt buyback) are mutually exclusive. The precise nature and conditions of future external support for Greece-- and their implications for bondholders -- are unclear, and may remain so, even after the greater clarity on permanent crisis resolution mechanisms is achieved. Moody's believes that, over time, the risks surrounding the implementation of the economic programme may grow and a solution that requires private-sector creditors to bear losses may become more appealing. This view is reflected in the B1 rating announced today.
Over five-year investment horizons, around 80% of B1-rated sovereigns, non-financial corporates and financial institutions have consistently met their debt service requirements on a timely basis, while around 20% have defaulted.
WHAT COULD CHANGE THE RATING UP/DOWN
A further downgrade could follow if the Greek government's commitment to the austerity programme were to appear to weaken, or if the Troika's willingness to provide support were to start diminishing.
Conversely, an upgrade could follow if the probability of a default event were judged to be diminishing in likelihood and the pace of fiscal consolidation were to proceed more rapidly than Moody's currently expects -- for example, through the receipt of large amounts of privatisation revenues, or if positive surprises to tax receipts were to reveal strong progress in the government's fight against tax evasion. If the Troika were to extend long-term fiscal support to Greece, without imposing losses on bondholders, this could also lead to an upgrade.
PREVIOUS RATING ACTION AND METHODOLOGY
Moody's previous rating action on Greece was implemented on 16 December 2010, when the rating agency placed Greece's government bond ratings on review for possible downgrade. Prior to that, Moody's last rating action on Greece was taken on 14 June 2010, when the rating agency downgraded Greece's government bond ratings Ba1 from A3 and assigned a stable outlook.
The principal methodology used in this rating was Sovereign Bond Ratings published in September 2008.
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