S&P Upgrades Greece from 'B-' to 'B'; Risks to Fiscal Consolidation Have Faded
On Sept. 12, 2014, Standard & Poor's Ratings Services raised its long-term foreign and local currency sovereign credit ratings on the Hellenic Republic (Greece) to 'B' from 'B-'. At the same time, we affirmed the short-term sovereign credit ratings at 'B'. The outlook is stable.
RATIONALE
The upgrade reflects our view that risks to fiscal consolidation in Greece have abated. We forecast that, from next year, the Greek economy will emerge from seven consecutive years of negative growth. We expect recovering real and nominal GDP will enable Greece to operate average primary surpluses of 2% of GDP during 2014-2017. This is less than the 4.5% of GDP target the government envisioned in its program with the European Union (EU), the European Central Bank (ECB), and the IMF (together, the "Troika"), but we believe the lower estimate is politically more feasible than the government's target and consistent with a modest decline in government debt as a share of GDP.
We expect the government to absorb an increased share of EU funds, further widen its tax base, and improve tax collection. On the other hand, we believe the government has little room for further maneuver on the expenditure side. We believe it will carry out modest tax cuts, and we acknowledge downside risks to our forecast should deflationary pressure in the economy become entrenched.
We also view as low the likelihood of additional step-rises in government debt due to bank recapitalizations: the four largest domestic banks have raised €8.4 billion of capital directly from the markets and the Hellenic Financial Stability Fund has a balance of €11 billion for any capital calls from the public sector. Although the government may receive additional debt relief from official creditors, we do not anticipate it will approach private sector creditors for a third rescheduling. We also assume the government will continue to service the approximately €3 billion of debt held by creditors who did not participate in the two debt exchanges of 2012.
In our view, the Greek government's gross borrowing requirements of about €43 billion (19% of GDP) over the next 15 months will be partly met by Greek banks repaying "pillar-one" bonds back to the government, as well as intergovernment lending within the broader public sector and, more marginally, through privatization. We also expect about €20 billion to be raised in domestic local-law markets, about €12 billion from official lenders, and up to €5 billion from additional foreign bond placements.
As a result, we expect the gross government debt stock to broadly stabilize in nominal terms, declining slightly to 164% of GDP in 2017 from a peak of 177% in 2014. We note, however, that even at this somewhat lower level, Greece's general government debt stock will remain among the highest of all the sovereigns we rate.
That said, since the April and May 2012 public debt restructurings, other aspects of Greece's debt profile have improved. At 15.8 years currently, the average maturity of the Greek government's debt stock has more than doubled (it was 6.3 years in 2011). Of Greek central government debt, 72% is now noncommercial, with interest rates consistently below-market. Furthermore--and partly reflecting the European Financial Stability Facility allowing the Greek government to defer second-program interest payments for the first 10 years--the average interest rate paid on the noncommercial stock of debt is less than 2.0%, compared to our average nominal GDP projection of 2.8% for 2015-2017. Moreover, about 40% of Greece's commercial debt is held by the ECB and the central banks of the Eurosystem. (We classify bonds held by the Eurosystem as commercial debt since we view these holdings as monetary and not fiscal operations.)
We view Greece's economic recovery as gradual but weak, with 2017 real GDP still 20% lower than in 2007. A 16% decrease in unit labor costs between 2008 and 2013 has helped Greece's tourism sector. Its small manufacturing sector, however, has not benefited to the same extent (unlike in Spain, Portugal, or Ireland). Investment, still 40% below the 2007 rate, should pick up but only slowly. We believe investment levels will be constrained by a lack of confidence, an ineffective monetary transmission mechanism, and limited foreign direct investment. Household consumption will only gradually benefit from eventual job market stabilization.
We expect the current account to remain broadly balanced in 2014-2017 against a deficit of 11% of GDP in 2009. Although the services sector has been buoyant, most of the adjustment has taken place through a decrease in imports. Greece's capital and financial accounts have adjusted through strong EU fund inflows, debt forgiveness, and fresh market funding.
Despite this positive shift in external flow dynamics, Greece's external vulnerabilities persist: it has high external debt and limited monetary flexibility. We estimate external debt at about 450% of current account receipts in 2014 (net of public and financial sector external assets). In particular, about half of Greece's gross external debt stock is short term, mostly contracted by Greek banks, and therefore has to be rolled over. We anticipate that cross-border interbank deposits will stabilize, while ECB funding--about 20% of total banking system liabilities--will remain in place.
While we expect the Greek government will broadly adhere to the current policy framework, we view Greece's complicated political and policy environment as a ratings weakness. Even though reforms have so far supported fiscal performance and progress in restructuring of the economy, social tensions and a weak institutional framework remain.
OUTLOOK
The outlook is stable, balancing our view of Greece's progress in fiscal consolidation against the still-weak economic recovery and political resolve to continue with structural and institutional reforms. The outlook also assumes no further distressed exchanges on Greece's remaining stock of commercial debt.
We could raise our long-term ratings on Greece if GDP growth were to increase more than we currently expect, or if the institutional framework were to strengthen significantly. This could result in structural reforms to the labor and product markets bearing fruit more rapidly than we foresee, or the banking system rehabilitating to the extent that it can provide more dynamic credit growth.
We could lower the ratings if the government does not succeed in stabilizing its debt as a share of GDP, due, for example, to greater deflationary pressures than we currently expect. We could also lower the ratings if we believe private creditors will be asked to participate in a third rescheduling, either because of a change in government policy or because of comparability of treatment between official (bilateral and multilateral) and private lenders.
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